Markets at crossroads as challenging times ahead

The week ahead will mark the end of the first half of this year, in what has been a very eventful period for financial markets, especially equities, which have surprised many by doing exceptionally well.

Stock markets have been helped by better-than-expected economic and earnings data and hopes that United States President Donald Trump will boost the US economy further through tax cuts and infrastructure spending.

Markets are at the crossroads as valuations are no longer cheap, making them prone to economic and earnings disappointments in the second half of this year.

Possible tighter monetary policy from the major G4 central banks, political risks in the US, Europe and Asia, are other headwinds facing markets in the second half.

For markets to head higher, a few factors need to play out. For one, the optimistic earnings outlook among analysts needs to be validated when companies announce their quarterly results in the second half of this year. The economy should also continue to do well to support the sanguine corporate earnings outlook.

Mr Trump, too, needs to deliver on his promises to cut taxes and increase infrastructure spending to keep optimism alive. However, he faces an uphill task as political partisanship and conflict following his election victory is at a record high.

Indeed, given the current divided state of the US Congress, passing infrastructure spending and tax reforms could be a tall order.

On the political front, the risk of Mr Trump running into domestic political problems and getting impeached cannot be ruled out. Also, he could still pursue protectionism to distract Americans in the face of domestic political problems as he tries to shift focus elsewhere.

The risk of a military conflict between the US, North Korea and China cannot be ruled out, either. In Germany, Chancellor Angela Merkel’s victory in the elections later this year cannot be taken for granted as we learnt from the Brexit vote and the US presidential elections.

In all, the easy money has been made in the first half of this year and a lot of good news has been priced into markets.

This limits upside and makes markets prone to a correction. However, this does not mean that there will be no investment opportunities — investors just have to be selective and diversify across asset classes and over time through dollar cost averaging. Prudence and selectivity will take on new-found importance in navigating uncertain waters ahead.

ABOUT THE AUTHOR: Vasu Menon is Vice President and Senior Investment Strategist, Wealth Management Singapore, OCBC Bank