Quarterly Market Overview – October 2019

“Don’t let volatility derail you. Staying calm and staying invested will keep your long-term goals on track” – JP Morgan

A key element of my job is meeting and talking to different investment managers. All managers will argue they are different but what really interests me is when a manager explains that short term noise is just that. If I asked people what the two key factors causing uncertainty in the world are, they would likely respond with Trade Wars and Brexit; the problem with this is that often we miss out on what is actually going on in the bigger picture.

Recent analysis from JP Morgan and Bank of America Merrill Lynch, highlighted that Trump has tweeted over 10,000 times since his inauguration. The analysis proved that equity markets are more likely to fall, and bond markets are more likely to be volatile when Trump tweets more than 35 times in one day (which apparently happens more than we think), and especially when he mentions China.

In the UK I can’t remember a time in the last three years when I have turned on the news and politics have not been within the first few stories. Will we have a hard or soft Brexit, or no Brexit at all. Corbyn wants an election until he doesn’t. Boris stabs everyone in the back to get his ultimate dream job, and so on.

All of this can be draining and frankly dull! I guess I am a thinker, a reader and socialist who wants positive modern-thinking ideas. I can therefore get frustrated at how dumb those leading or in influence within global economies appear to be. The problem is that in all this frustration you can miss the heartbeat of the local or global economy.

The world has moved to one where populism rules, and yet ironically some of the most stable economies are ones we seem to have problems with; China, Russia etc. There is something about one party rule!

In this update I will cover China/US Trade and I will look at Brexit and UK politics. I also want to explore whether we should be fearful, or perhaps we just need to look behind the headlines.

When someone says to me where is the sun, my response is often behind the clouds. Between 1986 and 2017, 72% of years ended with positive annual returns. During this period, we saw the 1987 stock market crash, the tech bubble burst, 9/11, financial crisis, eurozone crisis and much more. Recessions come and go but investing is a long-term game.

I feel very honoured that people entrust us with their money, and therefore I don’t believe it is right that we should take undue risk. We don’t want to second guess the market because the reality is that this very rarely improves things. People will always tell you when they have got something right, they will rarely tell you when they got it wrong.

News sells on fear, nothing more. Headlines focus on climate change, Trump, Brexit etc. My kickback on climate change is this, yes, we must do better but where have we come from, can we celebrate our achievements and use that as platform to do more? Why make it a negative message, why not make it a positive message? But as we have seen with Trump, Brexit, Climate Change etc positive messages do not seem to be heard as clearly as the negative ones.

My aim in these updates is to be a realist but positive at the same time. If I am not being positive enough, then let me know!

US, EUROPE & UK

Five year returns 1 October 2014 – 30 September 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.

Let’s go straight into trade, and then we can look at some other factors. A study by America’s National Bureau of Economic Research estimates that US real incomes fell $1.4 billion each month over the final half of 2018 as a result of tariffs falling on domestic consumers. The latest round of tariffs on imports from China increased from 10% to 25% and this imposed an annual cost of $831 on the typical US household. That is $106 billion in total or 0.8% of all US household spending.

A small price to pay you would think, in forcing China to agree to a trade deal. However, China and other emerging markets are not suffering to the extent the White House might have hoped. China has increased its share of global trade, thanks in part to “transhipping” – exporting to the US via another country.

My point is that trade wars rarely have any winners!

The real question is what is happening in the global economy? There is clearly a slowdown in business investment, and a contraction in trade. But we are in a cycle like no other. In the US the current expansion became the longest in June when it surpassed the previous record of 10 years. But it has also been one of the weakest expansions on record.

The current expansion is the second weakest since 1954 based on GDP growth at just 2%, where the average has been between 3% and 4%. Consumers contributed just 1.5% to expansion compared to previous periods where this has been as high as 2.5%.

Just because there is a slowdown it doesn’t automatically mean we will have a recession, which leads to large and protracted falls in asset prices. At this point I would add that normally within a couple of years of large falls, markets are back up to previous levels.

