Highlights and Lowlights: what caught our eye in March 2019
Equity markets continued their good start to the year, with all major markets rising during the month in local currency terms. The continued increase in risk appetite was not detrimental to bond markets, which benefitted from reduced concerns about the future path of interest rates. However, gold was the marginal loser, rising for much of the month before falling sharply near month end to finish slightly down. Within the long-term political issues, little was resolved. US President Trump continued to fight for his border wall with Mexico to be built, claiming that construction had begun, whilst there were limited signs of progress in the US/China Trade War, with China passing a new law regarding foreign investment that is seen as an olive branch to the US. However, UK politics dissolved into farce as, having rejected the deal to withdraw from the European Union put forward by the UK Government, Members of Parliament took control of proceedings, only to then reject all eight alternative options with which they themselves had come up.
Away from these well-covered issues, two things caught our eye: how well equity markets continue to do and the US Federal Reserve’s sudden slamming on of the brakes in regards to interest rate rises. These two issues are not unrelated. There is an apparent disconnect between the continued rise in equity markets and the data coming out of economies across the globe. In March, several more economies tipped formally into recession, including Italy and Turkey as Europe continued to struggle to generate growth anywhere near historical levels, this after Germany missed dipping into recession at the end of 2018 by a hair’s breadth. China announced that exports fell by over 20% for the year to February 2019, the largest fall in 3 years, raising concerns about the economic prospects of the world’s second largest economy. Figures for Chinese industrial production missed estimates too and the Chinese Government revised its annual growth target down. With such a swathe of apparent flashing red lights on the global economic dashboard, why are equity markets ‘climbing the wall of worry’ again? There seem to be two possible reasons.
Firstly, the data has led to a range of central bank and government responses. In China, the government announced cuts to VAT alongside a further reduction in central bank reserve ratio requirements, whilst the European Central Bank (ECB) announced a range of measures to pump money into the European economy. However, whilst all such moves would appear to be supportive of equities, European markets fell on the announcement of the ECB’s move, with some analysts suggesting that investors were expecting even more generous measures. This reaction calls into question how effectively central banks can move markets as it suggests that, to be effective, any such stimulus has to be bigger every time. This has long been a fear of these running these institutions, as a need to pump ever-increasing amounts of money into economies for ever-reducing effect will eventually break the model, as any effective move will simply be unaffordable. However, for now, it suggests that it may not be just stimulus that is keeping investors positive.
This leads to the second possibility, which is that the softening data makes the pace of interest rate rises slower, and this was confirmed by the Fed when they announced that the next rate rise was likely to be next year. It is clear that this more dovish tone has been taken very positively by markets, which is not surprising as it was fears about overly aggressive rate rises by the Fed that led to the sell-off in Q4 of last year. It has brought markets more in line with our view of likely Fed behaviour, as we had expected that the Fed would undershoot the pace of rate rises predicted last year and felt in Q4 2018 that fears of excessive rises were overdone. However, even we were surprised by how sharply the Fed changed tack. This has led some analysts to speculate that the Fed can see data that paints a worse picture of the near-term prospects for the US economy than has yet become clear, and that the risk of a recession is real. Clearly, if data continues to soften then the suddenness of the Fed’s move may cause fears that the US economy may tip into recession to dominate investors’ minds, overcoming the more positive aspects of benign rates, in which case volatility would almost certainly return to equity markets in the near term. However, for now, a watch and wait approach seems wise, notwithstanding that we continue to add assets to the portfolio that can exhibit a more defensive profile if markets sell-off significantly.
The information provided above is for Professional Advisers: All data has been sourced from Lipper. Any investment must be made in conjunction with reading the relevant KIID or Investment Mandate. Clients should be aware that the value of investments and the income from the may fall as well as rise and they may not get back the amount originally invested. Investors should note that the views expressed and information given were current at the time of publication but may no longer be so and/or may have been acted upon by the Investment Manager already. Source SmartIM