Economic Backdrop

UK government leaders found themselves in a set of double binds as October progressed: Chancellor Philip Hammond was cautioned that London-based companies would begin to enact Brexit contingency plans if a transitional deal with the European Union (EU) was not agreed upon by year-end, and Brexit Secretary David Davis was forced to assure parliament it would receive a final vote on any UK-EU agreement despite warning the Brexit select committee there may not be time if negotiations run long.Talks in Brussels between UK Prime Minister Theresa May and European leaders produced progress on these issues, albeit not enough to begin transition discussions.

Elsewhere, the Catalan regional parliament vote for and declaration of independence from Spain was followed immediately by a vote in the Spanish legislature to suspend the largely autonomous Catalan regional government; leaders of the independence movement may face criminal charges. Austrian and Czech election results handed the largest share of votes to parties that campaigned on populist messages with an emphasis on restrictive immigration policies. The Communist Party of China held its twice-a-decade National Congress, where President Xi Jinping publicly cemented his leadership. Japanese Prime Minister Shinzo Abe won re-election, and his party retained a parliamentary supermajority—giving him more time to enact policies designed to stimulate the economy. In the US, the focus throughout October remained on tax-reform plans and a change in Federal Reserve (Fed) leadership. At the end of the month, Special Counsel Robert Mueller announced the first criminal charges (including one guilty plea) stemming from his probe into possible Russian interference in the 2016 US election.

The US Fed met on the last day of October and announced no changes to its policy stance at the beginning of November, but noted that a benchmark-rate increase could be forthcoming after its December meeting. US President Donald Trump followed the Fed announcement with the nomination of Jerome Powell—current member of the Fed’s Board of Governors who is perceived as a continuity candidate—to replace Janet Yellen as Fed chair. The European Central Bank (ECB) announced a reduction in its monthly asset purchases—from €60 to €30 billion starting in January—and extended the programme until at least next September. The Bank of England’s (BOE) Monetary Policy Committee, meanwhile, increased its benchmark rate for the first time in a decade in early November. The Bank of Japan maintained its policy stance following a late-October meeting.

US and Japanese stocks climbed throughout most of the month and ended near the top of their respective ranges, while European stocks were flat until rallying late in the month. UK stocks were up overall, but finished considerably off their highs after some late-month volatility. Hong Kong stocks initially advanced and then sold off heading into the National Party Congress, while mainland Chinese stocks climbed post-Congress. Brazilian stocks rallied through early October, yet ultimately sold off to finish the period virtually unchanged. Volatility increased globally late in the month and then receded quickly, as third-quarter earnings season got underway and the ECB Governing Council convened its monetary policy meeting.

Energy prices rose, with West-Texas Intermediate crude-oil prices bumping up against two-year highs late in the month. The UK gilts yield curve flattened as short-term rates increased and long-term rates declined; the US Treasury yield curve flattened as short-term rates rose by more than long-term rates; and eurozone rates generally declined. The US dollar strengthened versus the euro—primarily after the ECB announcement—as well as against sterling and the Japanese yen.

UK construction activity bounced back to modest expansion territory during October, while manufacturing sector strength increased and services sector growth accelerated. Retail sales volumes appeared to decline sharply in October, however, and consumer prices remained elevated. The unemployment and earnings growth rates were unchanged in September’s report. Overall economic growth increased to 0.4% during the third quarter and 1.5% year over year.

Eurozone manufacturing activity accelerated from already-impressive levels to an 80-month peak in October, while inflation actually ticked down. The unemployment rate edged lower in September to 8.9%, led by improvements in smaller countries. Economic growth was recorded at 0.6% for the third quarter and 2.5% for the one-year period ending September.

The US manufacturing and services sectors both appeared to maintain strong levels of growth in October, while the Fed’s preferred gauge of consumer inflation remained low in September. Third-quarter economic growth was measured at a 3.0% annualised rate, more-or-less maintaining the prior quarter’s healthy pace.

Our View

Neither devastating hurricanes nor all-around political dysfunction have done much to halt the US equity market’s rise. Even the game of nuclear chess being played between President Trump and North Korea’s Kim Jong-un has failed to elicit much of a response. To be sure, all good things eventually come to an end. Yet, when we consider valuations, the upward momentum of the US economy and earnings, and the likely path of US Fed policy and inflation, we reason that the US equity bull market is not yet dead.

On the issue of valuations, there is no denying that US equities are trading at elevated levels. But the exceedingly low level of prevailing interest rates is an important mitigating factor. There has been a strong inverse relationship between bond yields and valuations over the past four decades, which we believe justifies structurally elevated valuations.

US equities also appear relatively expensive when comparing their valuations against those of other countries. Indeed, many other countries are on the cheap side—not only against the US, but also against their own histories. This is one reason we currently favour international equity markets versus US equities.

High valuations imply the US equity market could be a performance laggard in the years ahead relative to other stock markets; but they cannot predict an imminent downturn. We believe that valuations are a lousy timing tool for the simple reason that expensive markets can get more expensive.

The overriding question among investors is whether or not a recession is on the horizon. We contend that the answer is “no.” Financial stress, a harbinger of recession, is virtually non-existent. Recent economic data also point to the continuation of slow-but-steady economic growth.

A large portion of the world appears to be growing at a slightly better-than-trend pace. The breadth of the improvement is particularly impressive; as at July 2017, 72% of the countries that make up the Organisation for Economic Cooperation and Development’s (OECD) Composite Leading Indicator index have posted improvement over the past year—and 75% of the countries in the index came in above 100. This means above-trend growth will likely continue in the months ahead on a global basis.

