Quarterly Market Overview – July 2019

“This will look like the maddest period of history” – Russell T Davies

If you have watched the BBC Programme “Years and Years” you will be aware that it paints a rather bleak picture of how the future may play out. Starting in 2019, it travels over a period of ten years seeing the re-election of Trump, escalation in tensions with China, with the eventual election in the UK of a Farage-type Prime Minister. Whether elements of this come to pass or not, it is a reminder that the world is uncertain.

Growing up in an army family in the 1970s and 80s I was acutely aware of the Cold War and the tensions in Northern Ireland. But through every generation there is something that we are fearful about and although I love technology and the benefits that come with it, I realise it can be extremely damaging.

The speed and flow of information has changed especially over the last twenty years. Reading a paper, listening to or watching the news were the only means of getting information, but now it is available 24 hours a day, 7 days a week. We could argue that what we read twenty years ago could have been manipulated but today it is very hard to distinguish between fact and fiction.

Thinking about the suspension of the Woodford Fund; many investors are desperate to find someone to blame. If they invested via Hargreaves Lansdown, then they see the blame lies squarely at their door. The main reason why people invest directly without advice, is because some don’t want to pay for advice, but as we have said so many times the key to investing is research. Just because Hargreaves are promoting something it doesn’t mean it is a good investment or suitable for everyone. But it reflects at a micro level how some people follow the herd without employing critical thinking themselves, taking one source of information as fact.

In my job I hear and see so many things and the challenge is to separate fact from fiction. The top concerns seem to be around a Global Recession, the escalation in trade tensions between the US and China and how that might spill out to Europe and others, and then in the UK there is considerable political and economic uncertainty.

If I took what I heard and read at face value, then I would say that we have reasons to be concerned. No-one wins a trade war; it is ten years plus since the last recession and history tells us that we are due one now. In the UK not only is it likely the end result will be messy, but within months we could have either a coalition of Labour and SNP or the Brexit Party running this country.

It is scary to think about. But if I wear a different hat and go out and talk to people or read investigative papers etc the picture becomes very different. I am not saying some of the fears are unfounded but what is clear is that the world is not as bleak as perhaps it is being painted. It is also worth remembering that every day, month and year there is something that will worry us. But often twelve months down the line that has gone and is replaced by something else.

2018 was a difficult year for investors, and the final quarter was uncomfortable. However, much of the falls in value have recovered in 2019. After the noise surrounding events of 2018, how many media outlets are talking about this? In this update I want to explore some of the information being excluded from the headlines, and although I am not saying we shouldn’t be worried what I want to show is that there are always reasons to be positive.

DEVELOPED MARKETS

Five year returns 1 July 2014 – 30 June 2019

Special note to graph: You should note that past performance is not a reliable indicator of future returns and the value of your investments can fall as well as rise. The total return reflects performance without sales charges or the effects of taxation but is adjusted to reflect all on-going fund expenses and assumes reinvestment of dividends and capital gains. If adjusted for sales charges and the effects of taxation, the performance quoted would be reduced.

It is worth focusing on the bull market and the perception that this is coming to an end. This is the longest bull market since 1975, which lasted 152 months until the great October crash in 1987. We are now 120 months in. However, some argue that we didn’t come out of the bear market until 2013 which means we are only 74 months in.

It is also worth remembering that major bull market peaks come to an end with a proper melt down. Prior to that we normally see a significant surge; for example look back to the late 1990s and 1920s. If we consider where we are today inflation remains low, markets aren’t racing, and we could be in a period where equities remain high for longer than many expect.

The argument on the last point is that there is always a lag between new technology and productivity (railways, electricity, mass transportation, computers etc). As an example, electricity came in at the turn of the 20th century but it wasn’t until the 1920’s that the benefits were really felt.

Fast forward to today in the US the existence of oil was never a secret, nor was the method of getting it out but the challenge was finding it. The solution was inexpensive cloud computing prompting the data analysis that made finding it and extracting it worthwhile. The result was the transformation of the oil industry and a 60% rise in energy related jobs in the US.

