By Kevin Miskin, Hottinger Investment Management
The returns from global markets in November suggest that investors continue to feel more optimistic about the prospects of a truce in the US-China trade war, a positive outcome to Brexit and a general feeling that at US economy is mid-cycle rather than late-cycle.
The MSCI World Equity Index gained 3.1% during the month. US markets outperformed with the cyclically oriented NASDAQ leading the way with a rise of 4.5%. Whilst US companies reported their third straight quarter of declining earnings; the figures were better than anticipated and investors looked ahead to expectations of a robust recovery in 2020. The latest round of corporate activity, including the takeovers of high-end jeweler Tiffany and discount broker TD Ameritrade, also buoyed US stocks. The firmer sentiment underpinned other developed markets, which posted positive returns for the month. Notably, the FTSE250 index of UK mid-cap stocks, which has acted as Brexit barometer due to its domestic bias, gained 4%.
As a result of the upbeat market sentiment, risk-off assets traded lower during the month. Developed market government bonds marginally weakened in price / widened in yield across the curve. The benchmark 10-year sovereign yields in the US, UK and Germany ending the month at 1.77%, 0.57% and -0.36%, respectively. Meanwhile, gold declined by almost 4% to US$1,454.
The economic backdrop was broadly positive during the month. US gross domestic product for Q3 was revised higher to 2.1% and showed an improvement from the previous quarter. Elsewhere, Europe grew by a modest 0.2% in Q3, with Germany narrowly avoiding recession. The UK posted growth of 0.3% between June and September, having contracted in the previous quarter. The widely viewed Purchasing Managers Indices (PMI) were also supportive. Capital Economics estimate that a developed market composite PMI strengthened to 50.7 vs. 50.3, which is still at a level consistent with a Q4 slowdown but has led to hopes that Q3 was a nadir. At a sector level manufacturing showed a broad pick-up in activity while the services PMI strength was limited to the US and Japan.
Whilst there were no changes in interest rates among the major economies during the month, there was some notable commentary from central bankers. In her inaugural speech as ECB President, Christine Lagarde continued Mario Draghi’s theme of a coordinated eurozone fiscal policy with monetary policy having very few tools to implement. In the US, Federal Reserve Chair Jerome Powell indicated in a speech to Congress that the central bank is unlikely to cut rates further and that it would take a “material assessment” to prompt a change of policy. He added that current low rates of unemployment should help boost household spending. The comments left him in the Twitter firing line as President Trump announced that the US had been disadvantaged by not following Europe into negative rate policy. And in the UK, it emerged that two members of the rate-setting committee surprisingly voted in favour of an immediate cut.
Thus far, investors have profited from taking a glass half full view of political events and positioning for the economic cycle to have more legs. However, investors should be aware that markets are no longer priced for disappointment. According to Unigestion, the MSCI World Index requires earnings growth of 18% over the next twelve months to justify current valuations, with S&P500 companies and European stocks pricing-in earnings growth of 24% and 21%, respectively. These are lofty expectations considering a definitive Sino-US trade deal has yet to be agreed, the Chinese economy is slowing and the UK Withdrawal Act has yet to be ratified.
The outlook for the UK economy remains highly uncertain. With less than two weeks to go before the general election opinion polls would suggest that a Tory majority is the most likely scenario. It would be likely that a Tory government would be able to pass the withdrawal agreement by the end of January 2020 leading to the beginning of trade talks with the EU. We believe this would lead to an initial relief rally in sterling and UK equities, but the longevity of this rally would depend on the perceived progress of the trade talks.
There is also the possibility of a hung parliament which would delay Brexit further and raise the possibility of a “no deal”, with likely detrimental consequences for UK equities. What is certain is that both main parties have pledged generous spending packages including substantial increases in the national living wage. As a result, we will be looking for signs of any pick-up in inflation and do not believe gilts are attractive at current levels given the implied risks.
In terms of asset allocation, we retain conviction that the global economy is late cycle and, as such, there is a heightened possibility of a drawdown in equity markets. This risk is most extended in the United States, but also Europe and the UK would not be immune. We have taken several defensive measures over the last 12 months, but this month we have been looking at the correlation amongst equity markets to investigate the possibility of reducing drawdown through diversification.