According to the OECD’s calculations, Brazil’s economic situation is improving at the fastest rate. The eurozone as a whole looks set to grow above trend, as does Japan. China’s momentum remains toward the upside, even though recent economic data suggest some deceleration. The US economy, by contrast, is growing somewhat below trend. India also is signalling below-trend growth, but has begun to rebound. On balance, things are looking up in much of the world.

Economic growth of developed economies around the world is converging with that of the US. Although US monetary policy is further along the path toward tightening, other central banks have already begun to raise policy rates (the UK and Canada).

Market participants have adopted a far more sanguine view regarding the political stability of the eurozone following a series of national elections this year that enhanced the position of parties favouring further European integration. While confidence in the eurozone has increased, international confidence in the US has ebbed. The Trump administration’s decision to pull out of the Trans-Pacific Partnership and Paris climate accord was controversial in the US; it was especially confounding to those outside the US, and raised questions of whether it is relinquishing its role as leader of the free world. Confidence in the existing international economic order was also hurt by the threat of additional US trade discord with Canada, Mexico, South Korea and China. Trump was voted into office partially owing to his populist stance on trade; but we think a trade war could be as dangerous an economic blunder today as it was during the Great Depression.

We continue to expect a US business-friendly tax package to be enacted and signed by the Trump administration before the end of the year. However, the absence of such legislation could further dampen investors’ expectations for US economic growth—thereby causing a serious correction in the overall US equity market, especially hurting economically sensitive small-company and value stocks.

As noted above, the upturn in global economic activity is spurring the world’s major central banks to reassess their respective policy stances. The danger is in potentially making policy mistakes, either by acting too quickly or not fast enough. The BOE faces the greatest policy challenge, with an accelerating inflation rate at a time when its overall economic growth has been somewhat below that of the US and eurozone. Although the BOE has begun to raise rates, it is unclear whether the correct policy course calls for further tightening moves.

In the run-up to the National Congress of the Communist Party of China, the country’s economic policy has been geared toward growth. President Xi’s government has been focused on restraining rampant speculation in the property markets and curtailing growth of the shadow-banking system—with mixed success. As soon as China’s economy begins to weaken and financial markets exhibit signs of stress, its economic planners tend to reengage the accelerator.

It may be time to step on the brake again following the National Congress and the strengthening of Xi’s political power coming out of that meeting. The inflation rate for manufacturing producer prices at the end of August was near peak levels recorded in 2004, 2008 and 2011. A cyclical slowdown in China’s economy would likely be bad news for commodity prices and other emerging economies. Since the overall consumer price index remained at less than a 2% rate through August, we expect the People’s Bank of China to try a gentle tap on the brake.

While we would not rule out a correction in asset values more notable than others that occurred in the past 19 months, our investment mantra of buying on the dip still holds.

Our equity strategies remain positioned for further cyclical improvement around the world. They generally have a smaller-company and value bias versus their benchmarks. We tend to favour momentum-oriented opportunities, and view equity markets outside the US as more attractive than US equity markets. Indeed, our caution toward equities is most pronounced in the US, where the outlook for earnings growth is more modest than elsewhere in the world.

On the fixed-income side, we expect yields will slowly move higher (yields move inversely to prices) as global growth becomes more entrenched and central banks begin to remove the extraordinary stimulative measures of quantitative easing and zero (or negative) interest rates. Our underlying managers are generally short duration versus their benchmarks, favour credit-spread strategies and are positioned for a further narrowing of the yield curve, especially in the US.

Glossary of Financial Terms

Bull market: A bull market refers to a market environment in which prices are generally rising (or are expected to do so) and investor confidence is high.

Credit spread: Credit spread is the additional yield, usually expressed in basis points (one basis point is 0.01%), that an index or security offers relative to a comparable duration index or security (the latter is often perceived as “risk-free” credit, such as sovereign government debt).

Cyclical: Cyclical sectors or stocks are those whose performance is closely tied to the economic environment and business cycle. Managers with a pro-cyclical market view tend to favour stocks that are more sensitive to movements in the broad market and therefore tend to have more volatile performance.

Duration: Duration is a measure of risk in bond investing and indicates how price-sensitive a bond is to changes in interest rates. A long (overweight) duration stance indicates the portfolio duration is higher than that of the benchmark whereas a short (underweight) duration stance indicates a lower duration. Duration is measured in years and securities with longer durations are more sensitive to interest-rate changes.

Quantitative easing/tightening: Quantitative easing refers to expansionary efforts by central banks to help increase the supply of money in the economy; quantitative tightening refers to efforts by central banks to help decrease the supply of money in the economy.

Yield curve: The yield curve represents differences in yields across a range of maturities of bonds of the same issuer or credit rating (likelihood of default). A steeper yield curve represents a greater difference between the yields. A flatter curve indicates the yields are closer together.

Important Information

Past performance is not an indicator of future performance.

Investments in SEI Funds are generally medium- to long-term investments. The value of an investment and any income from it can go down as well as up. Investors may get back less than the original amount invested. Additionally, this investment may not be suitable for everyone. If you should have any doubt whether it is suitable for you, you should obtain expert advice.

No offer of any security is made hereby. Recipients of this information who intend to apply for shares in any SEI Fund are reminded that any such application may be made solely on the basis of the information contained in the Prospectus. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Bonds and bond funds are subject to interest rate risk and will decline in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments. Narrowly focused investments and smaller companies typically exhibit higher volatility. SEI Funds may use derivative instruments such as futures, forwards, options, swaps, contracts for differences, credit derivatives, caps, floors and currency forward contracts. These instruments may be used for hedging purposes and/or investment purposes.

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SEI sources data directly from FactSet, Lipper, and BlackRock, unless otherwise stated.