If we believe the bear market ended in 2013 then the bull market is still young, and if we haven’t seen the full extent of new technology then the price of equities could remain “high” for some time to come.

This might seem a controversial comment, but when I met a fund manager who likes Trump, I was ready for an interesting discussion. But his point was very simple. Trump is pro-business and this as a fund manager is what you want. His argument was that however nice Obama was, there was no growth and he oversaw the weakest recovery in history. Growth has only really been coming through in the last three years and this has been stimulated by tax cuts and deregulation. And in terms of the trade the deal with Canada, Mexico and the US was twenty years old and needed updating.

No-one had initiated talks with China for years, but Trump has. Much of this makes sense for the US because China has been able to get away with a lot for a very long time.

We might feel uncomfortable with this, but it is the argument of looking past the person and the tweets. There are concerns around the impact of tariffs and we will cover some of this when we look at the developing economies. Tariffs are complex and have the potential to impact many products from smartphones to clothing, furniture and chemicals. Retailers must absorb the costs or increase prices to the end consumer. This is a risk because as yet we are not seeing the impact of the tariffs on the economy.

For the US economy as Trump announces his candidacy focusing on trade, border walls and immigration where does it stand today? It is in a pretty good place. Retail sales are up, real GDP is expected to be higher than anticipated, unemployment claims and unemployment are at record lows. There is also optimism that a trade deal can be done with China but if not, there are opportunities with Japan, Korea, EU etc.

So, the US seems okay. We don’t know what will happen on the back of the trade wars, and there will be a lag before effects are known. Of course, if I am being overly optimistic others might share the same views as Jeffrey Gundlach who believes there is a 40 to 45% chance of a recession within the next 6 months and 65% chance in 2020!

In Europe we should start with the elections. The two mainstream blocs lost ground to the Liberals, Greens and nationalists creating a more fragmented European Parliament. The Centre Right in Germany had their worst ever election result with just 29% of the vote and the Centre Left 16%.

The centrist alliance saw seats increase from 67 to 107. The Green Party were big winners doubling its vote in Germany and this pattern was reflected across Europe. The nationalists had a mixed night; in France they were slightly ahead, in Germany it was up but down from the election in 2017 and it was down in Spain.

A fragmented parliament will not be easy for the UK. There are concerns for the economy of Europe. Draghi indicated there was potential for more QE if the inflation outlook failed to improve. The economy is focused on car production and this is poor, as is industrial production but there is growth.

Spain, Netherlands and Portugal are standout countries, and Germany and France have benefited from consumer consumption. Unemployment rates are falling and there is above inflation wage growth. And there are companies doing well. Moncler make high-end ski wear and are looking to tap into the Chinese ski market, Ferrari sell 62% of their cars to existing clients and FinecoBank are a digital platform in Italy.

This is a snapshot but there are plenty of good stories.

There are concerns, in the short term the continued trade wars may have an impact on exports. The recent rise in oil prices could impact energy prices which could affect consumption growth, but oil prices have drifted back down. Longer term 57% of people are not saving for retirement in Italy and with youth unemployment at 37% this is not a surprise. In the UK, this is 43%, 35% in Germany and 31% in Switzerland. The average across Europe is 42%. This is definitely something to focus on.

In the UK inflation has come down slightly, wage growth is beating expectations and unemployment remains low at 3.8%. But the UK is unloved, and unattractive to investors. The political uncertainty is the biggest risk to the UK.

It seems very likely that Boris will become Prime Minister (but remember he may have the support of the MPs however this doesn’t necessarily translate into support from the membership). He may well take the UK out of Europe without a deal. If this is the case then the economy would likely slow, and potentially fall into recession. There are also concerns that sterling will deflate, and inflation will spike. A spike in inflation will hurt consumer spending which is helping to drive the economy.

The continued delay in Brexit doesn’t help businesses and companies remain cautious and are holding back on business investment. The Bank of England is also holding back on decisions on interest rates until there is some form of certainty as to the future direction.

