Investment Comment September 2019
10th September 2019
More prominent signs of a global slowdown emerged in August as equity markets softened. Monthly macro indicators weakened, whilst an escalation in trade tensions between the US and China and political instability in several countries heightened investor concern. In addition, the two-year and ten-year U.S. Treasury bond yield curve inverted during the month. This event has preceded nearly all recessions dating back to the 1950s and so is seen as one of the most reliable recession indicators. However, markets have historically risen on average a further 15% after the inversion and in some cases continued to rally for as long as 34 months before a downturn. The predictive reliability of yield curve inversions may also have been compromised by unprecedented monetary expansion in recent years, which has served to suppress long-term interest rates. Many commentators now believe that rather than an imminent recession there will be a ‘stretching of the cycle’ as policymakers globally begin to consider and utilise the various fiscal and monetary tools at their disposal.
In the UK, the MSCI UK fell 4.16% in August, the largest one month decline since October 2018, as investors reacted to a -0.2% reading for GDP growth in the second quarter of 2019. This figure was attributed to the unwinding of Brexit stockpiling seen earlier in the year. Manufacturing and service sector survey data continued to suggest a weakening in business confidence. Politically, much happened but not much changed. Determined to see a conclusion to Brexit on 31 October 2019, the Government was granted a suspension of Parliament for the five-week period before 31 October. Unrest and uncertainty in Parliament followed, with the resulting situation pointing to possible outcomes of a further extension of the Brexit deadline or a General Election. The diminished likelihood of the UK exiting the EU without a deal on 31 October helped to lift Sterling from the historic low seen earlier in August.
In the US, trade tensions with China continued. In response to the US announcing an additional 10% tariff on $300bn of imports, China allowed the yuan to fall below 7 per dollar for the first time since 2008 and introduced tariffs on US crude oil. If a deal is not reached before 15 December, nearly all Chinese imports ($550bn) will be subject to tariffs. The impact of these tensions, in combination with the diminishing effect of last year’s $1.5 trillion tax cut package, began to show in US growth numbers. Q2 annualised GDP growth was reported at 2%, a significant drop from the 3.1% seen in Q1. PMI manufacturing data indicated an expectation for sector contraction for the first time since 2016, with new export orders dropping at the fastest rate since 2009. However, PMI data is still comfortably above the level associated with recessions. Moreover, with the Fed expected to continue on its dovish path by cutting rates further in September, business financing costs should fall, relieving some of the margin pressure currently being experienced with lower top lines and higher wage costs.
Although MSCI Europe ex UK was down 1.20% on the month, most macro data gave some respite to the increasingly negative trend seen in recent months. The August Euro area manufacturing PMI was up on July but did still signal contraction in the sector. The service PMIs were broadly strong across the Eurozone with Germany and Spain posting positive scores beating forecasts and French activity hitting a nine-month high.
Even Italy’s service activity, which was weaker than July, signalled expansion. Of greater importance to Italy was the coalition deal struck on 4 September 2019 between the Democratic Party and the Five Star Movement which brought an end to political uncertainty and prompted a reversion in the Italian 10-year bond yield to more normal low levels. Retail sales for the year were up 2.2%, ahead of consensus expectations of 2%. However, with growth only just apparent and inflation stubborn at 1%, the ECB is widely expected to announce another stimulus package in September.
The current developed country norm of low inflation and low unemployment was also present in Japan in July with Consumer Price Inflation falling to 0.5%, from 0.7% in June, and unemployment ticking down 10bps to 2.3%, a level not seen since October 1992. August saw many investors seeking safety in the Yen which helped to offset the 3.23% local currency fall in MSCI Japan. The manufacturing PMI continued to indicate contraction, albeit marginal, while the service sector reading pointed to the sharpest rate of expansion since October 2017. However, although Japan’s domestic demand remains resilient, China’s slowing growth, the US-China trade war and rising hostilities with South Korea are proving to be notable headwinds for the economy. In addition, an increase in consumption taxes coming into effect on 1 October 2019 may soften domestic demand.
Emerging markets had a difficult month with the MSCI EM index falling 4.36% in sterling terms. China’s PMIs were however all up, with the manufacturing sector joining the service sector once again in expansion territory. The picture was less bright in India where annualised GDP growth dropped to 5%, a 6-year low for the country. Slowing private consumption and near stagnating manufacturing were cited as the main reasons for the fall but a wave of government initiatives announced in August and the lagged effect of the four interest rate cuts thus far in 2019 should ensure that the deceleration is only short-term. Argentina returned to media attention when the centre-left opposition presidential candidate, Alberto Fernandez, claimed victory in a primary for the upcoming election. The event alarmed investors and a sharp fall in the Argentine Peso and 40% drop in the country’s equity index, the Merval, ensued. There was also bad news for South Africa as credit ratings agency Fitch downgraded its debt outlook from stable to negative citing economic growth and budget concerns. The dovish ‘mid-cycle adjustment’ initiated by the Fed however is welcome news for emerging economies; a cut in rates in the last four Fed rate cycles has typically precipitated a 2-3 year period of outperformance against US markets. The ability of China to cut rates and control its currency as it has done in the past month may also help to accelerate the growth of China and the broader region.
Although most data continue to point to slowing of global growth, we still do not see any sign of an imminent recession. The two global powerhouses, the US and China, have shown they are responsive to economic data and continue to implement policies aimed at avoiding a continued slowdown or worse. We are therefore still constructive on equity markets but continue to advise our clients on the importance of holding a well-diversified portfolio and taking a long-term investment view.
10 September 2019