Economic Backdrop

The imposition of trade barriers served as the defining global economic development of the second quarter. US President Donald Trump’s
administration applied tariffs against China, a major trading partner and geopolitical rival, as well as traditional US allies in Europe and Canada—
inviting comparable tariffs in response. These retaliations prompted followon threats of tit-for-tat escalations from President Trump.

Immigration became a key point of contention in Europe and the US during the quarter. The governing coalitions in Italy and Germany pointed a
spotlight on the issue, forcing action at a European Council meeting in late June with a deal that seeks to establish an EU-wide (rather than country-bycountry) approach centred on financial-burden sharing and more restrictive borders. In the US, the Trump administration enacted a zero-tolerance policy in recent months that targets illegal immigration at the southern border; this attracted condemnation from across the political spectrum for its practice of separating and detaining families, including children.

Turkish elections in late June produced another victory for President Recep Tayyip Erdoğan, who thereby retains an office with newly expanded
executive policymaking powers. Mexicans headed to the polls on 1 July, electing Andres Manuel Lopez Obrador (AMLO) as its next president by
a wide margin. Victory for AMLO, a left-leaning populist and outspoken critic of the Trump administration, signals a decisive turn away from the
establishment parties that have dominated Mexican politics for decades. The leaders of France and Germany hashed out an agreement for a
common eurozone budget—long a non-starter for Germany—representing a significant partial step toward greater EU integration. The UK’s EU
Withdrawal Bill—which repeals legislation that made Britain an EU member—was ratified, essentially certifying that Brexit will take place in March 2019. The relationship between the US and North Korea appeared to continue warming amid a June summit in Singapore between President Trump and Supreme Leader Kim Jong Un.

British equities performed well during the second quarter, accompanied by a strong US stock market driven by companies in the energy, consumer
discretionary and technology sectors. Throughout the rest of the world, equities mostly performed poorly—particularly in emerging markets, and most severely in Latin America. Major government bond yield curves generally continued to flatten during the second quarter. The US dollar mounted a fierce recovery (versus a basket of foreign currencies) after bottoming early in 2018. As crude-oil prices climbed throughout most of the quarter, Organization of the Petroleum Exporting Countries (OPEC) members and non-members agreed to increase production by one million barrels per day starting in July.

The Bank of England’s Monetary Policy Committee made no changes at its May and June meetings, yet registered a third dissenting vote in June (an increase from two recent dissenters) that favoured a higher bank rate. The European Central Bank (ECB) announced at its mid-June meeting plans to taper net asset purchases in September from €30 billion per month to €15 billion, with the program potentially concluding after December; it also said benchmark rates will likely remain at their current levels until at least mid-2019. The US Federal Reserve (Fed) increased the federal funds rate at its June meeting and suggested that it could hike rates by a total of four times in 2018 (up from three expected hikes). The Bank of Japan steered a steady policy course at both of its second-quarter meetings. The People’s Bank of China cut lender-reserve requirements by more than $100 billion (in aggregate) late in the second quarter, with a stated intent to support small businesses; the move also frees up capital to help offset tariff-induced shortfalls.

UK industrial conditions picked up surprisingly in June after lacklustre reports in April and May, while services-sector activity accelerated in the same months. Labour-market conditions appeared frozen, with the jobless claimant count remaining 2.5% in May and the unemployment rate a steady 4.2% from February to April; average year-over-year earnings growth edged down to 2.5% for the same three-month period. Economic growth improved by a modest 0.2% in the first quarter, but registered an unchanged rate of 1.2% for the year over year. 

Eurozone manufacturing growth maintained still-healthy levels at the end of the second quarter despite continued easing since the beginning of the
year; services appeared to re-accelerate in June after slowing in the year to date. The unemployment rate fell to 8.4% in May from 8.5% in the prior month. The final reading of overall economic growth was unchanged at 0.4% for the first quarter and 2.5% year over year, confirming a slowdown in growth from the fourth quarter of 2017.

