Against a rather mixed backdrop, global growth has been improving. Some call this the ‘Goldilocks’ macroeconomic environment, where inflation and wage growth seem to be kept in check, allowing corporate profitability to surge and global GDP forecasts to rise to 3.7 per cent for 2018 (according to the International Monetary Fund). 
Volatility remains stubbornly low despite clear risks. This has been surprising against the backdrop of rising geo-political uncertainty, such as an escalation in the North Korean missile fracas, other geo-political complications, the rise of populist politics or of central bank policy surprises.
On the one hand this lower volatility might appear supportive of positive market returns, but on the other it could be interpreted as a potential sign that markets are not pricing in risk appropriately, so a degree of caution should be attached to this level of market indifference.
Up until now, there has been no urgency for the US Federal Reserve (Fed) to hike interest rates materially or to reduce the level of quantitative easing (QE), as it needs to inflate the economy to reduce the massive pile of government debt it currently holds. But the build-up of debt is becoming unpalatable, leading the Fed to begin balance-sheet normalisation – or tapering – of QE towards the end of the year.
There is a lingering concern that inflation remains low despite strong employment and that the Phillips curve – the long-established relationship between unemployment and inflation – is broken.
In Europe, economic data continues to strengthen and is why the president of the European Central Bank, Mario Draghi, has flagged a desire to trim the bank’s asset purchases too, in effect the beginning of the end of quantitative easing for Europe.
Emerging markets lead the way, whilst Asia-Pacific ex Japan and North America lag
Emerging markets have led the country performance table over the past six months, driven largely by China. This region was closely followed by Europe, which built on earlier strong returns to leave it the best performing developed market year-to-date. Here we have been building weightings as we look to take advantage of an economic recovery that is at an earlier stage than in the US.
Of the larger markets, Pacific ex Japan has been the worst region in absolute terms, followed by North America which struggled to make a positive absolute return over the period. However, we are confident that, in aggregate, the holdings exhibit attractive (improving) growth and value despite the short-term weakness. That said, we have been reducing exposure to the more expensive names over the past months, in favour of cheaper valuations in Europe.
In terms of sector performance, IT was by far the strongest and financials, in particular banks and diversified businesses, have produced strong returns for the fund.
We also believe that the European banking sector looks interesting, as we have largely passed the political events that could have caused an increase in volatility, such as the French and German elections.
The sustainability of the current equity market rally is dependent on corporate earnings growth
It is our contention that both the Federal Reserve and the ECB have to tread carefully in normalising monetary and fiscal activity. The economy’s sensitivity to adjustments in interest rates must not be underestimated, and there is a real chance of policy error here.
Policymakers are therefore unlikely to withdraw the stimulus too aggressively, so lower-for-longer interest rates should allow economic growth to build; and the prolonged business cycle should be good for equities, despite their heady valuations.
Much of the equity strength we have seen in recent years has been driven by valuation expansion, as investors have agreed to pay a greater multiple of the level of profits generated.
This is unusual, as the longer-term drivers of equity returns are dividends and corporate profits. We therefore believe the sustainability of the current equity market rally is dependent on corporate earnings growth. However, against this backdrop of chronically low rates, equities offer investors their best opportunity for accessing returns.
Mark Whitehead is portfolio manager of Securities Trust of Scotland. The views expressed above are his own and should not be taken as investment advice.