INSIGHT QUARTERLY MARKET REVIEW

Transcription

1 INSIGHT QUARTERLY MARKET REVIEW Q2 217 HIGHLIGHTED IN THIS PUBLICATION: GLOBAL STRATEGIC ASSET ALLOCATION REGIONAL ASSET ALLOCATION GLOBAL SECURITY SELECTION REGIONAL PORTFOLIO CONSTRUCTION Tranquil waters? OVERVIEW UK EUROPE SPECIAL FOCUS Steady US expansion continues Brexit-related uncertainties Yield curve signals recovery will continue Small cap growth stock

2 OVERVIEW Expectations of more reflationary policies around the world have so far run ahead of actual events. Hard data show a relatively tranquil global economy, with reasonable real growth and low inflation. US: animal spirits are improving Animal spirits, the term memorably coined by J M Keynes to describe an improvement in business confidence, have been stirred by the election of President Trump (see Figure 1). The surge in US business optimism is seen, for example, in the ISM survey of manufacturing, which is at its highest level since 211 (during the sharp economic recovery after the Global Financial Crisis). Although the manufacturing sector is still (and will remain, despite Trump s protestations to the contrary) a small share of the US economy, 1 sentiment in that sector has been closely correlated with overall economic activity in the past: rising ISM survey readings are typically followed by higher overall economic growth. Small business optimism is at its highest level since late 2, boosted by Trump s agenda of reducing the regulatory and tax burdens. And consumer confidence has surged: it was last at its current levels during the 2-21 dot com boom. Of course, the cautionary message from that comparison is that such confidence may not be on firm foundations. 1. Animal spirits 2. US expansions year US GDP change on year Average 92 months.3 12 months financial crisis has typically tended to be weaker than during non-crisis periods. Furthermore, such recoveries tend to be slower and last longer. The current US expansion has now lasted for 93 months. There have been only two other periods of economic expansion longer than the current one (from 1961 to 1969 and from 1991 to 21). 3.6 Expansions Sources: NBER, Thomson Reuters Datastream as at 3 April months months 1. Index points Selected confidence/optimism/business conditions indicators compared to normal level* NFIB Small Business Confidence ISM Manufacturing ISM Services Low point in 216 pre-election Latest (Jan 217) Consumer Confidence *Normal level for NFIB and Consumer Confidence surveys=1; normal level for ISM indicators=. Source: Thomson Reuters Datastream as at 3 April 217. but not flowing through to actual data Indeed, there is no evidence as yet of a notable rise in consumer spending and economic growth. Indeed, on the contrary, the first quarter of 217 looks likely to have seen relatively soft gross domestic product (GDP) growth, probably no higher than 2 at an annualised rate. That, of course, is in line with the average growth rate seen since the current US expansion began (see Figure 2). However, it is a growth rate which we do not think should be regarded as disappointing. Economic growth following a The duration of the expansion has even led some to consider that a recession may be imminent. We do not see that as likely for two main reasons. First, as US post-crisis growth has been at a slower rate, we think it can continue for longer. Second, outside the US, economic growth is picking up: the eurozone, Japan and the rest of Asia are all seeing improving conditions; and the emerging economies, notably Brazil and Russia, which saw recessions in 216, are now growing again. Tranquil not revved-up Having said this, we still see little prospect of the revvedup economic growth which Trump, in those exact words, aims to achieve. A more sedate 2 real GDP growth rate, coupled with a similar rate of inflation, will be enough to allow US companies revenues to continue growing at around. That will provide a solid, if unspectacular, basis for continued corporate earnings growth, further helped by any tax cuts which are delivered. Border adjustment tax One key aspect of tax reform is the Republican Party s own plans for a border tax adjustment (BTA), which pre-date 1 The value added of the US manufacturing sector was 12 of US GDP in 21, according to the World Bank. See 2 Insight Q2 217

3 OVERVIEW Trump s nomination as Republican presidential candidate. The currently-favoured plan would impose a tax on all imports of 2 and make US exports tax-exempt. A body of economic theory holds that such a BTA will not affect prices and competitiveness in the country implementing the BTA or abroad because the exchange rate will adjust so as to provide a perfect offset. 