# Fundamental economic backdrop remains supportive to financial markets and corporate earnings Author: Pal Sinha, Barnali Author URL: https://financedigest.com/author/pal-sinha-barnali Published: 2017-04-18 Category: BUSINESS Category URL: https://financedigest.com/category/business Meta Title: Navigating the Current Fading Reflation Trade Meta Description: Gain insight from Investment Director Michael Stanes on market trends, including reflation trade, corporate earnings growth, and global economic outlook. URL: https://financedigest.com/fundamental-economic-backdrop-remains-supportive-to-financial-markets-and-corporate-earningshtml ![undefined](https://prod.superblogcdn.com/site_cuid_cm5qst7v3003gwirgwqtxn8i8/images/img0135-1942-1736843930553-compressed.jpg) By **Michael Stanes,** Investment Director at Heartwood Investment Management Notwithstanding that there has been a recent fading of momentum in the reflation trade, signalled by lower bond yields and the underperformance of certain more cyclical parts of the equity market, we believe the fundamental backdrop remains supportive to financial markets. Markets have come through a quieter period of late, but we view this pause as constructive. [Investors’ expectations had moved too quickly and are now being scaled back](https://www.financedigest.com/exclusive-new-investor-backs-bt-says-fibre-jv-may-not-be-needed-source.html "Exclusive-New investor backs BT, says fibre JV may not be needed – source") to more realistic levels. Economic survey data had reached lofty levels which were unlikely to be sustained due to the trailing gap with real [activity](https://www.financedigest.com/oil-slips-on-china-covid-curbs-weak-factory-activity-data.html "Oil slips on China COVID curbs, weak factory activity data") data. Furthermore, the rolling over of [inflation expectations](https://www.financedigest.com/u-s-consumers-inflation-expectations-highest-in-8-years-ny-fed-says.html "U.S. consumers’ inflation expectations highest in 8 years, NY Fed says") should in time help to relieve the pressure on real incomes and add support to consumption. Overall, [global growth](https://www.financedigest.com/global-growth-headed-down-as-inflation-surge-to-endure.html "Global growth headed down as inflation surge to endure") continues to present a positive picture. The fundamentals remain supportive to corporate [earnings growth](https://www.financedigest.com/bone-growth-stimulators-market-is-expected-to-earn-a-valuation-of-us-2-1-bn-by-2027.html "Bone Growth Stimulators Market is Expected to Earn a Valuation of ~US$ 2.1 Bn by 2027"), which is already seeing improvement. According to FactSet, companies in the S&P 500 reported their first two quarters of back-to-back [profits growth](https://www.financedigest.com/ab-inbev-aims-for-core-profit-growth-of-4-to-8-over-medium-term.html "AB InBev aims for core profit growth of 4% to 8% over medium term") in two years. In addition, plentiful liquidity continues to remain a [key driver of financial markets](https://www.financedigest.com/packaging-and-textile-industries-key-driver-for-digital-printer-market-demand-2021.html "Packaging And Textile Industries : Key Driver For Digital Printer Market Demand 2021"), aided by very accommodative central bank policies. Although our level of conviction in the [economic outlook](https://www.financedigest.com/credit-squeeze-biggest-threat-to-economic-outlook-fidelity-international-says.html "Credit squeeze ‘biggest threat’ to economic outlook, Fidelity International says") remains, we have made no changes to portfolios, remaining modestly overweight risk assets. That being said, our risk exposures are [tilted towards more specific and targeted areas of the market](https://www.financedigest.com/the-mass-spectrometry-market-to-tilt-towards-digitization.html "The Mass Spectrometry Market to tilt towards digitization"), whether by sector or market-cap, which reflect our degree of confidence in the fundamental outlook. We are not inclined to increase risk levels further, as we are mindful of upcoming event risk in Europe, especially the [French election](https://www.financedigest.com/poverty-education-levels-draw-battle-lines-in-french-election.html "Poverty, education levels draw battle lines in French election"), as well as broader geopolitical risks. Furthermore, while markets have paused, there has been no major setback and therefore few compelling broad valuation opportunities. On a final note, we should acknowledge that over the past month the UK government has triggered Article 50, an event that [largely went unnoticed by the markets](https://www.financedigest.com/growth-in-sales-of-fed-microbial-market-to-be-largely-driven-by-rising-consumer-adoption.html "Growth in Sales of Fed Microbial Market to be Largely Driven by Rising Consumer Adoption"). While [Brexit remains a significant event risk](https://www.financedigest.com/brexit-the-risks-to-the-city-and-fintech-have-never-been-greater.html "BREXIT: THE RISKS TO THE CITY AND FINTECH HAVE NEVER BEEN GREATER") in the UK, we believe any fallout will be relatively contained to our domestic market. We reiterate our caution on the UK economy and maintain a defensive home bias positioning. **Equities:** Our [view remains that a modest overweight in equity](https://www.financedigest.com/global-equities-waver-on-inflation-view-as-falling-oil-supplies-lift-prices.html "Global equities waver on inflation view as falling oil supplies lift prices") is appropriate. The reflation trade has lost some momentum around fears of Trump’s ability to implement his reform [plans post](https://www.financedigest.com/uk-plans-streamlined-post-brexit-border-checks.html "UK plans streamlined post-Brexit border checks") the unsuccessful attempt to repeal the Affordable Care Act. We wish to [remain fully invested](https://www.financedigest.com/unregulated-investment-schemes-remain-a-threat-to-investors.html "Unregulated Investment Schemes Remain a Threat to Investors") in the US (and no more given valuations), with more targeted exposure – healthcare being one theme we have recently added. We [remain positive](https://www.financedigest.com/adoption-scenario-of-automotive-bearing-market-to-remain-positive-through-2026.html "Adoption Scenario of Automotive Bearing Market to Remain