From Goldilocks to Reflation

#SICM18 @Schroders_UK

Economic Outlook - From Goldilocks to Reflation Schroders Investment Conference 2018, Manchester Azad Zangana, Senior European Economist and Strategist 22 May 2018 From Goldilocks to reflation Latest economic themes and questions

Global: Moving from Goldilocks to reflation – can risk assets cope?

Trade wars: A serious risk for the global economy

UK: Navigating Brexit

Source: Schroders Economics Group.

1 Global overview From Goldilocks to reflation – can risk assets cope? Thinking about the business cycle How do we define the different stages of the economic cycle

Recession / Recovery Disinflation Output below Output below trend trend and rising, and falling, growth growth decelerating, accelerating, inflation falling Inflation falling

Expansion Slowdown / Output above trend Stagflation and rising, growth Output above trend accelerating, and falling, growth inflation decelerating, rising inflation rising

40% 24% 20% 16%

Percentages refer to share of time in each stage of the cycle since 1974. Source: Schroders Economics Group.

3 Global growth has surged since 2016 Leading indicators for the G7 suggest a continued acceleration in growth

%, y/y 15

-5

-10

-15

-20 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Recovery Expansion/ Reflation Slowdown/ Stagflation Recession/ Disinflation G7 Industrial production, % y/y Global activity indicator, 3mMA (normalised)

Source: Thomson Datastream, Schroders Economics Group. 4 May 2018.

4 Inflation pressures are also building Producer prices in the G7 and China suggest higher CPI inflation to follow

%, y/y 10

-2

-4

-6

-8

-10 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Recovery Expansion/ Reflation Slowdown/ Stagflation Recession/ Disinflation G7 CPI G7 PPI China PPI

Source: Thomson Datastream, Schroders Economics Group. 4 May 2018.

5 US fiscal stimulus set to boost GDP growth Impact of Tax Cuts & Jobs Act (2017) and the Bipartisan Budget Act (2018)

Impact on the budget deficit Impact on GDP growth

Budget deficit (% of GDP) Real GDP growth, % 6% 3.0 +0.2 5% 2.5 +0.4 +0.4 2.0 4% +0.1 +0.3 3% 1.5

2% 1.0

1% 0.5

0% 0.0 2016 2017 2018 2019 2020 2021 2022 2016 2017 2018 2019 2020 Current law New spending bill (BBA, 2018) Impact of lifting secquester caps Impact of BBA New spending bill without sequester caps Impact of Tax Cuts & Jobs Act Underlying growth

Source: Oxford Economics, Congressional Budget Office, Schroders Economics Group. 2 March 2018. Forecast risk warning: Please see the information slide at the end of this presentation.

6 Has the recovery in the eurozone peaked? Some loss in momentum in the eurozone, but overall growth remains strong

6% 6%

4% 4%

2% 2%

0% 0%

-2% -2%

-4% -4%

-6% -6% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Eurozone GDP growth, Y/Y Belgian National Bank survey (standardised) Markit PMI, EZ Composite (standardised)

Source: Thomson Datastream, Markit, Belgian National Bank, Eurostat, Schroders Economics Group. 4 May 2018.

7 Higher inflation means rising interest rates Schroders interest rates forecast

Main policy interest rate (%) 6

-1 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Fed BoE ECB Schroders' forecast OIS forward curve

Source: Thomson Datastream, Bloomberg, Schroders Economics Group. March 2018 forecast. 4 May 2018. Forecast risk warning: Please see the information slide at the end of this presentation.

8 Trade wars A serious risk for the global economy Trade wars: US vs. China Limited impact from proposals so far

Share of Chinese exports by destination Share of US exports by destination

4% 4% 6%6% 19%

34% 2% 19%19% 2%

48% 48% 2% 2% 18%

17% 26%26%

Africa Asia US US (tariff) Europe LatAm Other China China (tariff) EU NAFTA RotW

Source: Thomson Datastream, Schroders Economics Group. 4 April 2018

10 Spill over effects A trade war between the US and China will impact third parties

% of GDP*

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

USA

Italy

Peru

Chile

India

Spain

Brazil

Israel

Japan

China

Korea

Russia

France

Turkey

Poland

Austria

Taiwan

Mexico

Ireland

Finland

Canada

Vietnam

Belgium

Thailand

Hungary

Malaysia

Australia

Germany

Colombia

Indonesia

Singapore

Philippines

South Africa South Netherlands

Value added from Chinese exports to the US Value added from US exports to the China

