25th July 2016 at 8:30am
During volatile markets, it’s easy to focus narrowly and locally on what’s happening. But when it comes to investing, the interconnected nature of markets means it’s crucial to look globally – and at the long-term picture.
At Standard Life Investments, we consider what’s likely to happen next and what may trigger further movements in markets and economies.
Politics are influencing markets
Politics are beginning to affect financial markets more than ever, and uncertainties and lack of confidence could have a material effect on economic growth.
So far, there haven’t been signs that the European Union (EU) referendum has led to unduly high levels of financial stress, nor are there signs of company balance sheets or the banking system coming under undue pressure.
However, the UK leaving the EU is a process that will last years; it’s not an event.
There’s still uncertainty over the UK’s negotiations with the rest of the EU. Clearly, co-ordination is key. A lack of co-ordinated solutions – whether at the level of the G7 nations*, the Eurozone or the UK economy – could have a negative impact on the final outcome for all involved.
Key events that could have an impact on economic growth include:
July: a series of decisions by central banks, notably the UK and US, Europe and Japan
October/November: political events, referendums and major elections taking place in several countries across Europe, as well as the US
2017/2018: expect detailed results of UK/EU negotiations, as well as general elections in The Netherlands, France and Germany.
A changing environment
Importantly, the EU referendum is not the only political event of significance. The results of a series of elections and referendums in the US and Europe between now and 2018 will be influential for markets.
Opinion polls in Italy show a steady decline in support for Prime Minster Renzi ahead of October’s referendum on reforms to one of Italy’s houses of parliament, the Senate. This is increasingly because of the bad debt situation facing many Italian banks. Tackling the banking issue fast and decisively to support the economic recovery would remove one source of political tension.
The European Central Bank (ECB) carries out annual stress tests on financial organisations across the EU. This lets it see how resilient these companies will be if there are difficult market conditions. And it allows the ECB to identify any trends and potential risks that could affect the EU financial system.
This year’s announcements in late July may be important. Worries about European politics have also meant more money going into perceived safe haven investments.
Here we’ve seen unintended consequences as a result of Japan’s decision to move into negative interest rates. In particular, quantitative easing programmes have driven more government bond yields lower, increasing the pressure on the remainder of the global bond market. Following the recent elections, there’s a growing expectation that further measures will be announced over the summer to boost the economy.
What’s the likely outcome for economic growth?
At Standard Life Investments, we analyse scenarios in depth and our most likely outcome for the global economy is a period of slow growth into 2017.
Our analysis shows mixed signals for the UK; however, many sectors are expecting a sharp slowdown and some are indicating a recession.
Indeed, in its July summary, the Bank of England’s Monetary Policy Committee suggests a similar slowdown in the UK economy over the short term. Although the Bank of England base rate was left unchanged in July, most Committee members believe it will be cut in August, possibly by 0.25%.
While it’s understandable that the focus has been on the UK and parts of the Eurozone in the past month, it’s important to keep an eye on other areas which may have an impact on economic growth, for example:
- how quickly the US dollar strengthens against other currencies
- if there’s further weakness in commodity prices
- renewed tensions in emerging markets, both political and economic.
What all this means for you
The result of the EU referendum marks a significant change to global market, economic and political outlooks. Short-term market fluctuations can be unnerving and make you feel like your investments are losing money. But volatility is part of investing and it’s crucial that you focus on the long term at times like these.
It’s also a valuable reminder of the importance of diversifying – of spreading your money across different types of investments, geographical locations and industries.
If you’re investing in only one or two of these then you’re exposing yourself to quite a lot of risk. But diversifying across investments can help you achieve a much better balance between risk and return.
*The G7 nations are Canada, France, Germany, the UK, Italy, Japan and the US.
The views expressed by Andrew in this blog should not be regarded as financial advice. You should speak to a financial adviser if you’re in any doubt about your investment options. There may be a charge for this.
The value of any investment can go up or down and may be worth less than was paid in.
The information in this blog or any response to comments should not be regarded as financial advice and is based on our understanding in July 2016.