2 In our view, that assumption is unrealistic: the impact of such a tax on the dollar s value is, we think, hard to predict; and the US dollar is already quite highly valued relative to fundamental exchange rate assessments. Under such a border tax system, the greater the proportion of overseas sales, the less tax a company will pay. The higher the proportion of imported costs, the more tax that is paid. So the change, if enacted, will benefit mostly those companies with a large domestic (rather than foreign) cost base and a high proportion of total revenues derived from overseas. We think it will therefore be good for sectors such as transportation and warehousing, manufacturing, and mining; and bad for many service sectors, especially those reliant on using foreign low-costs suppliers. China s reflation There are clear risks to China and Asia from such a US border tax. It could be very negative for Asian supply chains. Domestically, however, the Chinese economy is enjoying its own more reflationary trend. Chinese producer prices have picked up sharply with a large part of this due to supply shortages. Stronger producer prices are normally a good indicator of both nominal GDP growth (see Figure 3) and corporate profits growth. It may well be that China, not the US, provides the greatest stimulus to global GDP growth in 217. At market exchange rates China is expected to be the world s second largest economy in 217. The IMF forecasts its level of GDP to be US$12. trillion, behind the US at US$19.tr. But because China continues to grow much faster than the US, the growth in its GDP almost US$1tr will exceed that of the 3. China: PPI and GDP 16 2 US. In that sense, China will add an economy the size of Turkey in just one year. It will contribute more to global growth in 217 than any other country and, based on the IMF s forecasts, that will remain the case every year until 22. Currencies: long-term trends Currency trends have been an important determinant of overall returns in recent years, with exposure to the US financial markets bringing the additional benefit of currency appreciation. With the US dollar now overvalued against a number of currencies, however, relative currency movements may well take on more importance. Although currencies tend to be very volatile on a short-term basis, long-term trends can be powerful. A country such as Switzerland, with persistently low inflation and a large current account surplus, has seen its currency steadily appreciate against the US dollar over time (see Figure ). Quite the opposite fundamentals, and quite the opposite trend, have been seen for the pound sterling. The Swiss franc has appreciated over time so that one Swiss franc now buys around one US dollar; sterling has depreciated over time and may well approach a 1:1 milestone against the dollar, especially if the process of extrication from the EU proves difficult.. Swiss franc and pound sterling USD per CHF & GBP Bretton Woods system Number of US dollars bought with: 1 Swiss franc 1 Pound sterling Source: Thomson Reuters Datastream as at 3 April 217. Plaza Accord 22 September We return to these themes after a discussion of recent asset market performance Producer prices, change on year Nominal GDP, change on year (rh axis) Source: Thomson Reuters Datastream as at 3 April See Auerbach and Holtz-Eakin, The Role of Border Adjustments in International Taxation, American Action Forum, 2 December Insight Q

4 ASSET MARKET PERFORMANCE The prospect of more reflationary global policies and improved business and consumer sentiment helped global equities outperform bonds in the first quarter of the year. Asset market performance Over the course of the first quarter of 217, the US dollar weakened against other major world currencies. The declines were relatively modest against the euro, sterling and Swiss franc, but more notable against the yen, with that currency appreciating by almost against the dollar in the period. The weakening of the US dollar meant that the. local currency return from the MSCI World equity index rose to 6.9 when expressed in US dollar terms. Overall world equity market returns exceeded world government bond market returns. The phenomenon was seen across all the main regions and countries (see Figure ).. Asset market performance 6. Bond market returns Eurozone US Canada Switz. New Zealand Local currency terms US dollar terms Source: Citigroup. Data for three months to end-march 217. UK Japan Australia US Europe Japan Emerging World Bonds, total returns, US dollar terms Equities, total returns, US dollar terms Source: Citigroup (bonds); MSCI (equities). Data for three months to end-march 217. Bond markets The rise in US government bond yields seen in late 216 did not continue through into early 217: the ten-year government bond yield at the end of the first quarter was little changed on its end-216 level. In the eurozone, the general trend was for yields to rise, from what had been low levels at the end of 216. German 1-year yields, most notably, rose from.11 to.33 over the period. One concern was that the ECB may cut back on its bond purchases earlier than previously anticipated, not least because inflation moved up to 2 in February. The rise in yields meant that, in euro terms, there were modest losses from eurozone bonds in the period although the strength of the euro against the US dollar transformed that into a modest positive gain in US dollar terms (see Figure 6). The UK gilt market produced the strongest returns in local currency terms, as ten-year gilt yields dropped to little more than 1.. The strongest gains in US dollar terms were in the Australian dollar bond market, where local currency gains were accompanied by a strong gain in the currency: that was helped, in particular, by firmer commodity prices, which tend to benefit the Australian currency. Equity markets Asian equity markets produced some of the strongest returns in the first quarter of the year (see Figure 7). Signs of improved export growth helped South Korea, Taiwan and China; and the Indian market recovered as the adverse impact on the economy of last year s withdrawal of large denomination banknotes started to fade. Returns from the major developed markets the UK, US, Japan and Germany were in the range of.-. in US dollar terms in the period. The Russian market was one of the weakest in both local currency and US dollar terms as hope of relief from sanctions faded and the oil price did not sustain higher levels. 7. Equity market returns Russia UK Japan Italy Local currency terms Source: MSCI. Data for three months to end-march 217. US Switzerland China India Germany Brazil Spain South Korea US dollar terms Insight Q2 217

