Market Comment 01/11/2019
Market Commentary - November 2019
Cornelian's Investment Team give their Investment Outlook and analyse activity in the markets over the past month.
The MSCI UK All Cap NR index returned -2.5% during the three months to the end of October, outperforming the MSCI World ex UK (£) NR index which returned -2.9% in Sterling terms. The negative performance of international markets was driven by the strength of Sterling against most major currencies (MSCI World ex UK NR index returned +2.6% in local currencies).
Trade negotiations between the US and China unexpectedly broke down in August and President Trump surprised the market by announcing further proposed tariffs on Chinese goods. However additional monetary policy easing was announced in September by central banks in the USA and Eurozone and this helped support markets. October saw some profit warnings from economically sensitive stocks which increased nervousness ahead of the third quarter results season.
In Sterling terms, the strongest major regional equity index was Japan (MSCI Japan £ NR index, +2.2%), where some macro-economic releases suggested that that the economy was doing better than feared. Nonetheless, rising trade war risks and tensions in Hong Kong saw Asia ex Japan and Emerging Market equities perform poorly.
Gilts produced a positive return due to rising Brexit-related fears.
Gilts produced a positive return (iShares Core UK Gilts ETF, +2.2%) due to rising Brexit-related fears and expectations that central banks around the world would cut interest rates as numerous indicators suggested that global growth was slowing faster than expected. Both Investment grade debt (iShares Core £ Corporate Bond ETF, +1.2%) and ‘riskier’ high yield debt (iShares Global High Yield GBP Hedged ETF, +0.6%) underperformed Gilts.
The Brent crude oil price ended October at $60.2/barrel, a decrease of 7.6% since the end of July. The oil price fell as concerns increased that the weaker global economic growth environment could undermine OPEC attempts to stabilise the oil price going forward, notwithstanding the Iranian attack on Saudi oil refineries during the period.
The gold price rose 7.1% to $1,513/oz during the period on strong ‘safe haven’ demand and declines in the opportunity cost of holding gold as global interest rate expectations fell sharply. Sterling strength limited the increase in value to UK based investors to 1.0% (to £1170/oz).
In the past, the key to understanding where we were in the global economic cycle was to understand the outlook for the US consumer. Today, given the exceptional growth of the Chinese economy over the past two decades, we now have to assess the outlook for both the US consumer and the Chinese economy to determine the outlook for the global economic cycle. Whilst the US consumer looks well set (for now), it is fair to say the outlook for China is less strong.
The linkage between Chinese manufacturing and the US consumer has been thrown into stark relief as President Trump weighs up whether to continue to go toe-to-toe against President Xi in order to recalibrate global trade flows fundamentally.
We suspect President Trump will continue with his hard rhetoric against China whilst agreeing limited trade deals on agriculture (predominantly pork and soya beans) and possibly oil. This means continued tariffs on manufactured goods, with the threat of more to come, which will continue to undermine confidence in the global manufacturing sector, where companies in general are reporting reduced demand and higher inventories.
The weakness in manufacturing activity is leading to a noticeable slowdown in overall global economic growth.
The weakness in manufacturing activity is leading to a noticeable slowdown in overall global economic growth. In the past when this has happened the Chinese authorities have implemented large scale stimulus programs which have had the result of getting the global economy back on track. This time however the signals coming out of China suggest less willingness to go down this route. Whilst Chinese interest rates will continue to be cut and the amount of capital banks have to lodge with the central bank will be cut to encourage more lending, a significant ramp up in private sector lending or infrastructure investment is unlikely.
Thankfully the services sector, which is a much larger proportion of developed market economies, remains in good shape. In the US, where unemployment is at cycle lows and wages are growing at good rate, service sector confidence remains good. One of the key questions therefore has to be whether the slowdown in the manufacturing sector will take the services sector down with it. The Federal Reserve has already cut interest rates twice in order to try to stave off such an outcome.
The US labour market is beginning to show signs of slowing after a long period of good growth.
One of the by-products of the fall in interest rates is that mortgage rates in the US have fallen and this is having a positive effect on US housing market activity. Whilst recent newsflow concerning the US housing market is undoubtedly better than expected, and is to be welcomed, the US labour market is beginning to show signs of slowing after a long period of good growth.
Interestingly, one of the indicators used to determine whether there is an enhanced risk of recession is, counterintuitively, a low unemployment rate. If the unemployment rate is close to historic lows, it follows that the economic cycle is long in the tooth. Unfortunately one has to go back more than 50 years to observe a United States unemployment rate as low as it is today (3.6%).
Another reason for caution is that there are some tell-tale signs materialising that may be indicative of a more difficult refinancing environment. Symptoms include the bankruptcy of Thomas Cook, the Argentinian debt default, the stronger US Dollar and indeed the failure of the WeWork listing.
Given all the above it is difficult to accept the consensus estimate which suggests US earnings are going to grow at a double-digit rate next year. We think the real number could be negative due to lacklustre demand and pressures on company profitability. It does not necessarily mean that the stockmarket will follow the earnings downgrade cycle, but it will provide a headwind to further appreciation.
We believe a more prudent approach to risk is required.
As markets are not far from their highs, we believe a more prudent approach to risk is required and so we had reduced exposure to equities somewhat. However the third quarter results season, whilst not good, was greeted with some relief from investors, which is a positive sign. Furthermore credit spreads have remained tight indicating that fixed income investors remain sanguine about the outlook. We therefore added back some equity risk late on in the quarter.
Cornelian Investment Team