News & Views

Q4 Market Commentary21 October 2019

The usual summer lull was all but forgotten as, what can be the quietest quarter of the year, was far busier than many would have anticipated. The central bank U-turn is underway, and the global economy once again looks like it will be driven by central bank easing and Quantitative Easing (QE).

After the Federal Reserve moved against the tide of QE last year and hiked interest rates four times, they have now cut rates twice over the summer months, highlighting that on-going trade issues, slowing growth, and a faltering manufacturing sector has led to a change from attack to defence. Two 25 basis points cuts have now been made with the chances of further cuts to come being heightened, as risks continue to bubble away under the surface.

It is not just the US who have signalled a continuation of extreme policy setting. Central banks globally have become more dovish and this has led to increasing QE programmes and the cutting of interest rates to stabilise growth rates, increase lending, and prop up equity markets.

At his penultimate central bank meeting, Mario Draghi of the ECB enacted a large raft of stimulus measures to try and pull the European economy away from the brink of recession. Further bond buying, an increase to negative deposit rates, and a tiering system to help banks’ profitability was all enacted straight away, with the QE programme now having an infinite life. This further enhancement to the already large stimulus programme highlights how all central banks want to continue the cycle which has been present since the Global Financial Crisis in 2008.

The low growth, low inflation and low interest rate world that markets have been stimulated by for the last ten years looks set to continue.

This does not mean that risks are not present, but growth can continue at the levels that investors should be able to exploit for gains. The political situation globally continues to provide bouts of volatility, something that was witnessed on numerous occasions in the quarter. Brexit risks aside, Italy, China, Argentina and the US/China trade war all have led to increased volatility at different periods.

The US/China trade war has still not been resolved. It does seem that a deal may be close at hand. Both sides announced increasing tariffs after the G10 meeting in the summer, having an on-going effect on the global economy and most importantly on their individual economies. The two sides will be sitting down at the table during October to get a deal done. The US moves into an election year in 2020 and the US President will therefore want to show the electorate that the actions he has undertaken in his four-year term have provided them the best opportunities. China will also want to rectify the situation to allow for their growth target to be met without having to provide additional stimulus, which may be required in a global recession in the future.

Another risk which became more apparent at the start of the quarter is that of the global economy falling into recession. After the underlying yield of US treasuries became higher for a two-year bond compared to a tenyear bond, commentary on global recessions became far more regular. When what is known as the inverting of the yield curve occurred; where short term yields become higher than long term yields, many investors were spooked. An inverted yield curve in the past has been a predecessor to a recession, as interest rates have to be cut as growth slows and the economy falters.

This time around it is not as straight forward, central banks have stepped in quicker, quantitative easing has distorted bond yields globally, and growth in some parts of the economy is holding up well. There are pockets, like manufacturing, that are being hurt by sentiment and trade. However, the consumer is still healthy, and banks are far more capitalised than they were in 2008. This precursor to recession may not be all it seems.

The prominent and on-going risk for the UK and Europe is Brexit. With such a binary outcome, it is difficult to provide an economic viewpoint. This does mean that when looking to the future it is extremely difficult to price what may occur. What is known now is that the proroguing of parliament has been seen as unlawful meaning parliament reconvened earlier than Prime Minister Johnson would have hoped. Some believe that this reduces the risk of the UK leaving the EU without a deal, as this plus the fact that parliament passed a law saying that a No Deal Brexit should not be enacted will create an extension, a general election or a new referendum.

A deal could however still be passed by the 31st October as well. The talks did seem to be progressing until the end of September when the Supreme Court ruled that Prime Minister Johnson acted undemocratically when he shut parliament. Will any of this stop Prime Minister Johnson from enacting what he has pledged all along, and force the UK to leave the EU with or without a deal on the 31st October? Only he knows.

What we can be certain of is that the UK market is the cheapest it has been compared to other developed markets for several years. Much of the Brexit sensitivity has been priced in and dependent on if the Brexit outcome is favourable to markets, the UK could well be an outperformer over time.

With all that doom and gloom present, many would think that it’s time to take all risk off the table and wait for the recession to come. However, it does seem that the cycle may well be able to continue for longer. The central banks stepping in will help to buoy asset prices and provide a backstop for risks for the near future. The demand for government bonds will continue as QE and slowing growth will create a buyer for bonds even at these low yield levels. We do think some form of watered-down trade deal will occur between the US and China in the near future, as it is in the best interests for all for one to be completed.

Finally, it does seem that Governments will be pressured into providing fiscal stimulus as the effectiveness of QE starts to wane. Central bankers have been calling for fiscal stimulus and spending by governments for several years and now it seems likely that this will occur. With yields lower and growth slowing, this may provide the boost that global economies need to continue the longest economic cycle in history.

This does not mean returns will be stellar. Growth will slow, risks will increase, and returns will be harder to gain. It will just mean that for now the tide will not allow all boats to float. Selectivity and management will be key. Companies will be punished for poor results and investors will punish poor management of economies. Selection will be key to maximising returns, and providing defensive qualities when risks increase.

Being in a bull market for so long means that investors get very twitchy at the first sign of trouble. This will not change but will allow longer term investors to focus on the fundamentals and the risk to return prospects of an investment. The price paid for an asset will drive the returns not just politics and sentiment.

The change in fortunes over the summer may have started to push economic and company fundamentals to the forefront of investors mindsets. The next step will be to get through the political noise of the coming months and move from there.

Long term thinking is key and being focused should provide alpha. Changes have been made to the portfolios during the quarter in light of the above. Our action aims to maximise the upside potential remaining within markets by generating returns from sound fundamentals. In order to protect portfolios from the risks we have increased our weightings to alternative sources of return that could protect in a market downturn and have in some circumstances allowed cash weightings to increase so that we have the opportunity to enter the market at lower levels if a downturn does arise.

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