Expanding on this further. Many feel we are in a mid-cycle slowdown; manufacturing is shrinking due to the downturn in trade in goods and business investment. But this doesn’t appear to have spilled into the service sectors in the US, Eurozone and China. The service sector weakened much more in 2012 and 2015, neither of which lead to a recession.

This is the fifth time since the financial crisis in the US, that quarter on quarter growth in industrial production turned negative, and the fourth time that the German Manufacturing PMI dropped below the so-called boom/bust threshold of 50.

There are signs corporate profits are falling. It is however worth considering these statistics. Since 1960, the profits of firms listed on US markets peaked on average three and a quarter years before the start of a recession, during which time stocks returned 40%. Quite often that window has been over four years long. To look at it another way, equities made a positive return 82% of the time during the 12-month period following a peak in earnings growth (91% of the time over a 24-month period).

Looking at the US again the labour markets are not deteriorating; hiring intentions have dropped but are no lower than they were in 2015 and much higher than 2012. US households remain positive with consumption growth expected to be around 3% and lower mortgage rates have helped the housing markets. Given that interest rates are low, fuel costs are low, and jobs are plentiful it is obvious why there is confidence. There are concerns over trade, but the overall picture is positive.

In the UK there are many different outcomes. In the past I have tried to share where we think things will end. The reality now is that whatever anyone says there is no real certainty. What we do know is that there is likely to be a General Election. Boris has lost every single vote in parliament since he became Prime Minister and his ‘do or die’ approach has seen a rebellion within his party which no longer has a majority.

Where we stand now? Corbyn has been calling for an election ever since May was elected, as soon as Boris wanted an election Corbyn didn’t (well unless it was on his terms). There is 60% chance of no overall majority, 32% chance of Conservatives winning a majority. It seems Labour will turn to the SNP to form a Government. The problem with this is that the SNP do not want Brexit and Labour have no stated policy.

Interestingly, recent polls have shown the Conservatives took ground from the Brexit Party and the Liberal Democrats took seats from Labour. My own feeling is that if Brexit is extended and an election happens this will be the second referendum – Conservatives if you want to leave, Liberal Democrats if you want to stay.

The likely outcomes: If there is a no deal (which apparently has dropped from a 40% chance to 16%) we would see custom borders erected impacting delivery of goods, a fall in sterling, rising inflation and reduction in consumer spending. It would likely see a technical recession, and business investment would contract. On the flip side government spending should kick in and interest rates would drop to near zero.
If a deal comes in then sterling should rise, inflation would dip and there would be a positive impact on household income. We would see a rebound in business investment, likely see more government spending and interest rates could rise.

If we revoke, then we would see a strong recovery in sterling, and this would be positive for the economy.

The thing to watch is Boris and the EU. France and Ireland and have said no to any extension. If Boris ignores the Benn Act, he risks prison, or he could resign. He has a “new deal” and he needs the EU to back this, if they do then can he persuade Labour MPs to support him.

I am afraid the news in the next few weeks will test all of us, but my argument is that whichever route we go down, certainty (good or bad) will be better than where we are today.

Much of this update has focused on the US and the UK. It is worth touching on US tariffs on European goods which targets airplanes and parts as well as luxury goods, to which Europe will likely respond. As we have seen with China the US consumer has tended to lose out in these battles, but China is stronger than Europe.

In summary, behind the noise we have seen central banks cut rates. The impact of this takes about 18 months to filter through, the European Central Bank has restarted QE and there is positive sentiment. The Eurozone is coming to the conclusion that structural reforms and fiscal stimulus are needed and we need to watch for what happens next.

Markets fluctuate between positive news around geopolitics and negative news (recessions, decline in manufacturing etc). We are in a low interest rate environment; employment remains high and consumer spending is still relatively strong as is wage growth. Eurozone unemployment rate remains at its lowest level since June 2008; more than 11 million jobs have been added since 2012-2013.

There are short term fears; will Trump be impeached (unlikely), are we heading to recession (possibly at some point but it could be four years away) and so on. One of the biggest market shocks is if Trump doesn’t get re-elected so watch this space!