One other consideration is for parliament to issue a no confidence vote in the government and effectively force an election. Farage on the back of his success in the European Elections believes he can repeat this in the Westminster Elections. Opinion polls would seem to agree with this. So, any election is uncertain as to where the power base would lie and who would be the eventual winner.

It is worth adding that UK shares remain cheap, but that any decision must be positive for the UK because businesses will then have a roadmap. Whilst we stay in this impasse nothing will happen. It is worth adding that the GDP decline this year was the worst since March 2016.

Away from the UK there is the potential for a double election in Japan in late July. There is an improvement in growth, but household consumption has dropped. An election could see a delay in the scheduled VAT hikes and result in increased fiscal spending.

In summary, we are in one of the longest bull runs but we aren’t sure how old it actually is! If we think it was 2013 then the argument is that this has some time to run. Many economists refer to the yield curve as an indicator of when a recession is due, but we are in a period of relatively low inflation, wage growth and strong employment figures. At the same time, we are not seeing the sudden euphoria present before a recession hits. But there are challenges; we have touched on the uncertainty in the UK and globally there are worries about the impact of sanctions and the lag in time between when something is done and when the impact is felt.

EMERGING, ASIA AND FRONTIER MARKETS

Five year returns 1 July 2014 – 30 June 2019

Special note to graph: You should note that past performance is not a reliable indicator of future returns and the value of your investments can fall as well as rise. The total return reflects performance without sales charges or the effects of taxation but is adjusted to reflect all on-going fund expenses and assumes reinvestment of dividends and capital gains. If adjusted for sales charges and the effects of taxation, the performance quoted would be reduced.

I guess I always repeat myself, but the story is unchanged. Long term the global growth will be driven by “developing” economies with seven being in the top ten global economies by 2050. Throughout history there have been different powerhouses; from the Romans to the British to the Americans and now potentially China or India. Things change and we can cling to the past or accept natural evolution.

In terms of tariffs it is hard to take a view on this. Mexico and the US came to some agreement, but China is a harder nut to crack. There has been little engagement with China in the past and it feels that the US is fighting a battle they will eventually lose.

In the short-term US companies are starting to make contingency plans to avoid tariffs. Google has shifted production of motherboards to Taiwan with their Nest devices being developed in Taiwan and Malaysia. Apple is starting to relocate production out of China. Apple employ 10,000 people in China and around 5 million people rely on Apple’s manufacturing. The challenge for these companies is that they have developed highly skilled workers and moving does create a problem for them.

Ironically the idea that these companies would move production back to the US doesn’t seem to be happening. Ultimately the tariffs will hurt the end consumer in the US and the question is whether companies absorb this or increase prices.

But Chinese companies are also suffering; Huawei have seen a 40 – 60% drop in smartphone exports. On the flipside, they have their own market to focus on. Interestingly events in Hong Kong are something to watch; the extradition bill has been suspended but this is not enough for protestors. The US could cease to recognise Hong Kong’s independent status, and this would mean they would suffer the same tariffs as China, end its access to sensitive technologies and put a brake on its economy.

Some believe there will be a breakthrough but honestly, I think there is too much uncertainty to be sure. Fundamentally however you dress it up US companies and consumers will suffer. The concern is how this will feed into the global economy and whether Trump’s legacy will be about pulling it into recession.

Away from China there have been a few elections. Indonesia had the largest one-day elections, with some staggering numbers: 192,866,254 votes, 245,000 candidates and 20,500 seats! Several voting officials died from exhaustion. The result seems to be victory for Joko Widodo and the Democratic Party of Struggle, but this is being disputed.

Indonesia has improving macro indicators including consumption, current account balance and inflation. The focus of the government is likely to be on infrastructure development and expanding social welfare to promote education, boost investment and implement key reforms.

In India the BJP won an outright majority and Modi returns for his second term as Prime Minister. There is expectation of more investment in infrastructure, farming and the simplification of the Goods and Services Tax. One area of infrastructure is water management to help develop several cities.

