opportunity? George Bromfield, Investment Director 16 November 2017 - PowerPoint PPT Presentation

Financial markets post Brexit and Trump – apocalypse or opportunity? George Bromfield, Investment Director 16 November 2017

Agenda An update • How have financial markets fared since Trump and Brexit? – How is the global economy performing? – The key risks • Politics – Inflation/Interest rates – – Stretched valuations Looking forward – what happens next? • 2

2017 - a good year for financial markets Bond Returns in LCL currency, Source: Thomson Reuters, October 2017 Equity Returns in Sterling 3

A perfect symphony of economic growth Nov-15 Mar-16 May-16 Aug-16 Nov-16 Mar-17 May-17 Aug-17 Dec-15 Feb-16 Apr-16 Sep-16 Dec-16 Feb-17 Apr-17 Sep-17 Oct-15 Jan-16 Jun-16 Oct-16 Jan-17 Jun-17 Jul-16 Jul-17 Eurozone 52.3 52.8 53.2 52.3 51.2 51.6 51.7 51.5 52.8 52 51.7 52.6 53.5 53.7 54.9 55.2 55.4 56.2 56.7 57 57.4 56.6 57.4 58.1 France 50.6 50.6 51.4 50 50.2 49.6 48 48.4 48.3 48.6 48.3 49.7 51.8 51.7 53.5 53.6 52.2 53.3 55.1 53.8 54.8 54.9 55.8 56.1 Germany 52.1 52.9 53.2 52.3 50.5 50.7 51.8 52.1 54.5 53.8 53.6 54.3 55 54.3 55.6 56.4 56.8 58.3 58.2 59.5 59.6 58.1 59.3 60.6 Italy 54.1 54.9 55.6 53.2 52.2 53.5 53.9 52.4 53.5 51.2 49.8 51 50.9 52.2 53.2 53 55 55.7 56.2 55.1 55.2 55.1 56.3 56.3 Spain 51.3 53.1 53 55.4 54.1 53.4 53.5 51.8 52.2 51 51 52.3 53.3 54.5 55.3 55.6 54.8 53.9 54.5 55.4 54.7 54 52.4 54.3 Switzerland 49.6 49 49.9 50.2 51.1 53 53.1 55.3 51.5 51.5 51.6 54.4 55.2 55.9 56.2 54.6 57.8 58.6 57.4 55.6 60.1 60.9 61.2 61.7 UK 54.5 52.5 51.2 52.5 50.9 51.1 49.5 50.4 53.1 48.3 53.5 55.3 54.2 53.5 55.9 55.6 54.6 54 57 56.3 54.3 55.2 56.7 55.9 US 54.1 52.8 51.2 52.4 51.3 51.5 50.8 50.7 51.3 52.9 52 51.5 53.4 54.1 54.3 55 54.2 53.3 52.8 52.7 52.1 53.3 52.8 53.1 52.4 Japan 52.6 52.6 52.3 50.1 49.1 48.2 47.7 48.1 49.3 49.5 50.4 51.4 51.3 52.4 52.7 53.3 52.4 52.7 53.1 52.4 52.1 52.2 52.9 Brazil 44.1 43.8 45.6 47.4 44.5 46 42.6 41.6 43.2 46 45.7 46 46.3 46.2 45.2 44 46.9 49.6 50.1 52 51.5 50 50.9 50.9 Russia 50.2 50.1 48.7 49.8 49.3 48.3 48 49.6 51.5 49.5 50.8 51.1 52.4 53.6 53.7 54.7 52.5 52.4 50.8 52.4 50.3 52.7 51.6 51.9 India 50.7 50.3 49.1 51.1 51.1 52.4 50.5 50.7 51.7 51.8 52.6 52.1 54.4 52.3 49.6 50.4 50.7 52.5 52.5 51.6 50.9 47.9 51.2 51.2 China 48.3 48.6 48.2 48.4 48 49.7 49.4 49.2 48.6 50.6 50 50.1 51.2 50.9 51.9 51 51.7 51.2 50.3 49.6 50.4 51.1 51.6 51 Korea 49.1 49.1 50.7 49.5 48.7 49.5 50 50.1 50.5 50.1 48.6 47.6 48 48 49.4 49 49.2 48.4 49.4 49.2 50.1 49.1 49.9 50.6 Taiwan 47.8 49.5 51.7 50.6 49.4 51.1 49.7 48.5 50.5 51 51.8 52.2 52.7 54.7 56.2 55.6 54.5 56.2 54.4 53.1 56.2 53.6 54.3 54.2 Global 51 51 50.7 50.9 50 50.7 50.2 50.1 50.4 51 50.7 51 51.9 52 52.7 52.7 53 53 52.7 52.6 52.6 52.7 53.2 53.2 Emerging 49 49.2 49 49.4 48.9 50.2 49.6 49.5 49.3 50.3 50.1 50.3 51 50.8 51.1 50.8 51.3 51.6 50.8 50.5 50.8 50.9 51.7 51.3 Developed 52.6 52.3 52 52.1 50.8 50.9 50.5 50.3 51.1 51.4 51.2 51.5 52.6 52.9 53.7 54.2 54.1 53.9 54.1 54.1 53.9 54 54.2 54.6 Manufacturing PMI data Source: JP Morgan Asset Management 4

The key risks – Politics Some have receded • European elections – UK election… – China • Xi the most powerful leader since Mao – Frictions over North Korea rumble on – The Trump “slump” • Expectations are extremely low – Some upside if anything gets done! – 5