5 UNITED STATES Government finances are often considered a very complex subject. But the simple reality for the US is that tax cuts accompanied by no change in government spending will lead to an increase in public sector debt. Long-term US fiscal trends The general trends in US public finances are relatively straightforward. Government revenues have centred around 1 of GDP for decades (see Figure ). In the absence of any change in tax policy under President Trump the nonpartisan Congressional Budget Office expects these to stay at the same level for the next 1 years.. US government finances of GDP Revenues Revenues post-trump election Outlays Outlays post-trump election Sources: US Congressional Budget Office, The Budget and Economic Outlook: 217 to 227 (January 217) and Committee for a Responsible Federal Budget Promises and Price Tags: A preliminary Update, 22 September 216. Similarly, the path of government spending is quite predictable. In the absence of any changes by President Trump, this is expected to rise in the coming 1 years (see Figure ). 93 of the rise in spending is accounted for by entitlement spending, which is determined under current law: it is a path which is essentially baked in. 3 Less tax revenue, little change in spending Treasury Secretary Mnuchin initially planned to pass a very significant tax reform plan by August (but now more likely in the Autumn). On spending, President Trump plans an annual increase of US$bn for defence, as well as more for homeland security these being financed by cuts elsewhere. Trump s healthcare reforms would have provided an offset, as they were estimated to reduce the federal deficit by US$337bn over the ten years , but those reforms have now been dropped. Although produced before Trump s election, the projections from the Committee for a Responsible Federal Budget still provide a reasonable guide to Trump s intentions. Broadly, the plans amount, over ten years, to: tax cuts of US$.tr; US$1.2tr of primary (i.e. non-interest) spending cuts and an increase in interest costs of US$.7tr. The net effect is an increase in the federal deficit of US$.3tr over 1 years. Given that federal debt would have risen even in the absence of Trump s policies, this implies an increase to US$2tr, 9 of GDP, by 22 (see Figure 9) with his policies. 9. US government debt USD trillion : US$.tr 39 of GDP 216: US$1.2tr 77 of GDP 22: US$2.3tr 9 of GDP Debt USD trillion, pre-trump election Debt USD trillion, post-trump election Sources: US Congressional Budget Office (CBO), January 217 ( pre-trump election projections) and Committee for a Responsible Federal Budget, October 216 ( post-trump election projections) available at: There are important caveats to these projections: uncertainty as to which policies will actually be implemented; whether or not stronger US economic growth can indeed be generated and how much extra tax revenue it would produce; and, finally, prospects for the global economy, which has shown encouraging signs of strength recently, but which would be vulnerable to any dislocation from a marked change in US trade policy. means more debt Is there a concern about the US debt level reaching almost 1 of GDP? Certainly, Trump himself has criticised the doubling of the debt which took place under Obama. The work of Reinhart and Rogoff showed that government debt levels above 9 were associated with much weaker economic growth.. Although the size of the effect they found has been challenged, a link does still exist. Trump does not appear overly concerned by an increase in federal debt, claiming that he would borrow knowing that if the economy crashed, you could make a deal. Plans for a US$1tr infrastructure programme, with US$167bn financed by the government and the rest by the private sector, would be an additional source of borrowing but plans for that scheme now look unlikely to be announced until 21. Of the many uncertainties surrounding the outlook for US policy, those of a fiscal nature will dominate In the words of Kim Wallace, RenMac, speaker at the EFGAM Knowledge Exchange, January 217. Reinhart and Rogoff, Growth in a Time of Debt, American Economic Review (21). Wilbur Ross and Peter Navarro, Trump Versus Clinton On Infrastructure, 27 October 216. Insight Q2 217