There is an increase in foreign companies looking to or already increasing their manufacturing capabilities in India. There is a rising middle class with disposable income, which is fuelling the demand for financial products and adding to the small shift away from physical assets like gold and property to equities, which should help the stock market.

South Africa is one of the strongest performing economies this year. The ANC won the latest election with a slightly reduced majority with 58% of the votes. There are expectations for reforms to stimulate the domestic economy.

Brazil is facing challenges with retail sales and industrial production softening. The impact of the Brumadinho dam disaster has seen Vale being forced to suspend all mining operations which will have an impact on GDP.

Oil prices have been rising this year which is not good for some developing economies, although it has started to come drop back gradually.

In summary, the story is the same. Long term, developing economies offer significant benefits compared to developed economies. The trade war brings challenges, but it seems more about a change in supply chains than a move to bring manufacturing back to the US. The US consumer ultimately could end up paying for this and therefore Trump could be the person who drives the global economy into recession. But there is a lot of positive news especially in countries like India, Indonesia and South Africa. And even in China the picture seems relatively positive.

CASH

Five year returns 1 July 2014 – 30 June 2019

Special note to graph: You should note that past performance is not a reliable indicator of future returns and the value of your investments can fall as well as rise. The total return reflects performance without sales charges or the effects of taxation but is adjusted to reflect all on-going fund expenses and assumes reinvestment of dividends and capital gains. If adjusted for sales charges and the effects of taxation, the performance quoted would be reduced.

I want to take a different route on cash this time around. For the last ten years with low interest rates this only offers a negative real rate of return, but for investors there are perhaps good reasons to hold some cash.

For long-term investors cash is not the solution, but it does have some advantages. We are strong believers that once someone is in the market then they should stay invested for the long term. However, if there is spare cash then this can be used to ‘top-up’ when markets fall. Trying to time the market is a dangerous game but if we think there will be more volatility and we want to take advantage of this then having some cash on standby can be useful.

Another example is perhaps where someone is taking an income from their pension and is concerned market movements and withdrawals will deplete their investment fund quicker. Ring fencing cash within the pension to provide 12 months of income might be a solution in the shorter term.

And of course, having cash gives us liquidity for unexpected expenses. The last thing we want to do is be forced to sell our investments when markets are falling because we need some cash.

Everyone’s reason for holding cash is different but one thing is certain that we need to think carefully what we are doing is the right strategy. It is always useful to have a rainy-day fund ‘just in case’ – ideally 3 months’ net income as a rule.

CONCLUSION

I started this with rather a bleak picture, but the point was to highlight that throughout time there will be concerns and worries in the market. Many of these are short term, and even if we see significant market falls, markets tend to recover with 12 to 24 months. It is worth reflecting on the research by Fidelity that shows over ten years 96% of investors make money, over 15 years this rises to 100% and yet over 12 months it is 78%. Investing for the long term should deliver positive returns (there are of course no guarantees).

Looking beyond media hyperbole, are we about to enter a global recession? If we think the bull run started 120 months ago or 73 months, we should bear it in mind.

We have to also factor in low inflation and interest rates, above inflation wage rises and low unemployment. Growth is not racing away but it certainly doesn’t seem to be on its last legs. If we believe there is a lag in the benefits from innovation, then this may not have truly fed into the global economy.

If we had a crystal ball to see the outcome of potential problems, we would be very wealthy! Continued trade tensions might slow down the global economy and perhaps lead to a recession, the UK faces considerable political uncertainty and the outcome is still unknown. There are changes in Europe which may impact any future discussions between it and the UK. We have the ever-present threat of escalation of tensions in the Middle East.

In summary, yes there are concerns (and always will be) but look behind the headlines and there are also positive signs.

Source: Charts have been sourced from Morningstar. Other data sourced from Invesco, BBC, Schroders, JPM, L&G, and the Conversation. Any reference to a fund or share is not a recommendation to buy or sell that asset. Past performance is no guide to future performance and investments can fall as well as rise.

Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

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