EconomyNov 28 2016

Markets’ narrative beginning to shift as political environment is reshaped

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Markets’ narrative beginning to shift as political environment is reshaped
Getty ImagesGerman chancellor Angela Merkel, who is seeking a fourth term in office, is being challenged by the populist right-wing AfD party.

Prophecies of UK economic doom have also been allayed as activity data has bounced back, thanks in part to swift action by the Bank of England. It remains to be seen whether we are in a ‘false dawn’ period. 

The UK government is only at the beginning of its journey to extricate itself from the EU and there are numerous hurdles to overcome, which could yet have an impact on economic confidence in the UK and Europe.

The UK referendum unleashed the forces of anti-globalisation, a phenomenon that is growing globally. 

Investors only have to look to the outcome of the US presidential election as a barometer for those emotive feelings around trade protection, immigration controls and nationalism. 

There are many unanswered questions around president-elect Donald Trump and, if his rhetoric is to be believed, he could have a transformative impact on an accepted and longstanding political order. 

Many investors are comfortable in the belief that, as long as global central bank support remains forthcoming, this 'Goldilocks' state can continue

In Europe too, the political establishment is under pressure from disaffected electorates. Germany’s chancellor Angela Merkel is feeling the heat from the far right and Italy’s prime minister Matteo Renzi may struggle for political survival if the upcoming referendum on constitutional reform does not go his way.

Feelings of political dissatisfaction are, in many ways, a by-product of the economic environment that we find ourselves in. For nearly a decade, central banks have been aggressively cutting interest rates and pumping liquidity into financial markets to spur economic growth rates to levels that we had become accustomed to before the financial crisis in 2008. 

Frustratingly, despite Herculean efforts on the part of policymakers, nominal growth rates remain below pre-crisis levels, and their sustenance continues to rely on central bank support. 

Needless to say, questions are increasingly being asked about the effectiveness of central bank policies and whether they can positively impact the real economy – Japan is held up as a primary example. 

For financial markets, this glut of liquidity has distorted and inflated asset prices – bonds and equities alike. In a low-growth environment, the hunt for yield has driven developed sovereign bond yields to historically low levels, in some markets into negative territory, and boosted equity valuations, often without the earnings growth to support those premiums. 

Many investors are comfortable in the belief that, as long as global central bank support remains forthcoming, this ‘Goldilocks’ state can continue. This state of contentment then leads them to buy higher risk assets. 

It is this mixture of political discontent, a lack of economic growth to support future corporate profitability and an over-reliance on exhausted central banks that keep investors holding sizeable levels of cash in an uncertain world. 

However, in light of the UK referendum and US election results, we do sense a shifting narrative in markets as the political environment is reshaped. 

Central banks are recognising their limits, evidenced through hawkish signals of recent communications. Furthermore, we are now seeing the baton being passed to governments as politicians from all sides support the need for fiscal stimulus to boost growth. 

Markets are sensing the inflationary impact and, while many areas remain at the higher end of their historic averages, there is still value to be found in what remains a challenging economic environment.

Noland Carter is chief investment officer at Heartwood Investment Management