6 UNITED KINGDOM The prospect of two years of uncertainty, as the UK negotiates its terms of withdrawal from the EU, is a source of vulnerability. For now, however, markets have remained calm. Brexit uncertainties Two years of uncertainty lie ahead for the UK, as it seeks to agree its terms of withdrawal from the EU. Quite how that process evolves is very difficult to know, but both parties to the negotiation seem willing to conduct talks in a spirit of co-operation. UK economy holding up For the time being, UK economic growth has held up well. Projections of a sharp fall in output in the event of Brexit have, at least for now, proved groundless. The Bank of England, notably, now sees UK GDP growth running at 2 in 217 (above consensus forecasts). We are concerned, however, that UK growth and, with it, the value of sterling, remain vulnerable. Sterling vulnerability The weakness in sterling seen since the June 216 referendum decision is already impacting the UK economy. Higher imported goods prices have pushed up consumer price inflation to 2.3, the same as the rate of nominal wage increases. Real wages, therefore, which were showing a strong increase for much of 216, are now not growing (see Figure 1). That is expected to put downward pressure on UK consumer spending, especially as household debt levels remain high and savings have recently been run down. As consumer spending remains the main contributor to overall GDP growth, the vulnerability of growth is clear. It is likely that sterling will remain under pressure during the Brexit negotiations, not least because the UK still has a sizable current account deficit close to the size (relative to GDP) which has been associated with currency crises in other countries in the past (see Figure 11). That means that 1. UK real wage squeeze change on year Total wages, 3-month moving average CPI inflation Source: Thomson Reuters Datastream as at 3 April UK current account deficit Deficit as of GDP Mexico Source: Economist Poll of forecasters, 11 March 217. Data for Mexico, Thailand, Spain, Portugal, Greece, Estonia and Iceland refer to their crisis years South Colombia Egypt Thailand Africa (1996) US Turkey UK Mexico (199) Current account deficit as of GDP, 217 Spain (27) Portugal (2) Previous crises Greece (2) -2. Estonia (27) Iceland (2) the UK has to attract a foreign capital inflow to finance the deficit: in the words of Mark Carney, it is reliant on the kindness of strangers. 6 For the time being, that is not proving to be a problem: UK 1-year government bond yields fell during the first quarter of the year to just over 1, whereas yields on eurozone government bonds rose over the same period; the equity market has remained relatively stable; and anecdotal evidence of inward investment flows suggests that this has not been impaired. Looking for a Bafta Sterling s weakness does have some beneficial effects, of course: the income from assets overseas and profits earned by UK companies abroad become more valuable in sterling terms; and the UK s export price competitiveness is improved. After leaving the EU, the UK will be free to agree its own trade deals with the rest of the world. UK negotiators are apparently seeking a Bafta a Big Ambitious Free Trade Agreement involving closer trade ties with the US; the 1 other Commonwealth countries, a group which includes some of the largest and fastestgrowing emerging economies in the world (India, Nigeria and South Africa) as well as former colonies and dependencies which are now advanced economies (Australia, Canada and Singapore). As long as the UK is a member of the EU, trade with such economies is subject to the common external tariff, as well as other non-tariff barriers, imposed by the EU. While that means there may be much to gain after EU withdrawal, a difficult negotiating period lies ahead. 6 Mark Carney fears Brexit would leave UK relying on kindness of strangers, The Guardian, 26 January Insight Q2 217

7 EUROPE Improved business confidence is being seen in Europe as well as the US, but the recovery varies markedly between countries. Political concerns are subsiding and inflation is back on track. Recovery in confidence A revival of business confidence is being seen in Europe as well as the US. The German IFO business climate index, for example, showed its strongest reading in March 217 since 211 (before the onset of the eurozone crisis). Nevertheless, the recovery remains uneven, with Italy, in particular, showing little growth (see Figure 12). 12. Eurozone: an uneven recovery GDP Index, pre-crisis peak = Germany France Italy Spain Source: Thomson Reuters Datastream as at 3 April 217. Foreign inflows Attitudes towards Europe on the part of foreign investors also seem to have turned more optimistic, admittedly from very weak levels. Late March 217 saw the strongest inflows into European equity funds for more than a year, after relentless outflows for most of 216, 7 signalling in part reduced concerns about the European political situation. Easing political concerns Although Brexit and Trump s victory suggest extreme caution in predicting election results, it seems increasingly unlikely that Marine Le Pen will be successful in her bid to become the next French president. Polls show a lead for Emmanuel Macron, helped by scandal surrounding François Fillon, the Republican party candidate. While Le Pen may well progress from the first round of voting (on 23 April) to the second round (on 7 May), her support base of -9 million voters is unlikely to expand by the required 7 million votes needed for her to secure victory in the second round. In Germany, a federal government election will be held on 2 September. The SPD is seeing increased support under the new leadership of Martin Schulz, former President of the European Parliament. That party currently forms a Grand Coalition with the CDU/CSU grouping (Christian Democratic Union of Germany/Christian Social Union in Bavaria) led by Angela Merkel. While the AfD (Alternative für Deutschland) continues to attract support, it seems highly unlikely it will have a role in any new coalition government. Inflation back on track Eurozone inflation is back on track. At 1.9 in February 217, it is exactly in line with the ECB s target of less than but close to 2. It had been below that target since mid- 213, leading some to fear that the eurozone may become stuck in a Japanese-style deflationary trap. Those fears have now receded and expectations have turned towards the ECB s quantitative easing being phased out earlier than many expected and policy interest rates starting to rise. The message from the increasingly upward sloping yield curve (see Figure 13) is that a recovery in growth and higher interest rates are expected. 