Our Reviews look back at the markets over the last quarter as well as our thoughts on today's major issues.
April continued the pattern of the early months of 2019 with all the primary global equity markets posting a positive return, largely on the back of a strong performance from US stocks as corporate earnings proved to be better than expected. European markets also delivered notable gains, despite continued concerns over the underlying strength of the region’s economy.
Investor sentiment was boosted by the downbeat tone from central banks following data which pointed to a deteriorating economic outlook, together with seemingly more conciliatory rhetoric surrounding the US-China trade war. The prospect of ‘lower-for-longer’ monetary policy was being viewed as an extension of the huge stimulus that had been injected into the system since the Great Financial Crisis. And it was not just the US Federal Reserve Board adopting such a stance, as other central banks began to press the pause button to stave off the threat of recession.
However, the relative calm in the markets during the first four months of the year was abruptly broken on 6th May when President Trump decided to jack-up to 25% the tariffs on $200bn of Chinese imports, as well as blacklisting some Chinese companies such as the telecoms giant Huawei, thereby scuppering hopes that a trade deal with China was imminent. China immediately responded with its own retaliatory tariffs. This caused market participants to take fright and shelter in so-called ‘safe-haven’ assets as they began to assess the implications for slower economic growth. The situation was further aggravated as the US President threatened higher tariffs on Mexican goods unless Mexico took action to stem the tide of migrants crossing the Mexico-US border. The impact of all this was global equity markets having their worst month of the year, illustrated by the MSCI World Index retreating by 5.70% in local currency terms. Worries over the deteriorating global growth outlook also had a major impact on oil prices which retreated by about 15% during the month.
The final month of the quarter saw a major turnaround as global equities rebounded from May’s lows, boosted primarily by increased hopes of rate cuts by the US Federal Reserve. Weak US jobs and manufacturing data helped to fuel this expectation and, as if to leave no-one in doubt as to the likely direction of interest rates, Mario Draghi, President of the European Central Bank (ECB), announced that interest rates in the eurozone would likely be kept on hold at least through the first half of 2020, and raised the spectre of applying additional stimulus, amid weak manufacturing data and stubbornly low inflation.
Meanwhile, the trade wars continued with President Trump threatening to apply tariffs to a further $300bn of Chinese imports, although the impact on trade sentiment was temporarily cushioned following the US and Mexico reaching agreement on curbing migration to the US. However, commentators noted that the agreement with Mexico should not be interpreted as an indication that the US would reach agreement with China, because the US is far more important to Mexico’s export market – it absorbs 25% of its exports, than China’s export market – absorbing just 3%.
In the days before the G20 meeting in Osaka at the end of June, rumours had begun to flow of the possibility of a US-China trade agreement, perhaps more in hope than expectation, but this, together with the release of soft US inflation data was sufficient to provide a further fillip to the markets as the quarter drew to a close. By the end of June, the US S&P 500 Index had advanced by 17.3%, the strongest first-half performance for the benchmark since 1997.
Investors will welcome the strong market returns so far in 2019, especially as they more than compensate for the losses incurred at the tail end of 2018, but they should guard against complacency creeping in, especially given the slowing global economy and some significant geopolitical headwinds.
|Asset Class||3 Months||6 Months||1 Year||3 Years|
|FTSE All Share||3.3 %||13.0 %||0.6 %||29.5 %|
|S&P 500||6.6 %||18.3 %||13.9 %||53.6 %|
|FTSE World Europe ex UK||8.8 %||17.5 %||7.9 %||42.8 %|
|TOPIX||2.7 %||7.5 %||-2.1 %||33.1 %|
|MSCI Asia ex Japan||1.7 %||10.8 %||3.2 %||45.6 %|
|MSCI Emerging Markets||3.0 %||10.7 %||5.0 %||42.3 %|
|UK Gilts||1.3 %||4.7 %||4.9 %||6.0 %|
|IBOXX Sterling Corp Bond||2.3 %||7.3 %||6.8 %||14.6 %|
|MSCI UK Monthly Property||0.5 %||1.0 %||3.8 %||21.0 %|
|Brent Crude Oil (US$/bl)||1.5 %||24.2 %||-10.9 %||33.4 %|
|GSCI Commodities Index||0.9 %||13.4 %||-8.2 %||10.0 %|
|Gold (US$/ounce)||11.6 %||10.1 %||16.3 %||9.8 %|
Source: FE Analytics - rebased in Pounds Sterling
In our previous Quarterly Update, we commented on ‘inverted yield curves’ (where long-term debt becomes cheaper than short-term debt) and that their occurrence was often taken to be a signal of a forthcoming economic recession, evidenced by the fact the US yield curve has inverted ahead of every recession over the past five decades. We suggested that a sensible approach is to acknowledge that the recent flattening of yield curves has, at the very least, been indicating a slowdown in global growth, and that we may be about to experience a period of low growth, low inflation and low interest rates, with implications for markets and the level of returns that investors are likely to enjoy.