Growth in US manufacturing activity finished the second quarter on a strong note after buoyant reports in April and May; services-sector growth
accelerated as well. Personal-income growth was solid in the same two-month period, while the price index for core personal-consumption
expenditures (which excludes food and energy prices) increased to 2% year over year in May (hitting the Fed’s target level on its preferred inflation
gauge). Economic growth was measured at an annualised 2% rate in the final reading for the first quarter, 0.2% lower than earlier readings.

Our View

Investors were raging bulls at the beginning of 2018 as equity prices vaulted higher. But that optimism faded dramatically as the news flow
turned less favourable. As far as we’re concerned, that’s okay—because the potential for a meaningful advance in equities is greater when investors are pessimistic and bad news is already largely discounted in the price of riskier assets.

If one believes, as we do, that the global economy is sound and that the political uncertainties currently roiling markets will be contained, then the
proper course (in our view) should be to remain exposed to equities and other risk assets and ride out the short-term ups and downs.

The economic data coming out of Europe has been hugely disappointing this year. Instead of building upon the improved business activity of 2016
and 2017, there has been a widespread deceleration. At SEI, we have been reluctant to get too bearish on Europe’s fundamentals, but there’s
no denying that financial-market participants are disbelievers. Analysts 2018 and 2019 earnings-growth estimates for the companies within the
MSCI EMU (European Economic and Monetary Union) Index are quite low compared to those of other major regions and countries.

ECB President Mario Draghi and other bank governors decided to conclude net asset purchases by the end of this year because they view deflation risks as having moderated significantly. Since the ECB will no longer be a price-insensitive buyer of eurozone debt, we could see yield spreads rise as investors demand a risk premium for those countries with a heavy debt burden relative to the size of their economy. Italy’s new government wants to institute several expensive propositions that would blow a hole in the government’s budget, likely causing the country’s bonds to be further discounted by investors—with other periphery countries’ bond yields rising in sympathy (yields move inversely to prices).

Recent UK economic data reports, like those of other countries in Europe, suggest that Great Britain is wending its way through a soft patch. Underlying growth nevertheless appears solid, indicating the UK economy is in stable condition; although the trade sector looks to be a problem spot.

The biggest source of uncertainty facing the UK is its looming withdrawal from the EU. The Conservative Party’s internal fight over the country’s
future relationship with the EU has stalled progress toward a clear post- Brexit status. Maybe it’s sheer coincidence, but sterling versus the US dollar is almost where it was the day after the Brexit vote on 23 June 2016. The recent trend has been to the downside, as currency-market participants worry about the rising odds of a hard Brexit and more-thorough disruption of UK trade with the EU. We would not be surprised to see further downside volatility in sterling as we draw closer to the EU exit date.

Fears of a trade war pitting the US against foes and allies alike notwithstanding, American investors, businesses and consumers have
much to applaud. US corporate tax reform, tax cuts for households, and reduced or modified regulation of various industries have led to record-high consumer and business confidence.

But sabre-rattling between the US and China has deteriorated into actual skirmishing, and the latest back-and-forth suggests this spat will get worse before it gets better. To be blunt, the Trump administration’s strategy of waging a trade war with China could prove to be the equivalent of cutting off one’s nose to spite one’s face.

A trade war will likely lead to higher prices for consumers and hurt the bottom lines of companies that sell imported goods and those that
depend on global supply chains in their production process—resulting in a net loss for society. A small group of producers will probably benefit substantially from the trade impediments, while most consuming industries and households suffer declines in purchasing power—declines that may be small at the level of the individual, but would add up to an enormous loss across the affected economies.

SEI will be watching closely how this drama plays out in the months ahead. With any luck, the Trump administration will shy away from further
ratcheting tensions. But we must admit that doesn’t seem to be in the cards in the near-term.

