Fisher Investments Reviews the Global Economy in February 2017

After a flat January, the MSCI World Index rose 4.5% in February.[i] Eurozone equities also advanced, rising 2.6%. Throughout the month, global politics fixated investors. In anticipation of the Dutch and French elections, angst over possible eurosceptic populist victories rose. But in our view, as we saw with the Dutch election, these fears overrate the likelihood European elections bring radical change—teeing up bullish falling uncertainty as they pass without calamity for 2017. Last year, falling uncertainty in the United States and the United Kingdom buoyed markets. We expect a similar eurozone-centered round this year.

Eurozone political uncertainty is high, clouding investors’ view of healthy and improving economic fundamentals. However, as this year progresses and elections come and go, uncertainty should fall—boosting markets and possibly contributing to non-US equities leading later this year. The first vote was mid-March’s Dutch parliamentary election. Geert Wilders’ eurosceptic, nationalist Party for Freedom (PVV) led most polls for months, stoking fears his election could trigger a euro or EU exit. But Prime Minister Mark Rutte and his center-right party won a plurality, placing well ahead of Geert Wilders’ far-right party. Moving forward, we expect gridlock—Rutte will try to negotiate a coalition government with three other parties. Yet, knowing the outcome alone should quell investor fears and reduce uncertainty.

In France, the nationalist, eurosceptic Front National’s Marine Le Pen officially launched her presidential campaign, and her strong showing in early polling ahead of first-round voting raised fears of France exiting the euro—a “Frexit.” Partly as a result, French 10-year sovereign bond yields hit their highest levels in 17 months in mid-February, with Portuguese, Spanish and Italian yields also rising. That said, French rates are only just above 1%—far from alarmingly high—and such volatility is fairly typical ahead of elections. 10-year UK yields rose before last June’s Brexit vote, only to fall once the outcome was known. Italian yields similarly rose before December’s constitutional reform referendum—only to fall thereafter.

More recent polling shows Le Pen’s support falling modestly. But either way, first-round polling and Frexit fears overrate Le Pen’s election chances—and her ability to enact radical change if she wins. In the first round, opposition to Le Pen is divided among several centrist candidates (most prominently, the new En Marche! party of Emmanuel Macron and Republicain François Fillon). This increases her chances in the first round. But she is very unlikely to win more than half the vote, triggering a second, head-to-head round. The head-to-head race unites opposition to her. Polls show either centrist candidate trouncing her in a second round—despite a nepotism scandal embroiling Fillon. Even if she does win, her ability to take radical action like Frexit or reinstating the franc is extremely limited, as she would need parliamentary support and a successful referendum to effect either change.

The likely result of gridlock in two core European nations should relieve fears of extremism roiling markets. As it did in the United States last year, getting resolution—no matter who wins—allows investors to refocus on fundamentals.

Speaking of American politics, media and many investors stateside remain fixated on President Donald Trump, but very few of his actions carry any material market impact. Trump signed five laws in February and issued a raft of mostly non-market-related presidential actions. The vast majority of presidential actions to date amount to Executive Branch personnel-related decisions, sociological matters or demands to study and review regulation. Two laws were narrow rollbacks of financial disclosure and environmental rules involving Energy and Mining firms, both carrying little market impact. Neither rule existed for even a year. We anticipate intraparty gridlock preventing or watering down most economically significant legislation, which should mitigate possible dislocations from radical policy change and relieve fearful investors in the US and abroad.

Amidst the political fixation, many overlooked economic data. Yet data released in February showed sound global growth continued, generally beating analysts’ expectations. While eurozone Q4 2016 GDP was revised a hair lower (to 0.4% q/q from 0.5%), the quarterly expansion extends the eurozone’s growth streak to 15 straight.[ii] The bloc’s four biggest economies—Germany, France, Italy and Spain—all grew. More recent data were also positive. February’s preliminary purchasing managers’ indexes for eurozone services and manufacturing (PMIs, surveys measuring the breadth of growth) rose to 57.2 and 55.5, respectively.[iii] (Readings above 50 are expansionary.) As a result, eurozone composite PMI reached 56.0, the highest since 2011 and sixth straight rise.[iv] Citigroup’s surprise indexes—gauges that relate data to professionals’ expectations—show frequent positive surprise.

