News & Views

Q1 2020 Commentary24 January 2020

The final quarter of 2019 provided investors with further growth of assets, albeit with increased shorter-term volatility driven by political risks. The risks of recession reduced significantly over the quarter as data globally continued to provide a stable backdrop for growth.

As has been the case over recent years, trade, Brexit and global central banks dominated news flow and shortterm volatility. The very positive returns generated were led by positive political results but also stabilisation of economic data globally. The consumer continued to be resilient driving growth higher. Unemployment rates stayed low, wage growth improved, and manufacturing data showed signs of stabilisation at very low levels. As manufacturing continues to diminish, its effect on global growth falls, allowing the strong consumer to dominate the output, enabling growth to increase further.

In the US, economic data was stable with unemployment staying low and wage growth improving. Inflation continues to be benign allowing the US Federal Reserve to maintain its easing programme. Another rate cut was enacted in October reversing all rate rises which occurred during 2018. Additional stimulus was also provided by the Fed to increase liquidity for banks, as issues started to arise with overnight lending rates. As has been the case over 2019, the ongoing easing has and will continue to allow for recession risk to be pushed out further, and the continuation of the longest bull market on record.

The Federal Reserve was not the only central bank to enact stimulus measures. In his final meeting, outgoing ECB chair Mario Draghi initiated further quantitative easing and a tiering system for interest rates, hoping to spur growth and inflation in the region. Europe has struggled with the faltering manufacturing numbers, sluggish growth and very low inflation. The QE programme already enacted has not been able to change this, so further easing was implemented. For 2020, investors will focus on the new ECB chair, Christine Lagarde, and whether she will continue to concentrate on QE to drive growth, or push governments to move towards fiscal stimulus, as the effects of QE have so far failed to provide the required results.

Over 60% of central banks in the world enacted some form of easing or interest rate cuts over 2019. This is a huge number and highlights how the slowing of data has allowed for central banks globally to be proactive in their decision making. This again has provided a positive backdrop for economic data and the continuation of the long-standing bull market.

Other major events of the quarter were dominated by the political landscape. Firstly, the UK General Election provided Boris Johnson with a large majority, with seats taken from major Labour strongholds. The 80 seat majority means that the Conservatives have an opportunity to pass most legislation without any issues. It also removes a large stumbling block for investment in the UK. Whatever the outcome, a majority government in power is always better for growth prospects.

All parties focused on Brexit and capital investment in the run up to the election. It does seem that Brexit ended up being the major fillip for the Conservative party as the voters focused on this issue and how Boris Johnson and the Conservative party provided an indication of a timeline for leaving the EU. Other parties including the Labour party were less focused on this issue and so paid the price.

Investors will now focus on the Brexit deadlines of the 31st January and 31st December 2020. At the end of January, the Prime Minister will look to pass legislation through parliament allowing the UK to leave the EU. Many investors believe this should go through without any problems. The government then have 11 months to orchestrate the deal as Prime Minister Johnson has provided a hard leave date of December 2020. It does currently seem that this may not be able to occur in that timeframe. Whether an extension will be required is another hurdle that will have to be crossed. Currently no extension is being looked at. As all investors know, even if the current government have said they will not look at one, they may have to change their minds (as has been the case in the past) if the current timeline is too short.

Post the election, markets took the results very well. UK equity markets pushed higher with domestic stocks and small cap equities leading the way. Sterling rose initially and UK Government Bond yields rose. This is all due to there being more clarity in the future of the UK, the Brexit process and political stability. Moving forward, investors will focus on the Brexit deadlines and whether the UK government will enact the fiscal stimulus promised in the election. Currently this stimulus is required to push growth higher. UK economic data has been worsening over time due to the unknown of Brexit. The Bank of England have been on hold, but interest rate cuts may have to be enacted alongside fiscal stimulus to provide better growth prospects. Sterling will continue to be volatile over the shorter term and so removing currency risks will be a high priority.

The other major political event in the final quarter was the phase 1 trade deal between the US and China that was agreed after months of negotiation. The deal came at the 11th hour as seems to be the case with President Trump but did give markets a huge reprieve from further tariffs, and headwinds to growth. The deal is mainly a truce for both US and China. For investors it provides a better backdrop as the tariffs already enacted have had a negative effect on global markets and economic data.

The deal will stop any increase in tariffs by the US and any retaliatory tariffs that China were looking to impose. It currently doesn’t retract any tariffs in force. It also states that China will provide further regulation on intellectual property rights and purchase more agricultural goods from the US.

Markets took the deal very positively and added onto the gains generated for the year. It also removed the last stumbling block for 2019 to allow for excellent returns to be made. It also took away any bearish thoughts from markets that further tariffs could push forward the chance of recession globally.

All focus will now be now be on the phase two talks which will start during Q1 2020. With the US election taking place at the end of the year, President Trump may be less inclined to put too much pressure on trading partners. The President will be focusing on trying to keep stock market returns high but also keeping pressure on China and other trading partners. Voters will be happier with positive markets in an election year. In past election cycles, Presidents have been able to increase their terms in years where market returns are good. President Trump will also be aware that his election manifesto focuses on making America great again and putting pressure on trading partners and so will have to keep this up to keep the voters happy. As the year goes on and the election process moves forward, short term volatility is likely to increase.

The political risks have not diminished but have developed. The market backdrop does seem more favourable and market data points should reflect this. However, with central banks easing, the US election, Trade and Brexit all still evolving, volatility will be present, and management of portfolios will be key.

From an investment perspective we believe that equities should continue to provide long term investors better opportunities. However fixed income and alternatives should provide ballast in higher volatile market conditions and loss protection when required. They can also provide alpha when markets are rising. Selection will be key from a sector, country and asset perspective. This does mean an active allocation will be required to outperform.

Over the quarter, the portfolios did not engage in any changes. This is due to the positioning that was enacted during the second and third quarters of 2019. With the unknown political environment and binary outcomes from both the UK election and the US/China trade deal, we believed that our barbell approach of long term investing through active equity allocation alongside defensive allocation from fixed income and alternatives would provide investors the best opportunity from all possible scenarios. Thankfully this was the case.

Our allocation to gold, infrastructure and defined returns helped to provide some defence leading up to both the UK election vote and US/China trade deal. These themes also did not provide any headwind post the results and contributed additional alpha. The fixed income content where invested into also did the same job. The underlying fixed income managers have wide remits to invest and all have continued to rotate the underlying holdings to benefit from the changing market conditions.

From an equity perspective, the split of UK equities across the market cap and both overseas and UK earners provided excellent growth post the UK election, as did our holdings globally in equities post the US/China phase 1 trade deal.

The team are currently reviewing the long term strategic and tactical asset allocation of the model portfolios to position them for 2020 and the new decade. The underlying themes and strategies are being reviewed to make sure they continue to provide the best opportunity for a positive risk to return profile.

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