Keeping a close eye on inflation

03 August 2018
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Amid strong global economic growth and positive market sentiment, it would be premature to talk of an economic downturn. But with US inflation above target and set to increase further, interest rates on the rise and ongoing talk of a trade war, it’s important to look beyond the current economic cycle.
 

Positive outlook in the short-term
 

The US is showing a strong growth outlook, with businesses increasing their capital expenditure and continuing to create jobs. The impact of President Trump’s tax package is yet to be fully realised, and manufacturing data suggests that US corporates plan to increase investment to multi-decade highs. As a result, we’re expecting to see good company earnings growth in the coming months. Indeed, the US economy looks set to boom, and this will have a positive effect on the wider global economy.
 

Caution in the longer-term
 

While the short-term economic picture is positive, and investors are right to feel assured, it’s important to look beyond the here and now. With US unemployment below 4% (it was 8% just five years ago) and wage growth at 3%, conditions are supportive of rising inflation, and this could prove to be the catalyst for change.

Rising inflation leads to more interest rate hikes, which could ultimately reduce borrowing and capital investment. The reversal of quantitative easing and talk of a trade war are also not conducive to business confidence, and we could start to see a more cautionary picture prevail.
 

The Sanlam view

Our portfolios are positioned to take advantage of a continuation of the current environment – a gradual increase in interest rates and bond yields, combined with moderating equity valuations as earnings growth is delivered. At the same time, we expect volatility, and we’re well-positioned to take advantage of opportunities as they arise.

“The outlook for global economic growth remains strong as all the major global economies continue to demonstrate momentum. There is nothing to suggest that a recession will materialise in the next 12 months, and we anticipate generally strong company earnings growth. That said, we believe we’re in the late stages of the economic cycle and are fully aware of the risks that are building.” - Philip Smeaton, Chief Investment Officer

 
Investment view: Can the UK continue to weather the Brexit storm?

In times of uncertainty, companies and individuals tend to batten down the hatches, taking cover until the storm has passed. Unfortunately for the UK, Brexit is proving to be less of a storm and more of a longer-term depression, and the economy looks set to underperform most of the rest of the world for the foreseeable future.

As the graphs below show, both consumer spending and business investment spending has stalled, in stark contrast to the economic conditions we’re seeing in the US.

MV-graph-1.PNG

Falling consumer spending has meant the retail and hospitality sectors are suffering, resulting in the collapse of wellknown high street brands such as Gaucho, ToysRus and House of Fraser. Of those that are surviving, they are being forced to carry out fundamental strategic changes to grow sales in a subdued environment. John Lewis is a case in point, with their new flagship store focusing on ‘retail theatre’ to enhance the shopping experience.

As consumer spending falls, so does borrowing (and therefore lending). The residential property market continues to slow, with house price growth falling to 2% per year, down from 10% only three years ago.

 
A weak sterling helps to soften the blow
 

 It’s not all bad news. In recent weeks we’ve seen the FTSE All Share Index reach new all-time highs, supported by the weaker pound and a strong US dollar, which increases foreign profits in sterling terms. We’ve also seen UK Government Bonds rally from a yield near 1.65% on a 10-year gilt in February, to 1.27% in late July (a falling yield means a rising price).
 

Outlook
 

While the environment is tough, we should remember there are numerous world-class businesses in the UK. The consensus is that we’re heading towards a (business friendly) soft Brexit, but the political outlook remains uncertain, and therefore so does the economic outlook. We see this is as an opportunity. Our focus on business fundamentals, valuations and investing for the longerterm means we can take advantage of opportunities that others may miss just because they’re fearful of Brexit.

This article is for information purposes and should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed above are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by Sanlam Private Wealth. Any expressions of opinion are subject to change without notice. Reproduction of this commentary is not allowed in whole or in part without prior written agreement from ‘Sanlam Private Wealth. Past performance is not a reliable indicator of future results. Investing involves risk. The value of investments, and the income from them, may fall as well as rise.

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