Market and Economic Commentary August 2019

In “Jerry Maguire”, a film about a sports agent, the hero’s client demands to be shown “the money”. The agent finds himself dancing to the tune of the only man he represents. And so, it is with stock markets which at the moment are obsessed with how Central Banks will react to slowing growth and political uncertainty and are dancing to the tune of cheaper money and the possibility of a fresh round of quantitative easing.

Politics and geopolitical events continue to influence both investment markets and Central Bank policies. The trade dispute between the US and China continues to simmer despite a promising meeting between President Trump and President Xi Jinping at the end of June. The two sides have been “cautiously showing each other sincerity and goodwill” according to recent reports in a Chinese state-owned economic daily newspaper. In China’s eyes, the US exclusions from punitive tariffs imposed on some Chinese goods and a push to allow American companies to supply Huawei Technologies Co were positive signals to advance the trade negotiations. The US also backed away from imposing additional tariffs on Mexico.

There are increasing concerns that tariff increases are slowing world trade and threatening economic growth. Central banks are in sharp focus, with both the US Federal Reserve and the European Central Bank indicating that they will take action to support growth in the form of interest rate cuts and monetary stimulus.

In the UK, the contest for Conservative party leader, and therefore Prime Minister, was whittled down to two. Boris Johnson, having been clear favourite throughout the contest, has finally triumphed. Mr Johnson has promised to deliver Brexit come what may by 31^st October 2019 and has pledged to promote economic growth and become “the most pro-business Prime Minister in history”. With the possibility of a “No deal” Brexit in sharp focus currency markets are in heightened volatility mode and sterling is at multi-year low against the dollar and the euro; painful for holiday makers going abroad but good for Corporates with high overseas earnings.

Stock markets having recovered from the losses of 2018 with low double-digit returns in the first half of 2019, have traded sideways on limited volatility in recent weeks. As noted in previous updates, stock markets are polarised with companies earning high returns on capital and those offering reliable or high growth trading at unusually large premiums to the rest of the market. In this environment it is possible to find sound businesses, with robust market positions and long-term prospects, trading on low, or in some cases very depressed valuations. The UK market remains deeply out of favour, only trading on a higher dividend yield relative to UK government bonds once in the last 100 years.

Investors in stocks and shares should always be aware that ‘Mr Market’ is a manic depressive prone to swings from the extremes of pessimism to optimism and visa-versa. Greed might be the dominant emotion among investors for a while but, sooner or later, it is likely to be replaced by fear. And the opposite remains true also.

Over the long term, share prices tend to follow fundamentals so it is logical that sales growth and margin expansion are the key drivers of investment returns. Currently we are in a Goldilocks state where both margins and sales are expanding at a steady pace. Fear and greed are equally balanced, and markets are neither “too hot nor too cold” with only mild swings in direction but trending gradually upwards.