Investment Comment February 2020
4th February 2020
Global equity markets pulled back at the end of January, following the outbreak of the coronavirus in Wuhan, China. The virus has since spread to 24 other countries and, at the time of writing, has infected 28,292 people and claimed 565 lives. Markets are concerned by the impact on global supply chains and China’s economic growth, which currently comprises 35% of global growth. During the month, there was also a deterioration in US-Iran relations. The episode led to a temporary spike in the Brent crude oil price but following a de-escalation in tensions and concerns around oil demand following the virus outbreak, the Brent crude oil index ended the month down -11.9%. Once again, safe haven assets rallied on uncertainty, with government bonds in positive territory.
The MSCI Emerging Markets index was unsurprisingly the hardest hit equity market, down -4.19% in January. Since the outbreak of the virus, parallels, both human and economic, have been drawn with the SARS outbreak of 2003. The coronavirus has spread more quickly, not helped by the timing of the Chinese Lunar New year, the largest annual human migration in the world. The virus has been less virulent, with a mortality rate of 2% to date compared to 10% for the SARS virus. However, commentators have predicted that the virus could have a greater impact on China’s growth due to the country’s enlarged service sector, now at 53% of economic activity compared to 42% in 2003. Policy response efforts by global organisations like the WHO, as well as Chinese authorities have been better this time around and the Chinese government have made efforts to cushion the short term downside on the economy with the injection of $174 billion. Until the outbreak, December data suggested that the Chinese economy was beginning to show signs of stabilisation; both industrial production and retail sales were above market expectations and grew at 6.9% and 8%, respectively. In India, the recent budget failed to deliver the bold reforms that many investors had hoped for. The budget lacked initiatives to reinvigorate the struggling real estate and financial sector. However, the announcement of a cut in income taxes for the middle class should help to stimulate consumer spending.
The US equity market was the only major market to end the month in positive territory, with the MSCI USA up +0.66%. The boost to markets from the phase one trade deal and tariff cuts seen earlier in the month just about outweighed the coronavirus sell-off seen at the end of the month. Preliminary data for Q4 2019 GDP growth matched consensus forecasts, at an annualised +2.1%. More than half of US companies have now released their Q4 earnings, and thus far, they have been better than expected, with earnings year on year up 1.6%. Indeed, the Federal Reserve continues to see the economy ‘in a good place’, again electing to leave the Federal funds rate at a range of 1.5% to 1.75%.
UK markets eased off after a strong finish to 2019, with the MSCI United Kingdom down -3.31%. Stock market returns however did not reflect PMI data which saw a notable improvement. At 53.9, services PMI data signaled the fastest expansion since September 2018 while the manufacturing PMI pointed to a departure from sector contraction for the first time since April 2019. The data is an early sign of the diminishing headwind of political uncertainty on business activity and consumer spending. However, the UK’s official exit from the EU on 31 January only signals the beginning of an 11-month transition period in which an EU trade agreement will be sought by the EU and the UK. Inflation in December disappointed, falling to 1.3%, the lowest reading since November 2016. Nevertheless, in Mark Carney’s final meeting as Governor of the Bank of England, the committee again voted to hold interest rates at 0.75%. Officials did however revise down growth forecasts for 2020, to just 0.8%, from 1.3% in 2019.
The MSCI Europe ex UK fell -1.57% in January. The flash Q4 reading for GDP growth also disappointed, slowing to 1% from 1.2% in Q3. However, PMI data for January, like the UK, was healthier. The Manufacturing PMI, although still signaling contraction, was notably higher at 47.9 for the Euro Area. Of particularly significance was the German data, which at 45.3, was the smallest decline since February 2019. This was driven by an increase in export orders following an uptick in demand from China and the US. Service data remained robust for the region at 52.5. December unemployment and inflation data also improved, with unemployment falling a modest 10 bps to 7.4% and inflation nudging up to 1.3% from 1.0%. The European Central Bank followed suit in leaving interest rates unchanged but a monetary policy strategic review was announced. The focus of this will be on the appropriateness of the current inflation target, monetary policy tools and their effectiveness, and the central bank’s approach to environmental sustainability.
Japan’s equity markets were modestly weaker, with the MSCI Japan falling -0.87%. Soft economic data in Japan was also stronger in January. Both PMIs increased, with the services PMI signaling a return to sector expansion, helped by a rise in new orders and export sales. Inflation for December, although still subdued relative to developed peers, rose 30 bps to 0.8%, the highest it has been since April 2019. However, retail sales shrank for the third straight month in December, suggesting consumers have become more considered in their approach to shopping since the consumption tax hike. The Japanese government signaled their commitment to ‘Abenomics’ with the nomination of Seiji Adachi, another dovish economist, to the board of the Bank of Japan. After the appointment, the ‘reflationist’ contingent on the committee will still be in the minority meaning that further easing on top of that already in place is unlikely, as is a departure from the central bank’s 2% inflation target.
January was a reminder of the dangers of investor complacency and need for a balance in portfolios. Despite positive data across most major geographies, markets were again gripped by an unforeseeable event, this time in the form of the coronavirus outbreak. As the situation is still evolving and a cure has not yet been found, the human and economic impact on China and the rest of the world is still unknown. We continue to see long term value in equity markets but advocate holding a diversified portfolio to mitigate downside risk in situations like those seen in January.
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice as at the date above, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future.