However, given that we are three months further on in this economic cycle, it is appropriate to question if we are closer to the likelihood of an economic recession, not least because global trade conflicts have escalated in the intervening period and because the US administration’s willingness to use trade barriers as weapons remains a key risk. Interestingly, some economic commentators believe that it is the business sector’s response, rather than the direct impact of tariffs, which poses the greatest threat to global growth, and that worries of a recession or a bear market are excessive. That said, Capital Economics, a respected economic consultancy, believes that the trade war has already shaved off 0.3% from world GDP (gross domestic product) and that any escalation, to the extent of the US administration’s threats before the recent G20 summit, would likely reduce global growth by a further 0.5%. JP Morgan has just downgraded its GDP growth expectations for the US and China by an annualised 0.5% for the remaining quarters of 2019. Certainly, these numbers do not imply that the global economy is about to tip into recession territory, although it should always be remembered that a large enough shock could throw even healthy economic expansion off course.
The deteriorating outlook has resulted in the Fed adopting a dovish policy creating the expectation that interest rates will shortly begin to reduce, and this has been a key factor in shoring up confidence and boosting risk assets.
Looking at the recent weakness in economic data there is certainly cause for concern but some commentators question if lower interest rates solves the problem. Interest rates have been the primary tool used to nurse the global economy since the Great Financial Crisis as the central banks of advanced economies have sought to achieve a nominal 2% inflation target. But the fact that inflation has been so weak for so long suggests that it cannot be explained solely by the economic cycle, and that there must be other factors at play such as demographics and globalisation over which central banks have little control.
Furthermore, although looser monetary conditions generally stimulate economies, some economists question if this form of stimulation alone leads to sustainable economic activity and that governments have an important part to play. In summary, this means monetary policy working in tandem with fiscal policy, and the application of just the former tends to lead to ‘sugar highs’ causing risk assets to rally. We saw this recently when dovish language from the ECB caused government bonds to rally (setting a new record for the amount of negative-yielding European debt) and similar language from the Fed caused the yield on the US 10-year Treasury to fall to less than 2%. The equity markets also rallied, but this was not based on the expectation of stronger corporate earnings.
We all love a stock market rally, but the extent to which markets appear to react (both up and down) to media headlines should be a cause for concern, or at the very least, vigilance. After all, we want to try and protect the good first half of the year for stocks from turning into a rotten second half.
So, what does all this mean for asset allocation and stock selection?
In March, we marginally increased our weighting in equities, but effected some more substantive changes reducing our exposure to continental Europe in favour of an increase in our exposure to the Asia Pacific, Emerging Markets, US and UK equity markets.
We confess to being a little surprised by the strength of the European equity market this year given the region’s poor economic fundamentals, and, although we continue to retain some exposure to the region, we are not minded to revert to the level that we held at the start of this year. Our decision to increase our exposure to the Asia Pacific region and the Emerging Markets sector was based on the belief that the US dollar would depreciate in 2019 thereby aiding these economies, together with an expectation of a steady improvement in the Chinese economy. We increased our exposure to the US equity market based on the continued strength of its economy; we increased our exposure to the UK market based on its ‘unloved’ status, largely because of Brexit uncertainty, and the likelihood that sterling would weaken further thereby benefitting UK-listed companies with a large percentage of overseas earnings.
These changes have proved largely beneficial, but we felt it appropriate to make some further adjustments to our portfolios at the end of June given our views on the current outlook. These are summarised below:
|Alternatives||increase in Defensive, Conservative and Cautious portfolios|
|Property||decrease in Defensive, Conservative and Cautious portfolios|
|Fixed interest||no change|
|Japan||decrease in Adventurous and Global Opportunities portfolios|
|Asia Pacific & Emerging Markets||decrease in Balanced, Adventurous and Global Opportunities portfolios|
|Global||increase in Cautious, Balanced, Adventurous and Global Opportunities portfolios|
These changes are broadly mirrored across our Core, Passive and SRI portfolios.
Risk warning: Investors should be aware that past performance of investments is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them may fall as well as rise. The content of this bulletin is for general information and reﬂects the general market view of Parallel Investment Management Ltd. - it should not be interpreted as recommendations or advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of the content.