So far 2019 has been an interesting, eventful and in many ways, unusual year. Political uncertainty, poor economic growth expectations, muted inflationary pressures, fears about a worldwide recession and ever lower, sometimes negative, interest rates have dominated headlines.
We have yo-yoed between US-China trade wars and truce. Amid political deadlock in the UK we have a new Prime Minister, but one who is clinging to Office following the recent unanimous ruling in the Supreme Court that his decision to prorogue Parliament until mid-October was unlawful.
We have had political chaos in Italy and riots in Hong Kong and sadly in the last few days of September the collapse into administration of global travel group Thomas Cook after 178 years in business. Described as “an analogue business model in a digital world”, Thomas Cook was unable to meet its massive debt liabilities.
Investors could be forgiven for hoping we have reached a nadir but perhaps this truly is just the start of a revolution.
Global stock markets started January in the doldrums; only to rally through Spring and early Summer, falter in August and then recover again in September. Financial commentators have mixed views about where stock markets go from here and, as ever, it really is anybody’s guess.
A guess, however, would have a better chance of success if we knew where bond yields were heading. A bond yield inversion, where short term rates are higher than long term rates, happened to much dismay in August. This by any measure is an unusual but not an unknown event and is viewed by many as a predictor of recession. Some bond market “experts” have, however, forecast more recessions than we have lived through!
In recent weeks we have seen a reversal of this inversion as yields on longer dated securities have now recovered, although not yet normalized. This has resulted in a corresponding fall in bond values and a steepening of the yield curve which is an encouraging sign for equity markets as it suggests fears of a recession have been overblown.
As we begin the final quarter of the year, in this commentary, we take a closer look at events so far this year and see how they could continue to influence global stock markets.
We have a new Prime Minister in Boris Johnson and a new pro-Brexit cabinet, but still no idea as to whether or when we might reach an agreement with the European Union before the deadline on 31st October. Our Prime Minister has been unable to force an early election, a law has been elected to stop a no-deal Brexit and he has now been humbled by the courts. His instinct, however, will be to tough out this latest setback and he appears convinced that the only way out of the predicament is to secure a Brexit deal in Brussels later this month. A bright spot, therefore, is that Brexit in one form or another might still happen at the end of October and this, hopefully, will result in the removal of uncertainty to business confidence.
Brexit has been dragging on for more than three years now and the uncertainty is taking its toll on our currency, businesses, stock markets and now consumer confidence. Few investors see the UK as an attractive place to invest and there is a danger the economy could slip into recession.
However, the economy may have slowed but wage and employment data remain positive. Wage growth reached an 11 year high of 3.9% in the year to July. The number of people employed is at its highest since 1971, with close to 33 million in employment, 425,000 more than a year earlier.
As we await an outcome of Brexit, investors are finding it hard to know what to do. A No Deal or hard Brexit could send the pound plummeting further, which would give an artificial boost to the big UK dollar earning companies. In contrast, this could hit domestic companies badly.
However, recognizing when sentiment and fundamentals diverge is the basis of good investing and by most metrics, the UK stock market is the cheapest market in the developed world. The very simple reason is Brexit and the near hysteria of some commentators about the consequences of a no deal exit. Investors need to assess the fundamentals to determine whether this is justified but the extent of inward investment and foreign takeovers would suggest those outside these shores have more confidence.
But could our domestic doomsayers be right? The answer to this important question will help investors determine whether the UK market remains unloved or represents the buy of the decade. Britain might be stuck in an increasingly chaotic Brexit nightmare but even if a damaging no deal exit becomes a reality, life, and well-run companies, will carry on. This is something recognized by billionaire Hong Kong investor Li Ka-Shing with his £4.6 billion takeover bid for brewer Greene King. Any sort of good news could see an unloved UK stock market rally strongly.
In the meantime, investing in a sensible mix of different types of businesses and funds seems a prudent approach. Different asset classes often perform differently under various market conditions, so diversification is the key.
2. TRADE WARS
Trade tensions between the US and China remain a key risk to the global economy. This is because the US and China are the two great engines of the global economy and markets are hypersensitive to the perceived progress in trade talks.
Much of President Trump’s time this year has been spent baiting the Chinese about trade wars. Every time the US impose trade tariffs, global growth outlook and stock markets tend to fall. Likewise, every time President Trump backs off, stock markets rally. Donald Trump is seeking re-election as US President in 2020 and there is little incentive for him to be overly aggressive before Autumn next year although there may be some tough talk in the meantime.
Although the US-China trade dispute is a key risk for markets, it must be highlighted that China only represents about 7% of total US exports. In contrast, about 12% of US exports go to Mexico, 14% to Canada and 23% to the European Union. It might only be a matter of time before President Trump turns his attention on Europe.
But for now, the never-ending trade dispute between the US and China suggests the era of globalisation is over and that the world is becoming more local and regional. It’s obvious the major global trade related industrial sectors are set to suffer from this trend but what is often ignored is that the era of de-globalisation will have long term benefits across many industries such as the new energy economy, industrial automation and robotics.
