As if last year’s Brexit vote wasn’t enough to demonstrate the UK’s political unpredictability, Theresa May’s recent gambit to increase her parliamentary majority backfired in spectacular fashion. Jeremy Corbyn’s Labour party nearly overcame a lead measured at 25% less than two months before the election to spoil May’s victory. She was forced to form a parliamentary coalition with the Northern Irish Democratic Unionist Party in order to form a majority and avoid a hung parliament. This weakens her hand in Brexit negotiations and will force her to steer the UK more towards a “soft Brexit” than a “hard Brexit.” The hardline conservatives which make up much of her party will refuse to support such a shift, and she risks losing a vote of no confidence which would remove her from power. What a mess.
On the other side of the Channel, the political environment could not be more different. Emmanual Macron has secured a landslide victory in French parliamentary elections, winning 350 seats in the 577 member National Assembly. This gives him a mandate to pursue his policy agenda. With French and German policy philosophies in strong allignment, the political will is now in place to institute meaningful reform to promote economic and financial stability in the Eurozone.
Meanwhile in the US, we continue to be concerned about stagnating corporate credit creation. Typically businesses curtail borrowing after a yield curve inversion (when short-term rates are higher than long-term rates). An inverted yield curve indicates that borrowing costs are greater than long-term returns on capital. However, despite some recent flattening, the yield curve remains steep by historical standards. Furthermore, financial conditions are supportive of continued economic expansion. We therefore do not expect a sharp deterioration in US economic activity this year, but will keep a very close eye on this important indicator that is now flashing yellow. As a result, we continue to favor international equity over the US.
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*Some Emerging Markets allocation overlaps with regional allocations.
**Individual account allocations may differ slightly from model allocations.
^Excluding GTA’s 7% alternative and cash positions.
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