13. Eurozone yield curve m 9m 2y y 6y y 1y 12y 1y 16y 1y 2y 22y 2y 26y 2y Source: Bloomberg as at 3 April 217. Maturity (months/years) 2 March December June December 21 Search for yield The ECB s negative deposit rate of. has proved widely unpopular and even German finance minister Schäuble has voiced criticism. Such low rates encourage the search for alternative investments but German 1-year bond yields at just 3- basis points offer only a limited yield advantage. If political uncertainties continue to recede as expected, the European equity market may look increasingly attractive. It is fundamentally cheap compared to other equity markets around the world; it offers a much higher dividend yield compared to the yield on government bonds; and, an oftenoverlooked issue, European companies may well start to emulate US companies and start buying back their equities in a more enthusiastic fashion. As in the US, this may well be encouraged by particularly low borrowing costs. 7 Source: EPFR Global data to 29 March 217. Insight Q

8 JAPAN Japan s central bank looks likely to maintain its easy policies in a more determined attempt to raise inflation and growth. After more than two decades deflation may be conquered. Finally getting there? Since the mid-199s Japan has been unable to shake off deflationary pressures, but there is now greater optimism that new measures introduced in September 216 will start to work. The main technique now favoured is a cap on 1-year government bond yields at. The hope is that this will provide a positive feedback loop: bond buying by the Bank of Japan (BoJ) is accelerated as bond yields rise, thereby expanding the BoJ s balance sheet and increasing banks liquidity. Headline, core and core-core inflation The headline inflation rate (see Figure 1) has moved into positive territory but the BoJ s two other measures of inflation core inflation (excluding fresh food prices) and core-core inflation (excluding food, energy and the impact of the 21 increase in VAT) are both still close to zero. The longer-term trend on the basis of these three measures, since general deflation took hold in 199, is shown in Figure Japan: edging away from deflation INFLATION 2 Target DEFLATION CPI inflation rate ( Headline ) CPI less fresh food inflation rate ( Core ) CPI underlying inflation rate, excl. food, energy and impact of VAT rise ( Core-core ) Sources: Bank of Japan, Thomson Reuters Datastream as at 3 April Long-term inflation trends Headline Core Average inflation since 199 Maximum Minimum Average Sources: Bank of Japan, Thomson Reuters Datastream as at 3 April 217. Core-core Second, there is evidence of upward pressure on wages, notably for part-time hourly paid workers (see Figure 16). Companies tend to find it easier to raise part-time wages in response to economic conditions since they can quickly reverse course in a downturn, whereas the wages of fulltime staff especially in Japan, where lifetime employment remains prevalent at large companies are harder to cut. Third, that wage pressure reflects skill shortages in key sectors of the economy, notably construction, which may well intensify as Japan prepares for the 22 Olympics. Spending ahead of that can add.2 to.3 to growth, in our view, allowing Japan to register overall GDP growth above 1 in 217 (for the first time since 213). On balance, Japan now stands a better chance than for many years of shaking off its deflationary problems. 16. Japan: wage trends -1.7 Why now? Why might stimulative policy work now in generating higher inflation and growth when it has failed in the past? First, there seems to be a growing determination to maintain easy policies until they have worked. Krishna Guha comments that it is now accepted by the Bank of Japan that it needs to dig in for a longer game. However, a key element of the transmission mechanism from that policy to higher inflation is via a weaker exchange rate. And, as is so often the case in Japan, the trend in the exchange rate has defied conventional expectations by appreciating, rather than weakening, against the US dollar in the first part of 217. change on year Full-time monthly wages Part-time hourly wages Sources: Thomson Reuters Datastream and JBRC ( Krishna Guha, Evercore ISI, at the EFGAM Knowledge Exchange, January 217. Insight Q2 217