Optimism regarding Trump’s tax reform agenda builds Every 5% cut in the US corporate tax rate has the potential to increase S&P 500 Index EPS by $5 • or 4.2%. On average, S&P 500 Index companies pay an overall effective tax rate of approximately 27%, • with around 60% of profits sourced domestically and taxed at an average of 33.3% (the current rate of tax is 35%). • The US President has pledged to cut the federal business tax rate from 35% to 20%. Corporate tax rate of major countries 40 35 30 25 (%) 20 15 10 5 0 Source: Deutsche Bank 6

The key risks – Interest Rates and Inflation Rates are moving up in the UK and US but slowly… • Inflation outside of the UK continues to be muted • Central bank policy will remain accommodative • The debt pile keeps growing… • 7

Carney’s rhetoric has lowered rate rise expectations Source: Bloomberg, Nov 2017 8

Total global central bank assets will continue to climb in 2018 Oct 18 Sep 12 Dec 08 Fed begins balance sheet normalization Fed announces QE3 Fed announces QE1 Federal Reserve(SOMA) Central bank assets 4500 Nov 10 4000 Fed announces QE2 3500 3000 $Billion 2500 $ Trillion 2000 1500 1000 500 0 03 05 07 09 11 13 15 17 19 Treasuries Agency & MBS Treasuries Forecast Agency & MBS Forecast Source: Thomson Reuters Datastream Oct 2017 9

Debt continues to rise faster than GDP Change in Gross Debt, 2006-16 Global Gross Debt and GDP (Trillions of US dollars) 160 140 (Trillions of U.S. dollars) 120 100 80 60 40 20 0 90 92 94 96 98 00 02 04 06 08 10 12 14 16 General government Households Nonfinancial companies GDP Source: IMF, Oct 2017 10

Debt continues to grow… Advanced Economies Emerging Economies Saudia Arabia Great Britain South Africa Sovereign and Argentina Indonesia Austrailia Germany Nonfinancial Private Canada Mexico France Turkey Russia Korea Japan China Brazil sector Debt to GDP India USA Italy ratios 2006 184 70 64 41 103 10 29 64 66 25 66 77 31 45 38 10 26 70 36 General Government 2016 239 92 107 89 133 41 38 96 68 44 78 70 52 28 58 16 13 54 28 2006 59 74 96 90 36 105 70 44 65 11 14 10 39 9 12 8 12 4 11 Household 2016 57 101 79 88 42 123 93 57 53 44 23 10 35 18 16 16 15 6 17 Non 2006 100 76 65 79 67 73 83 56 49 105 39 38 33 27 14 32 28 20 14 Financial 2016 92 102 72 73 71 79 100 72 46 165 44 45 37 67 28 52 50 12 23 Corps 2006 343 221 225 210 205 187 183 164 180 142 118 125 104 81 64 49 66 93 61 Total 2016 388 295 259 250 246 243 232 226 168 254 145 125 124 113 103 84 78 73 68 Sources: Bank of International Settlements; Haver Analytics, IMF World Economic Outlook Database and IMF staff calculations, Oct 2017. 11

....but this is not a regime shift as inflation remains contained for now 2.50 2.00 1.50 Percentage YoY Percentage YoY 1.00 0.50 0.00 -0.50 -1.00 Sticky Price CPI less Food, Energy, and Shelter Flexible Price CPI less Food and Energy Source: Thomson Reuters Datastream Oct 2017 12

Inflation and rates – what are the risks? Policy Error End of Cycle Bad for equities Bad for equities Bad for bonds Good for bonds Interest Rates Goldilocks Behind the Curve Good for equities Good for equities Good for bonds Bad for bonds Inflation 13

The key risks – Stretched valuations The “easy money” has been made in equity markets • However corporate earnings continue to deliver • With cost cutting remaining central to many corporate strategies – Lack of alternatives – is it really different this time? • 14

Regional Valuations Source: Thomson Reuters Datastream, Oct 2017 15

A synchronized recovery in corporate earnings Source: Thomson Reuters Datastream Oct 2017 16

“It’s different this time…” “Asset valuations are somewhat rich if you use some traditional metrics like price • earnings ratios, but I wouldn’t try to comment on appropriate valuations, and those ratios ought to depend on long- term interest rates,” Yellen 27 June 2017 30 25 Price to Earnings Multiple 20 15 10 5 0 04/1991 04/1996 04/2001 04/2006 04/2011 04/2016 US Forward PE Median PE Source: Thomson Reuters 17

Equity risk premium still attractive US Equity Risk Premium 9.0% 8.0% Equities more attractive 7.0% 6.0% Percentage 5.0% 4.0% 3.0% 2.0% Equities less attractive 1.0% 0.0% 61 66 71 76 81 86 91 96 01 06 11 16 Source: NYU Stern – School of Business (Aswath Damodaran) Updated to 1 st October 2017 18

What happens next? Goldilocks Scenario Market - breather/ correction Normal late Cycle – Inflation pickup but not likely to get out of control Economic Data + Corp Earnings +VE Economic Data + Corp Earnings = +VE Chinese data turns over Inflation moves higher Yields remain range bound Peaking US/European Data Term Premium normalizes Policy – US trade policy Real Yields pickup Value outperforms Growth Growth continues to outperform Equities – Risk off Beneficiaries : Financials/ Energy Beneficiaries :Technology/Healthcare Inflation pick up ->? 45% 40% 15% 19

Conclusion In spite of Trump and Brexit, economic data has continued to be strong • Corporate earnings are also exceeding expectations • Brexit remains the great unknown – with a wide range of potential outcomes – we • wait and see Equities remain our preferred asset class, but diversification is crucial • Continued trend of businesses needing to do more with less • 20