EMERGING, ASIA AND FRONTIER MARKETS

Five year returns 1 October 2014 – 30 September 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.

If we start with China, the slowdown is not at the level of 2014-2015. The trade war brings risks and Chinese Firms listed on US markets could be targeted but as it stands China is seeing its share of global trade increase. There is social unrest in Hong Kong because they are concerned by the influence of China. This in the short term is impacting retail, hospitality, real estate and tourism but over the long term we think this will be resolved.

Away from China, there was a recent survey from the IMF which shows the growth in mobile money accounts across regions. This started in Africa and is now taking off in Asia. Countries like Bangladesh, Indonesia and Pakistan are examples of economies experiencing high mobile money growth. It responds to economies where countries lack deep banking penetration.

Afghanistan is one example where 200 out of 1000 adults have bank accounts but more than 80% of the population have a cellular phone. Mobile money transactions equate to 1.2% of GDP. This expansion in mobile money services has helped meet a significant pent-up demand for financial services.

Vietnam released a wide set of macroeconomic figures, the majority of which were stronger than expected. Real GDP Growth accelerated to 7.3%. Industrial, construction and service activities were all strong. At this stage it does not appear to have been impacted by the trade wars.

Mexico saw interest rate cuts due to sluggish GDP Growth. On the positive side they have favourable demographics and it is the manufacturing hub for the US and could benefit from the Trade War. Colombia has seen both industrial and retail confidence rise to its highest since 2016 due to strong domestic fundamentals and growth prospects.

In South Korea industrial production growth has dropped to nil and surveys for both manufacturing and non-manufacturing have trended down in recent months and this is expected to continue in the near term. In Japan, Abe remains the longest serving Prime Minster and this year has seen workplace reforms, consumption tax from October and in 2020 equal pay for equal work reforms. Many feel that labour shortages and reforms will lead to improved productivity, high wages and growing inflation.

In summary, yes the trade wars are foremost in our minds but the world is adapting and China is seeing its global trade increase. Frontier markets are behind many developed and developing economies but change is happening as can be seen in Afghanistan and Vietnam. Japan has shown how a stable government can change an economy.

CASH

Five year returns 1 October 2014 – 30 September 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 am not sure if I agree with this statement, but I was in a recent fund manager meeting and a statement was made that the UK could move to negative interest rates. The problem is that banks couldn’t implement this and the only way around this would be to charge customers for holding money.

If this does happen then this would be a game changer especially for those holding large sums of cash. Using figures from JP Morgan in 2007 the annualised returns from cash were 6%, this dropped to 0.5% in 2017. The annualised returns from cash between 1899 and 2017 was just 0.7%, Government Bonds returned 1.5% and equities 5%.

In summary, there is a reason to hold cash for a ‘rainy day’ but if interest rates in the UK come down then it could become a lot harder to manage large cash sums.

CONCLUSION

The two main things that dominate the landscape and news are trade and Brexit. Yes, there could be a recession at some point. But at this stage lots of the data would indicate this is some way off. Whilst employment remains strong, there is wage growth etc, which lessens the risk.

Corporate profits are slowing but again this doesn’t mean a recession is about to happen. With the UK things should settle down over the coming weeks and months, but any certainty whether good or bad has some positive elements to it.

In Asia, Emerging Markets and Frontier Markets we see exciting changes especially around mobile money; this is often a start to building an economy. Vietnam continues to grow, and we are seeing the benefit of a strong Prime Minister in Japan. China faces challenges but it certainly has not been the pushover that Trump expected and growing global trade shows that actually the trade war really is impacting US consumers more than China itself.

Markets move on sentiment and we saw some of the strongest falls for a while at the start of October. The question is how long will it take for the markets to recover those losses. My guess is that in a period of heightened volatility not that long. So we come back to where we started, volatility is normal, focusing on the long term goals and staying calm is where the sun will eventually shine. If we focus on the clouds and rain then actually the picture looks pretty grim!!

Source: Charts have been sourced from Morningstar. Other data sourced from Rathbones, IMF, JP Morgan, Schroders, Alquity and Hermes. 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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