Yet again economists find themselves paring back their forecasts as economies defy even their modest growth expectations. The US Federal Reserve has once again deferred lifting interest rates and tellingly, this was a unanimous decision across the FOMC. Yellen is still talking about two rate rises this year; in contrast the market isn’t even fully pricing in one. There has been much talk in the British press about falls in gilt yields being related to Brexit. It would be fatuous to suggest that US Treasury and German bund yields have also fallen on Brexit concerns. Bond yields are merely reflecting the dreary outlook for growth.

This is not to say that next week’s Brexit vote is unimportant. This should have been a shoo-in for the remain camp but the dissatisfaction within the UK underlines quite how much of the benefits of European integration have been squandered through messy compromises made for political expediency. We fear a vote for exit. This would be extremely disruptive for industry and the loss of confidence will retard business investment for years to come. Markets will not react well to the news. Our move up the capitalisation scale earlier in the year should bring some insulation from the effects, as sterling will weaken and the blue chips’ international earnings should be largely unaffected.

Europe is currently enjoying something of a cyclical uplift. Markets would view a Brexit as bad news for Europe but after a while, the full implications for the EU will begin to sink in. Who will pick up the tab of the UK’s contribution to the EU budget? How long will it take for other nationalists within the EU to press for their own referendums? The structural imbalances leave the zone acutely vulnerable to any political and economic shocks. This is a danger that won't go away, even if the UK remains, but the vote has reminded us of what poor health this particular patient is in.

The US election approaches. Clinton is likely to appeal to conservatives who wish to keep to the status quo. Trump has appealed to voters to a far greater extent than originally expected and is the surprise candidate for the Republicans. His campaign is plagued by inconsistencies but there are glimmers of sense within the rhetoric. A more forthright approach and strong leadership could achieve more than Obama’s rather wet approach. Who knows, Trump might even manage to redistribute America’s lopsided wealth. Could he be another Ronald Reagan? Thankfully, the States founding fathers built sufficient checks and balances to protect the nation from a loose cannon President. Unfortunately, there are more important things to be worried about than the Presidential elections.

Japan continues to stew in its demographic and structural problems. The Abe arrows have failed to pierce their targets. Kuroda at the BoJ has announced that he can do little more and that the ball lies in the government’s hands. Although the stockmarket has been lousy this year, thankfully the yen strength has protected the value of our positions. Last year was a good one for the Japanese markets and we agreed that it is now time to close out our overweights here.

We are to extend exposure within the emerging markets. Valuations appear cheap but the aggregates mask the gulf in valuations between the absolute junk and the well run companies. This region rightly has a reputation for risk but does this really represent a material uplift above that faced in Europe? We think not. Growth may not be as strong as it once was but it is likely to be far higher than elsewhere in the world. We believe that investors will become prepared to pay a premium to access this growth and we currently have the opportunity to pick it up at a discount. That said, this is a region where we need to be picky. We will focus on managers who have a broad mandate and a large team that can shift through the stocks in detail and avoid the dross.

Action:
Move Europe to ‘avoid’, Japan to ‘neutral’ and GEM to ‘favour’. We will delay any transactions until the Brexit vote is complete. If we get the sensible result, markets in Europe should rally. An exit vote will cause European markets to fall; our guess is that they won’t fall far enough. 

 




JB 16 June