Financial markets have responded positively to two key events this week: another hint from the White House that a trade deal with China is close and a convincing victory for the Conservative Party in the UK general election. Signalled as a sign of renewed confidence in UK growth, sterling has continued its move higher against other major currencies, including the dollar, and now sits at its highest level against the euro since the EU Referendum in 2016, as shown in the chart below.
The UK election result will have a significant - and in our view constructive - implication for the UK economy. We expect it to boost growth in 2020 and expectations for future years. It removes immediately two factors that have weighed on the economy and UK assets: the previous ongoing political crisis and stalemate; and downside risks that might have followed a change in Government. Instead now there is a period of political stability ahead. A key remaining area of tension may be continued calls for a second referendum on Scottish independence. Overall, this backdrop should help the domestic economic policy outlook: growth should benefit from a credible easing in fiscal policy and some rebound in private sector investment plans. The stronger pound should have a disinflationary impact, with inflation easing further. Alongside modest wage growth, this should help consumer spending. We expect Bank of England policy rates to remain on hold for now. The other major area to focus on will be Brexit. The election result guarantees the UK will leave the political structures of the EU soon and will likely speed up the pace of UK-EU trade talks. The markets have moved to reflect expectations of a deal being reached but there is still some uncertainty about the detail and how quickly it will take to agree.
The global environment has also noticeably changed in recent months. From spring 2018 the world economy slowed, so much so that only a few months ago the markets were fearing an imminent global recession, which we did not think would occur. Since then, economic indicators have stabilised and market expectations for 2020 now point to steady growth and low inflation. Key has been that the three main factors that contributed to the 2018-19 slowdown have reversed: monetary policy globally, led by the US, has eased; China too has taken policy steps to help growth and mitigate financial risks; and also there has been slow but positive progress on addressing US-China trade tensions.
Over the past year, Netwealth’s portfolios have held more exposure to the domestically focused FTSE 250 Index and hedged more international exposure back to sterling than normal, in anticipation of revaluation when some of the Brexit uncertainty lifted. Lately, the market has begun to reward this stance, so a key question in the coming weeks will be how to balance greater clarity on these UK assets with the facts that the global picture has improved and valuations are now less compelling.
Source: Bloomberg with Netwealth calculations of total return indices
We will of course keep clients updated on our thoughts and actions designed to ensure that portfolios are best positioned for diversified exposure to a changing environment.
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