By Johanna Kyrklund, Group Chief Investment Officer and Co-Head of Investment at Schroders

Over the second quarter, economic data continued to confirm our expectations of a soft landing, with activity remaining positive and inflation moving in the right direction.

Global investors have found plenty to worry about in recent newspaper headlines. From surprise elections to sticky inflation, plus “known unknowns” like the US Presidential election, it all adds up to a complex environment to negotiate. Being able to cut through the noise, and focus on what’s most material for markets, is essential.

A number of major central banks have started to cut rates – Swiss National Bank, Bank of Canada and European Central Bank. We expect the Bank of England to join them this soon while the US Federal Reserve will likely wait until slightly later in the year. This supports our positive view on global equities, particularly as corporate earnings are also coming through. The narrowness of global equity market performance, with technology stocks powering this year’s gains, is a source of concern, as are relatively elevated valuations (particularly in the US). However, valuations in the technology sector continue to be supported by strong revenue momentum and positive operating leverage (i.e. revenue growth outstripping cost growth).

With interest rates starting to fall, emerging market equities are looking more compelling. Many emerging economies have brought inflation under control, are running prudent fiscal policy and benefit from the manufacturing recovery that is currently under way.

As we came into the year, there was a lot of concern about elections. We have stated before that politics matter but they tend to play out over months and years rather than days. In many cases, the results have indicated frustration with the incumbents - think of South Africa, India, France and, of course the UK. This is consistent with an environment where the political consensus is being challenged.

And as a consequence, as we have highlighted before, we think this will lead to fiscal policy being looser and monetary policy being tighter. This is a shift from the regime of the past decade which was characterised by tight fiscal policy and loose monetary policy.

Of course, the most important election from a global perspective is still ahead of us with the US heading to the polls in November. Protectionism is likely to remain a feature of US policy whoever wins. Immigration policy could be important in the context of wage growth, particularly because labour markets are still buoyant.

The possibility of a Republican clean sweep (winning both houses of Congress as well as the presidency) does raise concerns about more expansionary fiscal policy which could point to higher yields at the longer end of the yield curve as investors worry about the sustainability of the fiscal deficit.  

This is one of the reasons why we do not view government bonds as offering the same diversification benefits that they used to. However, interest rate cuts should underpin yield curves and there is still a significant role for fixed income as a source of yield in portfolios - what I call the old-fashioned reason for owning bonds.

My teenage son typically accuses me of over-thinking but this year we have kept it simple and, so far, it has paid off; a benign environment for growth is supportive of equities. And inverted yield curves, where shorter-term rates are higher than longer-term, mean that in bonds it still pays to wait for better levels or more tangible signs of recession risk.

As ever, it’s important to focus on the fundamentals, not the newspaper headlines.