Q3 2017

Risk assets continued to perform well in the second quarter with strong gains to be found in Europe, particularly the peripheral equity and bond markets such as Italy and Spain. These returns were enhanced for international investors by an appreciation in the euro as capital flowed back into the region.

The catalyst was the election of Emmanuel Macron as president of France, an outcome which quelled concerns of a populist revolt in a country seen as a bastion of the European Union (EU). In practice France chose not to follow the UK out of the EU and risk political and economic isolation.

Meanwhile, we have seen the further demise of the “Trump trade” as although the US economy would seem to have bounced back in the second quarter, progress on policy has been painfully slow.

We ended the second quarter in much the same way as we ended the first, with Congress delaying a vote on the critical healthcare bill, seen as a prerequisite for tax reform. Nonetheless, with a change in sector leadership, US equities have performed well led by technology and the more defensive quality stocks. We look at the performance of a broad range of assets in our mid-year review (see page 15).

These gains have been accompanied by an unusually low level of volatility and with the VIX index remaining close to all-time lows, many have argued that investors are ignoring risk. We examine the key drivers below and the importance of central bank policy and liquidity (see "Are investors complacent?" page 20).

Political uncertainty has diminished in Europe, but is alive elsewhere. Rumours continue to dog President Trump and whilst it is unlikely that a Republican Congress would impeach one of its own, this may change after the mid-term elections next year, especially if policy gridlock persists.

Brazil has also run into problems with President Temer and we take a look at the behaviour of markets during periods of presidential impeachment (see page 25).

In terms of asset allocation, we have moved to a more neutral stance over the quarter by closing our overweight on equities and our underweight on bonds. Within equity markets we remain positive on Europe ex UK and the emerging markets. Within bonds we have a preference for emerging market local currency debt and remain wary of Bunds and investment grade corporates.

The full document is available as a PDF below.