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International Equity Strategy Commentary - Q1/2018

International equity markets continued to advance in the early part of the quarter however, the fear of rising interest rates, trade tensions between the US and China as well as potential regulatory risks in IT following Facebook’s data privacy combined to produce a sell-off later on.  Volatility in markets returned after the low levels experienced in 2017.  The EAFE index fell 4.16% in local currency terms and 1.41% in US Dollars as the loonie declined even more than the US$ against other major currencies.  Unusually the defensive and unloved utility sector was the best performing rising 1.46% while telecom was the worst falling 3.88%.

In our last quarterly commentary we noted that the liquidity backdrop for markets had deteriorated with global money growth slowing suggesting a peak in economic activity around the end of Q1 2018.  Data has begun to confirm this growth peak and global real money trends are suggesting the economic slowdown could extend through late 2018 although money trends are possibly bottoming due to the recent tax cuts in the US and potential policy easing in China.

News in Europe has been more mixed economically with exports in Germany under some pressure from the strength of the Euro and global trade tensions have troubled the stock market.  Angela Merkel has finally confirmed her fourth term as chancellor as the Social Democratic Party voted to form another grand coalition with her Christian Democratic Party.  In France President Macron is facing the first serious challenge to his reform program as rail unions started industrial action designed to disrupt rail services to protect their generous employment terms including life-long employment and retirement as early as 52.  The railways represent the strength of the state and are a source of national pride and strikes have badly damaged previous presidents.  In Italy it remains unclear who will form the next government and the fear remains that the populist Five Star Movement, now the largest party in parliament, and far-right League will form a coalition leading to a fiscal expansion and more anti-EU rhetoric although the parties remain unlikely bedfellows and it is hard to see any partnership sustaining.  Germany has rejected a request from Spain to extradite former Catalan leader Carles Puigdemont for rebellion but the Madrid government continues to hold the upper hand in the war of words with the Catalan separatist movement. 

In the UK slow progress is being made on the terms of Brexit with fears of a general election and subsequent victory by a Jeremy Corbyn led opposition holding the fragile Conservative party together behind prime minister Theresa May.  The attempted murder of a former Russian spy and his daughter using a nerve agent handed Mrs May some brief respite with the opportunity to appear statesmanlike in comparison to the pacifist Corbyn, and the united response by western governments expelling Russian diplomats was striking.  The war of words also helped Vladimir Putin win the presidential election, securing 77% of the votes.  UK monetary trends continued to weaken in February, suggesting deteriorating economic prospects and arguing for the Monetary Policy Committee to hold off on plans to raise interest rates.  The stock market continues to underperform on fears of domestic economic stagnation post departing the EU and its lack of anything resembling a technology sector.  It is notable that many of the UK’s best companies have been acquired by international buyers leaving a stock market that feels much diminished in global terms post the global financial crisis which hit the significant financial sector hard.

In Japan earnings revisions have remained positive despite the rising Yen which is hitting business sentiment.  Employment shortages and the massive asset-purchase scheme by the Bank of Japan have yet to feed through to significantly higher prices anywhere near Governor Kuroda’s 2% inflation target.  Like Germany, Japan suffers when trade tensions rise but improving corporate governance, low unemployment and a vibrant tech and industrial sector still argue for at least an index weighting.  Elsewhere in Asia, China has responded relatively calmly to President Trump’s tariffs and consumption continues to grow in importance within the economy.  A shrinking of the labour force and reduction in rural-urban migration is allowing a shift away from debt-fuelled investment and real wages are rising, improving household disposable income.  There seems to be a welcome thaw in relations between North Korea and the international community including the US which should help reduce the risk premium for the region.  Our emerging market checklist is sending a mixed message but the key narrow money growth gap between developed and emerging suggests maintaining exposure.

The composite rose 0.05% (falling 0.13% Net) versus a 1.41% fall for the benchmark.


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