De-globalisation has become a major market theme around trade wars but here at Clarion we think it is wise to think beyond the immediate negative impacts and seek out positive opportunities from a reconfiguration of the world economic system. In this environment, investment diversity will once again be key. There are no winners in a trade war, but some countries, sectors and companies will fare better than others. The right mix and selection of funds is more important than ever before.
A further point to note is the momentum behind climate change concerns with sustainability growing rapidly over the past couple of years. Globally, companies and individuals are waking up to the pressing issues and finally starting to do something about the problem. Environmental, Social and Governance (ESG) investing is growing in popularity but it is important that these principles do not undermine diversification.
Our planet has given us deadlines, so while we are very much at the beginning of our journey in making the necessary changes, the clock is ticking. Companies that are at the forefront of solving the problem could do very well in the future.
3. INTEREST RATES
A major influence on savings and investments is interest rates. Since the financial crisis, interest rates across the world have been slashed and, in some parts, have even turned negative. Negative yielding government debt recently hit a new record of $17 trillion and the yield on 30-year US government stock temporarily went below 2%.
In Germany and Japan, yields on 10-year government bonds fell below zero. At one point all of Germany’s government bonds had negative yields. Denmark even had a bank offering a negative interest rate mortgage. It is bizarre when ‘investors’ are willing to pay for the pleasure of lending money! This just shows that investors are finding it difficult to know what to do with their money.
It looks as though this situation will only get worse as according to Goldman Sachs Asset Management, not a single central bank around the world is currently raising interest rates. Instead, they are all either keeping them on hold or cutting them. Why? Because global growth is slowing, and central banks are worried that it might slow so much that we will have a global recession.
As soon as there are signs of trouble, central banks step in to try and keep their economies expanding. There are no signs of this changing and little sign of interest rates returning to ‘normal’, perhaps for another decade or even longer.
The hunt for income producing investments is set to continue which will see bonds and dividend paying equities become ever more expensive providing opportunity for active investors.
The Eurozone is showing signs of moving towards a recession. Inflation as measured by the Consumer Price Index (CPI) slowed from 1.3% on an annualised basis in July to 1% in August. A year earlier it was 2.2%. This decline takes the level of inflation further away from the European central Bank’s (ECB) target of 2%. With weak growth in the Eurozone, the ECB recently unveiled its highly anticipated monetary stimulus package and urged Governments in the Bloc to act quickly to revive flagging growth by introducing fiscal stimulus.
The ECB cut interest rates further into negative territory and revived its €2.6trillion program of buying bonds for an unlimited period. The ECB also eased lending terms for eurozone banks and offered them tiered interest rates to ease the pressure on lending margins.
The biggest loser from de-globalisation is unfortunately Europe. Exports from Germany have been a big economic driver for some time. These exports have, in recent years, predominately been directed towards China but the slowdown in China is in turn causing economic weakness across Europe. And as Europe has always had a relatively weak domestic consumption sector there is a suggestion that fiscal policy might be necessary to revive economic growth.
For now, at least, we remain underweight to Europe in our Portfolio Funds and model portfolios.
5. HONG KONG
In August, over a million people (approx. 20% of the total Hong Kong population) attended protests against a Repatriation Bill introduced by the Chinese governing body. Hong Kong enjoys a disproportionately important place in the global economy because of its role as a ‘super connector’ between China and the rest of the world. The Province’s developed capital markets and legal infrastructure act as a valve through which foreign capital can be funneled into China, and vice versa. The political protests are not only damaging to the Hong Kong economy but also to China as well. A measure of stability was restored in early September only for riots at Hong Kong airport to erupt again towards the end of the month.
Finally, there is technology. The sector has been leading the charge in terms of stock market gains for several years now and many people believe that the scale of disruption being caused by technology today actually amounts to our fourth industrial revolution.
Technology touches every single area of our lives and so has the ability and potential to touch every sector of business. A couple of years ago there was no Alexa – in the future, it has been joked, she could be cited in divorce cases. Artificial Intelligence is now being used to scan data to help with targeted medication, robotics is helping an ageing Japanese population work longer and Facebook is launching Libra, its own digital currency.
What technology and our world will look like in five years, let alone 25 years, is anyone’s guess, but being invested in the disrupters will surely pay handsomely.
The global economy is in the process of slowing down and one or two major economies, particularly Europe, are in or very near recession. Economies and markets are likely to be supported by central banks utilizing loose monetary policy which could result in additional Quantitative Easing (QE) and even lower interest rates as we have just seen from the European Central Bank and the Federal Reserve Bank of America. Some developed countries’ governments may also support their economies through expansionary fiscal policy
We live in uncertain times but as always, uncertainty brings opportunity. Clarion’s ongoing fund research unearths fund managers with the ability to capture the growth prospects provided by the unusual but exiting times which lie ahead.
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