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 and a positive outcome to Brexit. There is also a general feeling that the 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 jeweller Tiffany & Co and discount broker TD Ameritrade – also buoyed US stocks. This 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 and widened in yield across the curve. The benchmark 10-year sovereign yields in the US, UK and Germany ended 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 GDP 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 only 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 estimates 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 the nadir. At a sector level, manufacturing showed a broad pick-up in activity while 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 reassessment” 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 had 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&P 500 companies and European stocks pricing in earnings growth of 24% and 21%, respectively. These are lofty expectations considering that 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 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’ exit, with likely detrimental consequences for UK equities. What is certain is that both of the 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 we do not believe gilts are attractive at current levels given the implied risks.
In terms of asset allocation, we retain our conviction that the global economy is late cycle and, as such, that there is a heightened possibility of a drawdown in equity markets. This risk is most significant in the United States, but Europe and the UK would certainly not be immune. We have taken several defensive measures over the last 12 months, but this past month in particular we have been looking at the correlation amongst equity markets to investigate the possibility of reducing drawdown through diversification.