9 ASIA At the start of the year Asian prospects were overshadowed by President Trump s trade rhetoric. Underlying conditions in Asia, however, have picked up. China is now set to be the biggest contributor to global growth. Trade recovery Asia is still a very export-dependent region and in that respect conditions have improved quite markedly. Exports from Taiwan and South Korea, the two economies which report their trade data earliest, show a sharp upturn early in the first three months of the year (see Figure 17). 17. Asian exports change on year, USD terms Taiwan Korea Source: Thomson Reuters Datastream as at 3 April 217. That has come, ironically, as the region has been overshadowed by the uncertainty surrounding the direction of policy under President Trump. His election pledges to impose punitive tariffs on China and to label the country a currency manipulator have, so far, not materialised. The issue of tariffs on China has been deflected by the proposals for a general US border tax with all countries and any issue of alleged currency manipulation is in the domain of the US Treasury, which will report in April 217. It uses three tests: whether a country has a trade surplus with the US of more than US$2bn per year (China does); whether the economy has an overall current account surplus with all countries above 3 of GDP (China does not); and whether the country buys foreign currency amounting to more than 2 of GDP (China does not it is now running down, not accumulating, foreign currency reserves). China s (predictable) economy While exports help drive growth across Asia, China itself is also a large importer. Net trade (exports minus imports) has made little contribution to overall GDP growth in recent years (see Figure 1). Rather, just over half of GDP growth in 216 came from fixed capital formation; and just under a half from consumer spending, continuing a pattern seen in each of five preceding years. 217 is expected to be little different. 1. China: contributions to GDP growth F Final consumption expenditures Gross capital formation Source: National Bureau of Statistics China as at 3 April 217. Net exports of goods & services Real GDP Capital formation (and destruction) Beneath the surface, however, important changes are taking place. 216 was the first year of China s new -year plan, which has a focus on infrastructure spending, an important component of fixed capital formation. 3 more cities are now able to construct a subway system, after the threshold qualifying population was halved (in that plan) to 1. million inhabitants. At the same time, China s investment boom over the last three decades has created widespread excess capacity in heavy industries (such as coal, steel and cement) which the government is now addressing. Capacity is being cut and job losses are inevitable. Meanwhile, a key focus of China s long-run growth prospects is spending US$1tr on infrastructure in its One Belt, One Road plan. This links China to as many as 6 countries in Asia, Europe and Africa. The plan is to open up new markets for Chinese production. Consumer spending Consumer spending in China has continued to grow in a relatively stable manner, at around 1 year-on-year in nominal terms. The trend is supported by state-mandated minimum wage increases and pent-up demand for many consumer goods and services. Chinese consumers accounted for 3 of the worldwide market for luxury goods in Despite threats from US policy, we see China continuing to contribute strongly to global growth in 217 and thereafter. 9 Bain & Co, Luxury Goods Worldwide Market Study, Fall-Winter 216, 2 December 216. Insight Q

10 LATIN AMERICA Mexico remains in the spotlight as far as the impact of President Trump s measures are concerned. But important developments are taking place elsewhere, from Argentina to Venezuela. Mexico, Trump and Ross Mexico remains a key focus not just for Latin America, but for the entire global economy. Its supposedly unfair trade practices and the need to build a wall with it were keynote aspects of President Trump s election campaign. Attitudes have, however, changed quickly, demonstrated by the recent strong appreciation of the Mexican peso against the US dollar (see Figure 19), from what was a clearly oversold position in the immediate aftermath of Trump s election. 19. Mexican peso pre- and post-trump s election USD:MXN Weaker peso 23 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr US dollar : Mexican peso Source: Thomson Reuters Datastream as at 3 April Trump election victory Self help Indeed, some see the new administration s policies as potentially strengthening US-Mexico trade links. Wilbur Ross, US Commerce Secretary, has suggested, for example, that the US could work with Mexico to stabilise its currency (as happened in 199 s Tequila crisis ). It could also be the case that any renegotiation of the North American Free Trade Agreement (NAFTA) strengthens, rather than weakens, the Mexican economy. Such a renegotiation could improve protection of intellectual property rights, putting Mexico s trading relationship on a firmer, developed world basis. It could also lead to better labour market practices, with better protection for workers rights. 2. Brazil: interest rates and inflation Brazil s official interest rate Consumer price inflation rate Source: Thomson Reuters Datastream as at 3 April 217. Figure 2). While the weak economy and declining inflation give scope for rates to fall much further, the central bank is determined to burnish its counter-inflation credentials. From Venezuela to Argentina The threat of high inflation, indeed hyperinflation, remains a clear and present danger in Latin America. In local currency terms, the Venezuelan stock market has produced the highest returns so far in 217 (see Figure 21). But those gains are illusory. Rampant inflation, bordering on hyperinflation, and a consequently depreciating currency far outweigh any notional gains. Meanwhile, Argentina, no stranger to very high inflation itself, continues to make good progress with economic reform and the equity market gains which have reflected this are more firmly based. 21. Stock market performance There has, importantly, been an element of self help in the currency s stabilisation. Banxico, as the central bank is colloquially known, has delivered six half-point increases in its policy interest rate over a year, taking the rate to 6.. Brazil Brazil is in a different position. The central bank has cut rates from 1.1 to 12.1 over the last six months (see Mexico (IPC) Brazil (Bovespa) Sources: Thomson Reuters Datastream as at 3 April 217. Chile (IGPA) Argentina (Merval) Stock market change, 31 December 216 to 31 March 217 Venezuela (IBC) 1 Insight Q2 217

