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Larry Hatheway on Markets - June 2018

7 June, 2018

Chief economist and head of GAM Investment Solutions Larry Hatheway discusses the risks facing equity markets, whether the US dollar will strengthen from here and what that means for portfolios as well as what we can expect from the Fed over the remainder of this year.

Presently, there are a number of risks posed to markets. First, the outcome of the Italian elections
produced a populist government with anti--EU sentiment, marrying the left and the right together.
Many in Italy feel they have been left behind in the decade since the global financial crisis. Hence, it is
natural that there should be antagonism towards the establishment in Italy and Europe. Given Italy’s
large stock of public debt, the new government’s emphasis on fiscal expansion has rattled markets.

Presently, there are a number of risks posed to markets. First, the outcome of the Italian elections
produced a populist government with anti--EU sentiment, marrying the left and the right together.
Many in Italy feel they have been left behind in the decade since the global financial crisis. Hence, it is
natural that there should be antagonism towards the establishment in Italy and Europe. Given Italy’s
large stock of public debt, the new government’s emphasis on fiscal expansion has rattled markets.

Third, investors are wary that inflation may accelerate in various countries, as that outcome would
prompt a more aggressive response from central banks.

Finally, we can add protectionism to the list of concerns. The US has now imposed tariffs on steel and
aluminium imports against its NAFTA partners and Europe. Retaliation is likely; whether that
escalates into even greater trade frictions will be decisive for equities.

The US dollar has rebounded smartly from its weakness in 2017. A key reason has been weakness in
European economic activity, as well as in the emerging markets, which has not been matched in the
US. That growth discrepancy has driven the dollar higher. My sense, however, is that the dollar’s
rebound is unlikely to continue, in part because weakness in European growth earlier this year was
probably seasonal owing to Q1 weather, flu and holiday effects rather than to anything more
fundamental.

As growth in Europe re-accelerates the dollar ought to peak in currency markets. However if it does
not, and other factors such as populism in Western Europe drive the dollar even stronger, the impact
is likely to be profound for multi-asset portfolios. In particular, emerging debt and equity markets are
most vulnerable to dollar strength.

At the upcoming Federal Reserve meeting investors widely anticipate, as do we, a further 25bp rate
hike. The market also discounts a similar hike for September and rising odds of a December move as
well. We agree. US growth remains resilient, job formation is above trend, wage inflation is edging
higher and core price inflation is already at the Fed’s target. Although the Fed has said it would
accommodate a modest inflation overshoot it has also communicated a message that it sees the need
for 3 further hikes this year, followed by more tightening in 2019.

Provided inflation does not move much above the 2% Fed target, rate hikes can be absorbed by the
market. They are already anticipated in market pricing. The Fed remains an important factor, but more
important is the course of inflation. Inflation has the ability to disrupt everything, which is why it merits
particular attention.

The views expressed are those of Larry Hatheway (Group Head of GAM Investment Solutions and Group Chief Economist, GAM).

June 2018

Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. Allocations and holdings are subject to change.

Larry Hatheway on Markets - June 2018

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