After a dismal 2018 when global financial markets posted their worst performance since the dark days of the banking crisis in 2008, 2019 has got off to an excellent start with the US S&P500 index posting its best monthly performance since October 2015. Let’s hope it is a good omen that the Chinese year of the Pig is about to get underway; pigs in Chinese culture are traditionally a symbol of wealth.
The recent market rally is the result of some strong corporate results from large US companies which have started to report their earnings for the last quarter of 2018. So far, 210 of the S&P500 companies have reported, with 71% beating market forecasts. This is most encouraging and demonstrates the underlying health of the US and global economy. Companies beating analyst estimates have come from a diverse range of sectors too and include names such as GE, Boeing, Apple and Facebook. Outside America, the luxury goods company LVMH (producer of Moet Chandon champagne and Louis Vuitton amongst other brands) had excellent results with no sign of a slowdown in demand from aspiring Chinese and Asian consumers. In the UK, the drinks company, Diageo and Royal Dutch Shell also announced strong results. Emerging markets have also surged, benefiting from a weaker US dollar and recovering after a difficult 2018.
The markets have also been buoyed by the recent U-turn by the US Federal Reserve not to increase interest rates and even hint that the next move could be lower if the situation requires it. This makes it most unlikely that the US Fed will increase rates twice in 2019 as previously expected. The Fed also indicated that it would be ‘patient’ with the withdrawal of the economic stimulus (Quantitative Easing). This dovish statement was in marked contrast to Mr Powell’s hawkish comments last year which led markets to expect interest rate rises and Quantitative Tightening (ie. withdrawal of QE by balance sheet reduction on the part of the US Fed). Seen in a positive light, the US Fed is alert to slower growth in China and Europe and focused on maintaining economic stability in the face of trade tensions and potential hard Brexit, as well as the US federal government shutdown; the concern is that the Fed’s U-turn is a result of focusing on short-term numbers and reacting to market volatility or potential political pressure. The continuation of a loose monetary policy, whilst keeping the party going will only defer the time when economic policy needs to be ‘normalised’ to avert long-term economic problems. Also, markets benefit from predictable communications from central banks to help moderate volatility.
Of course, 2019 is likely to see continuing market volatility. Indeed, not all US companies are beating expectations and those underperforming have buffeted markets in recent days. Poor numbers have been announced by companies ranging from Microsoft, Caterpillar (construction machinery), Dow DuPont (chemicals), Nvidia (computer chips), AT&T (telecommunications) and Tesla. In many cases, disappointing earnings have been attributed to slowing Chinese demand. China confirmed its economic growth (GDP) was 6.6% in 2018, its lowest level since 1990; this growth is expected to slow further over the coming years as the Chinese economy matures.
The ongoing trade dispute between the US and China is the biggest single issue affecting global markets. This is because the imposition of tariffs on goods discourages trade, which affects companies in a wide range of sectors. The US has already applied tariffs of $250b on Chinese goods and has threatened to double duties on 2 March if agreement is not reached with China. Beijing has responded with tariffs of $110b on US goods, in particular targeting politically important industries such as agriculture. Talks are expected in late February between President Trump and Chinese Premier Xi Jinping in an attempt to resolve the dispute.
Closer to home, Brexit dominates the outlook for the UK economy, as well as affecting the EU more widely, both in political and economic terms. Markets and companies seek clarity in respect of the direction of travel, so businesses can plan appropriately for how to continue trading across the EU. It is unclear at this time how Brexit will play out, as a large range of potential outcomes are still possible. This uncertainty has hit the FTSE-250 particularly hard as investors are wary of domestically focused UK companies in light of the political situation.
UK house prices grew at their slowest rate in six years in January according to Nationwide Building Society, up just 0.1% over the last year, down from 0.5% growth in the year to December. The uncertain economic outlook with Brexit and poor buyer sentiment is outweighing the generally positive factors of solid employment growth, steady wage growth and low mortgage costs. The latest weak low growth figures are the lowest since Feb 2013 when growth was nil. The Royal Institute of Chartered Surveyors (RICS) has recently announced that their members consider the housing market outlook over the next 3 months is the worst for 20 years.
Elsewhere in Europe, the news is not much better. Italy is the first European country to face a recession for 5 years, shrinking 0.2% in the final quarter of 2018. Italy’s radical coalition government is currently challenging the European Commission by seeking to pass a budget which exceeds EU borrowing rules. Italy has been affected by a general economic slowdown across Europe. Europe’s largest economy, Germany is expected to avoid a recession by a narrow margin as it is hit by a severe slowdown in Chinese demand for German goods and machinery. The French economy has been hit by the ‘yellow vest’ protests with patchy economic forecasts.
Currently, politics are key to how the markets perform in 2019. The US/China trade dispute will have a significant impact – if it is resolved, markets could rally and resume the bull run. However, an ongoing or worsening trade war would hit global growth and make it difficult for stocks to perform. Whilst less important from a global perspective, a resolution of the Brexit situation is key for confidence to return for international investors in the UK economy.
Linked to these political issues are how central banks manage interest rates and Quantitative Tightening, or the normalisation of the economy by moving interest rates up and withdrawing the economic stimulus of the last decade. It seems so far this year, that loose monetary policy may continue, but this cannot be relied on.
I expect 2019 to be characterised by continuing volatility as the generally positive macro-economic backdrop resulting in good corporate performance (strong employment, low interest rates and healthy global economy) faces uncertain political headwinds. From an investment perspective, these market conditions demand portfolio diversification to preserve capital in ‘risk-off’ periods, whilst maintaining equity exposure to benefit from potential market recovery when political challenges are resolved.
Please note, this article is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.