A confluence of events has conspired to hurt the performance of emergingmarket assets. An extensive trade war that disrupts multinationals’ supply chains would disrupt the flow of raw commodities and semi-finished materials from developing economies, which depend on these exports for economic growth. Rising US interest rates, resulting in another period of sustained US dollar strength, is a second threat. The soft patch in Europe and recent signs of deceleration in China’s economic growth is a third.

But while emerging-market stocks and bonds have come under pressure this year, we’ve yet to see any widespread deterioration in economic
performance or financial conditions. On balance, we think most emerging markets have the ability to weather the storm—again, assuming the
disruption to global trade does not devolve into something more encompassing.

Make no mistake about it: the headwinds blowing in the face of risk assets have picked up. Growth in business activity has slowed a bit, especially in Europe. Monetary policy in the US is getting tighter, and is set to become less expansionary in Europe as well. Inflation has ticked higher, driven
by synchronised global growth and a tightening of labour markets and industrial capacity in the US, Germany, the UK, China, and elsewhere in Asia. A jump in oil prices is also pushing headline consumer-price index readings to their highest levels in several years; OPEC and Russia have shown a fair degree of discipline in constraining the supply of crude oil at a time when demand is strong and inventory levels have fallen. Some developing countries have been forced to raise their policy rates dramatically to defend their currencies.

Most important, the stoking of trade-war tensions by the US threatens to undermine the very foundation of the system that has supported the global
economy since the end of World War II. Although the actual trade actions to date have been modest, the impact on global supply chains bears close watching.

But the economic fundamentals that drive the stock market still appear solid, even in places like Europe and developing economies. Plus, interest rates remain at levels that are accommodative to global economic growth. The key risks—escalating trade tensions and the polarization of electorates over issues like immigration and fiscal sovereignty—appear more political in nature. The positives include a still-solid global economy; strong momentum in corporate-profits growth; and equity valuations that still appear reasonable against the backdrop of still-low, albeit rising, interest rates.

Signs of financial stress remain isolated to the weaker economies; although Italy is an important case, owing to its size and position as a major eurozone country.

A broadening of the trade war with China or a US departure from the NAFTA accord would likely have a severely negative impact on the profitability of US manufacturers, prompting us to reassess our still-positive view. Impediments to trade also could lead to a higher inflation rate as US companies use the tariffs umbrella to raise their selling prices. The Fed may feel compelled to lean against this threat to price stability, thereby aggravating any economic shock arising from the disruption of global supply chains—which is how a bear market could develop.

This is not our base-case scenario. We still think this old bull has some life left in it, but the risks to the equity market now seem more balanced than skewed to the bullish side.

Glossary of Financial Terms

Bear market: A bear market refers to a market environment in which prices are generally falling (or are expected to do so) and investor confidence is low.

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.

Federal funds rate: The Federal funds rate is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight in the US.

Fundamentals: Fundamentals refers to data that can be used to assess a country or company’s financial health such as amount of debt, level of profitability, cash flow, inventory size, etc.

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.

Yield spreads: Yield spreads represents the difference in yields offered between different types of bonds. If they tighten, this means that the difference has decreased. If they widen, this means the difference has increased.


Index Definitions

The MSCI EMU (European Economic and Monetary Union) Index: The MSCI EMU Index captures large- and mid-cap representation across the developed-markets countries in the European Economic and Monetary Union.

Important Information

Data refers to past performance. Past performance is not a reliable indicator of future results. 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. Returns may increase or decrease as a result of currency fluctuations. 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.

While considerable care has been taken to ensure the information contained within this document is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.

This information is issued by SEI Investments (Europe) Limited, 1st Floor, Alphabeta, 14-18 Finsbury Square, London EC2A 1BR which is authorised and regulated by the Financial Conduct Authority. Please refer to our latest Full Prospectus (which includes information in relation to the use of derivatives and the risks associated with the use of derivative instruments), Key Investor Information Documents and latest Annual or Semi-Annual Reports for more information on our funds. This information can be obtained by contacting your Financial Adviser or using the contact details shown above.

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