Eurozone inflation accelerated to 1.8% y/y in January, and prices in all 19 eurozone nations rose—the first uniformly inflationary reading since 2013.[v] This should quell lingering deflation fears and possibly pressure the ECB to curtail its counterproductive quantitative easing program, which flattens the yield curve, constraining banks’ loan profitability. The yield spread was the largest contributor to the eurozone’s Leading Economic Index rising 0.6% in January, extending an uptrend.[vi] Recently rising yields suggest a bigger contribution in February.

UK Q4 2016 GDP was revised up to 0.7% q/q from 0.6%, but the media reception was negative.[vii] While private consumption rose 0.7% q/q and exports rose 4.1%, business investment’s -1.0% fall prompted more handwringing over Brexit’s negative impact. Many believe growth is too reliant on consumption, especially since retail sales fell -0.3% m/m in January, a third straight drop the media blamed on weak-pound-driven inflation. However, retail sales volatility is normal, and about 60% of UK consumer spending goes to services, where spending appears healthy. Moreover, inflation isn’t hot. At 1.8% y/y in January, headline CPI is still tame and the acceleration largely reflects rebounding energy prices.[viii] Core CPI, which excludes volatile inputs like energy, is more modest and only slightly up from readings commonly seen over the last couple years.

Revised data confirmed US GDP growth at 1.9% annualized in Q4, and early 2017 data show more growth.[ix] Retail sales rose 0.4% m/m in January, despite dipping automobile purchases, which still remain near record highs.[x]  Excluding volatile cars, retail sales rose 0.8% m/m. Unseasonably warm January weather depressed utility output, causing industrial production to fall -0.3% m/m. However, manufacturing and mining rose 0.2% and 2.8%, respectively, as oil drilling rebounded.[xi] While a boon for industrial output, rising oil production does little to help oil prices and Energy shares, which continue to face headwinds from elevated supply—hence our underweight. The Institute for Supply Management’s (ISM’s) January Manufacturing PMI rose 1.5 points to 56.0, while New Orders ticked up to 60.4, a two-year high.[xii] ISM’s Non-Manufacturing Index fell 0.1 point to a still-high 56.5 in January, suggesting ongoing service sector expansion.[xiii] With 465 S&P 500 companies reporting, Q4 earnings are up 4.9% y/y. Profits are rebounding as Energy’s drag wanes. As the year progresses, barring a renewed drop in oil prices, Energy should boost headline profits, as year-over-year growth calculations will be based on very low 2016 levels.

Japan’s tepid economic growth continued in Q4 2016. GDP grew 0.2% q/q (1.0% annualized), its fourth straight quarterly rise—a rare positive streak for a moribund economy.[xiv] January retail sales rose 1.0% y/y, another sign of life, though rising fuel prices played a big role.[xv] While data remain weak, investors seem to be souring on Japanese shares. If this sentiment weakens further, it could reach a point that any positive news could surprise to the upside, providing an opportunity for investors.

This update constitutes the general views of Fisher Investments and should not be regarded as personalized investment advice. No assurances are made we will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.

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[i] FactSet, as of 1/3/2017. MSCI World Index with net dividends, 31/12/2016 – 31/1/2017 and 31/1/2017 –28/2/2017.

[ii] Source: Eurostat, as of 2/3/2017.

[iii] Source: IHS Markit, as of 2/3/2017.

[iv] Ibid.

[v] Source: Eurostat, as of 24/2/2017.

[vi] Source: The Conference Board, as of 2/3/2017.

[vii] Source: FactSet, as of 2/3/2017.

[viii] Source: Office for National Statistics, as of 2/3/2017.

[ix] Source: US Bureau of Economic Analysis, as of 2/3/2017.

[x] Source: US Census Bureau, as of 15/2/2017.

[xi] Source: US Federal Reserve, as of 1/3/2017.

[xii] Source: Institute for Supply Management, as of 1/2/2017.

[xiii] Ibid., as of 3/2/2017.

[xiv] Source: FactSet, as of 2/3/2017.

[xv] Ibid.

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