The European Central Bank kept a cautious tone in last week’s policy meeting, where Mario Draghi stressed the importance of keeping monetary easing measures on standby, for any significant weakening in economic data.

Having said that, tapering will be up for discussion in the coming policy meetings, so long as economic data remains supportive. The pace at which the ECB would most likely consider such a move would be a very gentle one, for the purpose of not undermining all the positives that easing measures have had on the economy to date.

The economic cycle has historically ranged from a few months to a decade long. Economies generally go through expansionary phases, before peaking and subsequently falling into recession. A cycle would then repeat itself when a recovery kicks in, for a time frame that can range considerably depending on policy measures, economic data and demand and supply conditions in an economy.

The current global environment has economists split on the direction of financial markets over the next few quarters.

Historically, in a booming economy, as employment and productivity increase, wages and consumer prices, for a given increase in demand, also increase.

The situation in the US and the Eurozone, however, is one of weaker than expected inflation. Inflation is the driver of higher prices and ultimately causes central banks to tighten policy measures when an economy shows signs of overheating.

A bit of inflation is beneficial, but too much then hinders purchasing power and can potentially trigger a currency crisis when a nation’s currency becomes expensive.

Both the EU and the US are yet to reach their inflation targets and questions are arising on whether these will be achieved at all. The International Monetary Fund has in fact this week recently lowered the US growth outlook for 2017 to 2.1% from 2.3% along with that of the UK.

What is hindering inflation?

Core inflation seems to be faring well, yet it is the headline inflation figures, which includes volatile factors such as energy that appears to be keeping global inflation growth relatively subdued.

Concerns have emerged on whether a production cut agreement reached by OPEC will be offset by continued drilling and supply in the US, in hand with increased use of alternative fuel sources. Results would emerge in sustained oil prices hovering around the $50 a barrel mark and below.

If headline inflation doesn’t pick up, arguments go as far as suggesting a new economic cycle is underway.

In fact, the US is experiencing its strongest rally in equities since the financial crisis of 2008, so much so that technology stocks have surpassed the peak they reached in the Dotcom era.

Consensus goes as far as expecting a continued rally in the asset class given continued attractive earnings yields as compared to the fixed income counterparts whose performance is set to be hindered by interest rate hike policies.

Yet, so long as inflation markers fail to reach their target, equities may be the asset class of choice for a substantial while longer in the midst of a hawkish environment, so long as company valuations and profitability justify some record breaking valuations being seen notably in US technology stocks.

Investors this year are already sitting on attractive profits in the equity space. Locking in those profits or purchasing downside protection may not be an irrational option. After all, all it takes is for a series of missed investor expectations data and/or an unexpected increase in inflation to send markets in correction mode.

It is not a question of if but when a bear market will subsequently follow suit, but so long as inflation and oil prices for that matter are hindered, the next few quarters look promising for a continuation of positive momentum, at least for now.

Disclaimer:

This article was issued by Mathieu Ganado, junior investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt.The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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