Positive Through 2026") on Europe, despite the upcoming event risk of the French election, and are encouraged by continuing economic improvements. Japanese equities have delivered lacklustre returns, but we continue to believe that developments in the corporate sector are supportive. We have taken some exposure to small- and mid-cap Japanese equities. Our less [preferred market](https://www.financedigest.com/walk-in-coolers-and-freezers-market-preference-for-customized-and-smart-machines-growing.html "Walk-in Coolers and Freezers Market: Preference for Customized and Smart Machines Growing") is the UK amid signs of slowing consumption, meaningful structural imbalances and Brexit uncertainty. In [emerging markets](https://www.financedigest.com/surgical-masks-market-emerging-trends-and-will-generate-new-growth-opportunities-status-2030.html "Surgical Masks Market: Emerging Trends and Will Generate New Growth Opportunities Status 2030"), we maintain our overweight position but would not add at this point, given recent resilience and possible risk of a trade policy shock out of the US. **Bonds:** The loss of momentum in the reflation trade has benefited [bond markets](https://www.financedigest.com/britains-bond-market-turmoil.html "Britain’s bond market turmoil") through lower inflation expectations, a fall in longer-dated bond yields and support to emerging market debt given a softer tone to the US dollar. A [supportive fundamental backdrop has also helped corporate credit markets](https://www.financedigest.com/engineering-pipe-hanger-and-support-market-estimates-the-to-expand-at-around-4-8-cagr-from-2021-to-2031.html "Engineering Pipe Hanger and Support Market Estimates The To Expand At Around 4.8% CAGR from 2021 to 2031"). Given the hawkish tone of the [Fed minutes](https://www.financedigest.com/shares-choppy-u-s-yields-fall-as-investors-digest-fed-minutes.html "Shares choppy, U.S. yields fall as investors digest Fed minutes") as well as more focus on an ECB exit strategy, we continue to believe that being short duration remains appropriate. Moreover, headline [inflation trends in the UK continue to rise](https://www.financedigest.com/greek-eu-harmonised-inflation-rises-in-september.html "Greek EU-harmonised inflation rises in September"). We hold select exposures to shorter-dated investment grade corporate bonds, specialist lenders and [emerging market](https://www.financedigest.com/analysis-after-sanctions-barrage-russias-emerging-market-allies-explore-workarounds.html "Analysis-After sanctions barrage, Russia’s emerging market allies explore workarounds") sovereign debt. **Property:** UK property developers and listed vehicles have been solid performers this year, supported by better than [expected fourth quarter](https://www.financedigest.com/food-group-danone-raises-2022-outlook-as-third-quarter-sales-beat-expectations.html "Food group Danone raises 2022 outlook as third-quarter sales beat expectations") results and the rally in UK gilt yields. Nonetheless, there are few catalysts that we can see in the shorter term, given [supply concerns](https://www.financedigest.com/oil-edges-up-but-on-track-for-big-weekly-drop-on-supply-concerns.html "Oil edges up but on track for big weekly drop on supply concerns") and uncertainty around Brexit, and we retain our underweight position. On a regional basis, we are primarily invested in cities outside of London, which are less exposed to ‘Brexit’ fallout. Outside of the UK, we are also looking at opportunities in the US REIT ( [real estate](https://www.financedigest.com/real-estate-brokers-vs-agents-which-one-should-you-work-with.html "Real Estate Brokers vs. Agents: Which One Should You Work With?") investment trust) market, although we remain wary of the impact of the Fed’s more hawkish stance. **Commodities:** The lack of [volatility in the oil market](https://www.financedigest.com/analysis-oil-prices-turn-more-volatile-as-investors-exit-the-market.html "Analysis-Oil prices turn more volatile as investors exit the market") came to an abrupt end in the last few weeks, but having fallen sharply prices are now recovering. We continue to expect that an improving global economic environment and a tighter supply/demand balance will ultimately be supportive to commodity prices this year. Direct access to this [market is through owning futures](https://www.financedigest.com/title-n95-mask-market-future-is-set-for-massive-growth-with-high-revenue.html "N95 Mask Market Future is Set for Massive Growth with High Revenue") contracts rather than the physical assets and while the risk/return profiles are looking more attractive across some parts of the complex, they are not yet at levels where we are ready to invest. We have, though, a position gold in some strategies for diversification. **Hedge funds:** While we have held a limited allocation to hedge funds in recent years on concerns around performance, we believe that increasing interest rate divergence should [create more opportunities](https://www.financedigest.com/tire-materials-market-to-create-an-incremental-opportunity-of-us-99-99-bn-by-the-end-of-2028-fmi.html "Tire Materials Market to create an incremental opportunity of US$ 99.99 Bn by the end of 2028 – FMI") going forward. Our preference remains for macro/CTA strategies, but we are also taking a more positive view on equity [hedge strategies](https://www.financedigest.com/fx-hedging-strategies-to-protect-your-business.html "FX hedging strategies to protect your business"), given the greater likelihood of increased stock dispersion (i.e. between [winners and losers), as well as credit long/short strategies](https://www.financedigest.com/the-pound-gilts-and-stocks-likely-winners-and-losers-from-uk-budget.html "The pound, gilts and stocks: likely winners and losers from UK budget"). **Cash:** We have reasonable levels of liquidity across our portfolios both in cash and short-dated bonds, which we willo invest as and when we see specific opportunities. [Market volatility remains low](https://www.financedigest.com/digitized-assimilation-to-drive-the-low-vision-aids-market.html "Digitized assimilation to drive the Low Vision Aids Market"), a situation unlikely to persist throughout 2017. --- This blog is powered by Superblog. Visit https://superblog.ai to know more. ---