11 SPECIAL FOCUS US SMALL CAP GROWTH STOCKS US small cap growth stocks are, we think, a particularly attractive area of the US equity market at the moment. Such stocks have tended to be neglected in recent years. Small cap growth stocks Historically, US small cap growth stocks have delivered stronger returns than large cap stocks in some years, but the performance has been volatile: in the last few years the sector has underperformed the large cap market (see Figure 22). The returns from initial investors in such small cap growth stocks have, in the past, been very attractive. Apple, Microsoft and Amazon were all small cap stocks (that is, with a market value of less than US$2bn) at their IPOs. Tech sector The technology industry provides a good example of that trend. In that sector, the private fundraising market now dwarfs its public counterpart. There were just 26 technology IPOs in the US in 216, raising $.3 billion; meanwhile, US tech companies raised $19 billion in the private equity market (see Figure 2). 2. US tech sector funding 22. Small cap growth versus large cap stocks Total return in year () Small cap growth stocks (Russell 2 Growth Index) Large cap, all stocks (S&P Index) Source: Thomson Reuters Datastream as at 3 April 217. De-equitisation Public listings have, however, become less popular for US companies. The US equity market is becoming deequitised. The number of domestic US-listed companies has declined from its peak in the mid-199s (when over such companies were listed) to little more than half that number currently (see Figure 23). USD billion IPOs (Initial Public Offerings) Amount raised in 216 US$.3bn 26 Number of times accessed Sources: Dealogic and Dow Jones VentureSource as at 3 April 217. US$19.bn PE (Private Equity) Advantages of being private In the technology sector, and more broadly, many small cap growth companies tend to favour private equity channels for a number of reasons. These include less onerous reporting requirements; the desire to keep a lower public profile; a reduced emphasis on maintaining and improving quarterly earnings; and a greater flexibility to spend on, for example, research and development which may harm earnings in the short-term but have a long-term benefit US: listed companies in decline Number of domestic US-listed companies Source: World Bank as at 3 April 217. At the same time, inflows into private equity funds have been strong, meaning that, in the language of the industry, there is a large amount of dry powder money committed by investors, but not yet invested. This surplus of investable funds has tended to bid up the value of private small cap growth companies. Meanwhile, the recent underperformance of listed small cap growth stocks has improved their relative valuation compared to the large cap market. Creative destruction Although both private and public financing routes are attractive ways of tapping this vibrant source of US creative destruction and future economic growth, public listed markets may well have the edge as a route into the market at this point in time. Insight Q

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EFG Asset Management (UK) Limited is authorised and regulated by the UK Financial Conduct Authority, registered no Registered address: EFG Asset Management (UK) Limited, Leconfield House, Curzon Street, London W1J JB, United Kingdom, telephone + () If you have received this document from any affiliate or branch referred to below, please note the following: Bahamas: EFG Bank & Trust (Bahamas) Ltd. is licensed by the Securities Commission of The Bahamas pursuant to the Securities Industry Act, 211 and Securities Industry Regulations, 212 and is authorized to conduct securities business in and from The Bahamas including dealing in securities, arranging deals in securities, managing securities and advising on securities. EFG Bank & Trust (Bahamas) Ltd. is also licensed by the Central Bank of The Bahamas pursuant to the Banks and Trust Companies Regulation Act, 2 as a Bank and Trust company. Bermuda: EFG Wealth Management (Bermuda) Ltd. is an exempted company incorporated in Bermuda with limited liability. Registered address: Thistle House, 2nd Floor, Burnaby Street, Hamilton HM 11, Bermuda. Cayman Islands: EFG Bank is licensed by the Cayman Islands Monetary Authority for the conduct of banking business pursuant to the Banks and Trust Companies Law of the Cayman Islands. EFG Wealth Management (Cayman) Ltd. is licensed by the Cayman Islands Monetary Authority for the conduct of trust business pursuant to the Banks and Trust Companies Law of the Cayman Islands, and for the conduct of securities investment business pursuant to the Securities Investment Business Law of the Cayman Islands. Guernsey: EFG Private Bank (Channel Islands) Limited is licensed by