Market and Economic Commentary September 2019 – Slowdown or Mid Cycle

The debate about where we are in the global economic cycle rages on, and the range of opinions appears to be widening not narrowing. The US Federal Reserve Chairman believes we are in a “mid-cycle adjustment” yet observers of the trade war between the US and China, the political unrest in Hong Kong or the Brexit situation closer to home, tend to feel more pessimistic.

The US economic expansion following the financial crisis in 2008/09 is the longest since records began in 1857, now surpassing the ten-year boom of the 1990s. Post war expansions have been long because central banks have operated pre-emptive monetary policy to keep demand on track. If it wasn’t for central banks, economic cycles would be dominated by shorter term cycles linked to companies building up and then liquidating inventories. These mini cycles had an average life span of around three years and explain the recessionary false alarms seen in 2012 and 2015 when business confidence was at a low ebb. In both cases a lack of inflationary pressure allowed central banks to ease policy and trigger a recovery in the global economy and stock markets.

The same fundamentals are in play today. Inflation is surprisingly muted despite a tight US labor market. The US Federal Reserve have embarked on a rate cutting cycle with a range of developed and emerging market central banks likely to follow suit, China included. A fresh round of monetary easing looks set to provide fuel for a renewed upturn in both global growth and stock markets into 2020. Not only are interest rates set to remain low for much longer, but they are falling from already historically low levels and adding yet more pain for cash savers.

However, short-term negativity abounds as US President Donald Trump has shaken the foundations of global trade, slapping steep tariffs on billions of dollars’ worth of goods from the EU, Canada, Mexico and China. It is with China that Trump is having the biggest issues, as the two global superpowers lock horns. Trump is planning to raise tariff levels from 25% to 30% on hundreds of billions of dollars’ worth of Chinese goods. By digging their heels in, both the United States and China increase the risk of breaking a global economy that is already starting to crack.

President Trump, though, is as clever as a Fox and could be ramping up tensions over trade with the direct intention of engineering a mild slowdown in the US economy thus encouraging the Federal Reserve to lower interest rates and abandon quantitative tightening. This in turn will set the path for the economy to expand later this year and into 2020 setting favourable conditions for the run up to the Presidential Elections in November 2020.

In the UK, we are no closer to knowing if the Government will get a deal with Europe over Brexit, and market volatility could pick up towards the end of October when Boris Johnson engages in brinkmanship with the European Union. Mr. Johnson sparked constitutional outrage when he announced plans to shut down Parliament for five weeks between the second week of September and October 14^thcreating further uncertainty on the road to Brexit. As the saying goes, ‘a week is a long time in politics’ and now we have further uncertainty with the possibility of a General Election and/or a vote of no confidence in the government. Brexit divided the country, but worse still it is now threatening to destroy the stability and fabric of our beloved country.

Tensions in Hong Kong have also escalated and the 12 weeks of protests against Chinese rule have evolved into the biggest political crisis since the handover from British Rule in 1997. The long-cherished “one country, two systems” policy that has governed the former British Colony is now under threat and the freedom enjoyed by Hong Kong compared to mainland China is now at risk.

Political risk is elevated throughout the world and Investors understandably are cautious with cash levels high and alternative assets such as bonds and gold continuing to rally. Stock markets exhibit a high degree of seasonality, historically posting most of their returns between the months of October and May. Over the summer months, markets tend to move sideways and are prone to shocks which often increases volatility due to low volume.

On a positive note, and despite the strong run over the past decade, stock markets are now valued at the steepest discount to bonds since 2012 when the European crisis was at the centre of investors’ thoughts (which feels like a lifetime ago). Perhaps that observation can give perspective to the issues which we currently face at home and abroad; Especially when paired with the fact that across the developed world employment is high, borrowing costs are low and economic growth still prevails, albeit at a lower rate.

As a key barometer of US activity, given their 66million customers, the following comment from Bank of America’s CEO, Brian Moynihan, echoes what many suggest continues to be a robust enough environment for growth and business success:

“Many of you discussed, wrote about and engaged in debate about the perceived change in the forward environment that we all saw this quarter. However, what we saw in our client base during the second quarter 2019 was solid consumer activity, pointing to a continued growing economy in the United States this year, albeit at a slower pace. In that environment, our company reported the best earnings quarter in the company’s history.”

At Clarion, our process dictates that we do not attempt to second guess changes in the economic cycle or stock markets, instead we invest in a selection of individual funds which we believe will grow intrinsic value through each cycle. Many of the underlying companies favored by our Fund Managers reported their Q2 earnings recently and there were a standout number of positive comments which gives us confidence for the future. Our UK fund managers also comment that there are several unloved and undervalued companies in the UK, and should a Brexit deal take place, there is hope that the shares of several domestically focused companies could rally significantly. The risk/reward of Brexit is much more balanced than it was in 2016 and is, in some cases, favorable. Also, should a sensible trade deal be reached between the US and China, things could turn quickly and be a timely boost for both countries.

We believe the Clarion Portfolio Funds and Model Portfolios are well placed to deliver competitive returns in a multitude of economic environments and where appropriate our non-equity investments, short dated bonds, offer solid protection on the downside should economic growth turn negative.