Source: OECD TiVA, Thomson Datastream, Schroders Economics Group. 6 April 2018. *Estimates based on 2011 data

11 A wider trade war would be a disaster for EM growth Many EM countries are highly leveraged to global trade

%, y/y Exports % GDP

40 80 90

80 30 60 70 20 40 60 10 20 50 0 0 40 -10 30 -20 -20 20 -40 -30 10

-40 -60 0

05 06 07 08 09 10 11 12 13 14 15 16 17 18

IDR

INR

TRY

CLP

BRL

ZAR

PLN

PEN

THB

PHP

CNY

HUF

RUB

COP

MYR

KRW

TWD MXN EM export values MSCI EM EPS

Source: Thomson Datastream, Schroders Economics Group. 6 April 2018

12 Are equities under threat? US equity P/E ratio suggests valuations are stretched

MSCI-US reported price-earnings ratio 35

25 1 SD=21.9 Equities overvalued

20 Avg. 16.4

10 -1 SD=10.8 5 Equities undervalued

0 50 54 58 62 66 70 74 78 82 86 90 94 98 02 06 10 14 18

Data based on MSCI US index. Source: Thomson Datastream, Schroders Economics Group. 4 May 2018.

13 Equities appear to be well supported by growth Earnings growth has been the key driver of returns, but the market is derating

%, Y/Y 120%

100%

80%

60%

40%

20%

-20%

-40%

-60%

-80% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Dividend growth Rerating (change in P/E ratio) EPS growth Total returns

Global equities calculated by Datastream (7,048 stocks). Source: Thomson Datastream, Schroders Economics Group. 4 May 2018.

14 UK Coping with Brexit Brexit negotiations to move to phase II A broad agreement reached on citizens’ rights, Northern Ireland and the divorce bill

The 8 December agreement on citizens’ rights, Northern Ireland GBP: the Brexit barometer and the divorce bill paves the way to begin phase II of negotiations, which will include a framework for trade. 5 1.16

Northern Ireland is not fully resolved yet, but a commitment to maintain the 1998 peace accord could lead to a softer Brexit, 0 possibly EEA membership. 1.14

The UK still believes it can get a bespoke deal, with a full -5 withdrawal from the single market and separate trade deal for tariff free access. 1.12 -10 Some restrictions on migration are politically necessary for the UK, along with repatriation of power from the ECJ.

-15 1.1 A 21-month transition period has been agreed, but the terms have Oct 17 Nov 17 Dec 17 Jan 18 Feb 18 Mar 18 Apr 18 May 18 not been finalised, and is subject to the Irish border solution. Google Trends: Soft - Hard Brexit GBP/EUR, rhs

Source: Schroders Economics Group. 4 May 2018.

16 That sinking feeling – the Brexit effect so far The UK has slipped from top of the G7 growth league to bottom

Source: Thomson Datastream, Schroders Economics Group. 20 April 2018.

17 House prices continue to slow Range of house price indices

House prices (Y/Y) House prices (Y/Y) 15% 15%

10% 10%

5% 5%

0% 0%

-5% -5%

-10% -10%

-15% -15%

-20% -20% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Range of houseprices Average of surveys

Source: Thomson Datastream, ONS, Halifax, Nationwide, LSL/ACAD. Schroders Economics Group. 4 May 2018.

18 Strong growth to continue to support risk assets Key questions

As the global economy moves from goldilocks to expansion, higher interest rates will challenge further gains in risk assets

Strong growth can support earnings further, but as bond yields rise further, equity valuations will put prices under pressure

The fiscal stimulus package in the US could be very powerful for growth

Europe has lost some momentum recently, but temporary factors are probably to blame

Brexit details have to be finalised by the Autumn, expect more volatility

The UK economy will continue to struggle, but will this stop the BoE?

Concerns over trade wars are likely to persist, and may dampen confidence and growth

If trade wars escalate, many third parties will be impacted

Emerging markets look healthy, but a strong US dollar could hurt risk assets

Source: Schroders Economics Group.

19 Thank you Disclaimer

Marketing material for professional investors and advisers only.

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.

Schroders has expressed its own views and these may change. The data contained in this document has been sourced by Schroders and should be independently verified before further publication or use. This presentation is intended to be for information purposes only and it is not intended as promotional material in any respect.

The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Unit Trusts Limited (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors.

Issued in May 2018 by Schroder Unit Trusts Limited, 31 Gresham Street, London EC2V 7QA. Registered No. 4191730 England. Authorised and regulated by the Financial Conduct Authority. UK12846