the Guernsey Financial Services Commission. Hong Kong: EFG Bank AG is authorized as a licensed bank by the Hong Kong Monetary Authority pursuant to the Banking Ordinance (Cap. 1, Laws of Hong Kong) and is authorized to carry out Type 1 (dealing in securities) and Type 9 (asset management) regulated activity in Hong Kong. Jersey: EFG Wealth Solutions (Jersey) Limited is regulated by the Jersey Financial Services Commission in the conduct of investment business under the Financial Services (Jersey) Law 199. Liechtenstein: EFG Bank von Ernst AG is regulated by the Financial Market Authority Liechtenstein, Landstrasse 19, P.O. Box 279, 99 Vaduz, Liechtenstein. Luxembourg: EFG Bank (Luxembourg) S.A. is listed on the official list of banks established in Luxembourg in accordance with the Luxembourg law of April 1993 on the financial sector (as amended) (the Law of 1993 ), held by the Luxembourg supervisory authority (Commission de surveillance du secteur financier), as a public limited company under Luxembourg law (société anonyme) authorised to carry on its activities pursuant to Article 2 of the Law of Luxembourg residents should exclusively contact EFG Bank (Luxembourg) S.A., 6 Grand Rue, Luxembourg 213 Luxembourg, telephone , for any information regarding the services of EFG Bank (Luxembourg) S.A. Monaco: EFG Bank (Monaco) SAM is a Monegasque Public Limited Company with a company registration no. 9 S 267 (Registre du Commerce et de l Industrie de la Principauté de Monaco). EFG Bank (Monaco) SAM is a bank with financial activities authorized and regulated by the French Prudential Supervision and Resolution Authority and by the Monegasque Commission for the Control of Financial Activities. Registered address: EFG Bank (Monaco) SAM, Villa les Aigles, 1, avenue d Ostende BP Monaco (Principauté de Monaco), telephone: The recipient of this document is perfectly fluent in English and waives the possibility to obtain a French version of this publication. People s Republic of China ( PRC ): EFG Bank AG Shanghai Representative Office is approved by China Banking Regulatory Commission and registered with the Shanghai Administration for Industry and Commerce in accordance with the Regulations of the People s Republic of China for the Administration of Foreign-invested Banks and the related implementing rules. Registration No: Registered address: Room 6T1, 6 F, Shanghai World Financial Center, No. 1, Century Avenue, Pudong New Area, Shanghai. The business scope of EFG Bank AG Shanghai Representative Office is limited to non profit making activities only including liaison, market research and consultancy. Singapore: The Singapore branch of EFG Bank AG (UEN No. T3FC6371J) is licensed by the Monetary Authority of Singapore as a wholesale bank to conduct banking business and additionally carries on the regulated activities of dealing in securities, fund management and securities financing. Switzerland: EFG Bank AG, Zurich, including its Geneva branch, is authorized and regulated by the Swiss Financial Market Disclaimer (cont.) Supervisory Authority (FINMA). Registered address: EFG Bank AG, Bleicherweg, 22 Zurich, Switzerland and EFG Bank SA, 2 quai du Seujet, 1211 Geneva 2, Switzerland. Taiwan: EFG Securities Investment Consulting Co. Ltd, Suite A-1, 1th Floor, Hung Tai Center, No. 16 Tun Hwa North Road Taipei, , SICE License No. BO26. United Kingdom: EFG Private Bank Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority, registered no EFG Private Bank Limited is a member of the London Stock Exchange. Registered company no Registered address: EFG Private Bank Limited, Leconfield House, Curzon Street, London W1J JB, United Kingdom, telephone + () In relation to EFG Asset Management (UK) Limited please note the status disclosure appearing above. United States: EFG Asset Management (UK) Limited is an affiliate of EFG Capital, a U.S. Securities and Exchange Commission ( SEC ) registered broker-dealer and member of the Financial Industry Regulatory Authority ( FINRA ) and the Securities Investor Protection Corporation ( SIPC ). None of the SEC, FINRA or SIPC, have endorsed this document or the services and products provided by EFG Capital or its U.S. based affiliates, EFGAM Americas and EFG Capital Advisors (EFGCA). Both EFGAM Americas and EFGCA are registered with the SEC as investment advisers. Securities products and brokerage services are provided by EFG Capital, and asset management services are provided by EFGAM Americas and EFGCA. EFG Capital, EFGAM Americas and EFGCA are affiliated by common ownership and may maintain mutually associated personnel. This document is not intended for distribution in the United States or for the account of U.S. persons (as defined in Regulation S under the United States Securities Act of 1933, as amended (the Securities Act )) except to persons who are qualified purchasers (as defined in the United States Investment Company Act of 19, as amended (the Investment Company Act )) and accredited investors (as defined in Rule 1(a) under the Securities Act). Any securities referred to in this document will not be registered under the Securities Act or qualified under any applicable state securities statutes. Any funds referred to in this document will not be registered as investment companies under the Investment Company Act. Source information The source for data used in this publication is Thomson Reuters Datastream, as at 3 April 217, unless otherwise stated. 12 Insight Q2 217