By Hottinger Investment Management
August tends to be a quiet month due to the holiday season with problems only arising when major events combine with low volumes and reduced liquidity. In recent history, this has meant that the month has become one of the more turbulent of the year; however, the anticipated increase in volatility particularly in the US stock market largely failed to materialise. The major earnings figures released in July showed equities performing well in the US, Europe and Asia, most likely reflecting the strong economic tailwinds that have seen most global regions performing well. However, the rather benign 1% increase in the MSCI World Index masked quite different performances at regional level.
The US stock markets continued to play a significant, positive part with the S&P500 finally surpassing the January high to print a new all-time high of 2,916.50, and, the current equity bull-run became the longest in history on August, 22 2018 at 3,453 days beating the rally of the 1990s that ended with the dot-com crash in 2000. The S&P500 rose 3.03% during August but continues to be surpassed by the NASDAQ (+5.70%), driven by the small selection of consumer technology companies as represented of the FAANG+ Index.
US Treasury yields having momentarily hit 3% in 10 year maturities at the beginning of the month recovered to closer to 2.82% during the month, as fears of an overshoot by the Fed in raising rates or an inflation surprise failed to weigh on investors’ worries. Interestingly, as Morgan Stanley point out, the yield spread for US investment grade corporate bonds has failed to fully re-tighten after they widened out during the equity weakness in March, even though equities have recovered all their lost ground. Such divergences do not tend to last for long, and if they do they tend to signal the end of an economic cycle. This situation underlines our cautious equity stance at present.
Europe was again the main region to see investor outflows over the month as European equities weakened 2.7% and the trials and tribulations in Italy also caused Eurozone Government Bond yields to edge higher. The European banking sector has a significant exposure to Turkey, which provided the month’s emerging market shock by announcing the fastest pace of inflation since 2003, causing the Turkish Lira to collapse 40% vs. the USD. The US Dollar Index gained 3.79% over the month and other vulnerable EM currencies such as Argentina Peso, Brazilian Real and South African Rand suffered contagion while Emerging Market equities lost 2.9% over the month. The on-going trade dispute between the US and China continues to undermine the Chinese Yuan but the more robust Asian markets only gave up 1.25% over the month.
During the UK House of Commons summer recess the frailties of both Conservative and Labour parties managed to dominate domestic headlines while sterling lost ground against the Euro (-.51%) and the USD (-1.28%). Brexit headlines continue to exploit deep divisions within the ruling Conservative Party, and many industries are becoming noticeably anxious about maintaining trade with the Eurozone after March 2019 when the UK is supposed to leave the EU. UK domestic orientated stocks have tended to lag the large cap global exporters this year so there are possible opportunities for UK investors amongst depressed valuations; however, the UK FTSE All-Share index fell 3.46% over August.
The macroeconomic focus was largely on the thinking of the Federal Reserve and the proceedings of the Jackson Hole summit. There, we learned that while Fed Governor Jay Powell believes that the ‘gradual process of normalization remains appropriate’, he also said that ‘there does not seem to be a risk of inflation acceleration’. He expressed the view that monetary policy should respond not to academic models of where interest rates should be but instead to conditions in the actual economy. This was an important statement because many models such as the Taylor Rule point to much higher interest rates than the market expects over the next 18 months. The median FOMC member, often using these models as a guide, expects the Fed Funds Rate to be 3.5% by the end of 2019, which would mean a 25bp rise each quarter (or another 6 rate rises). Markets think that two or three are more likely. Fed overshooting provides the greatest risk to the US economy in the near- and medium-term.
If the Fed is moving in a more flexible direction, and they see signs that productivity is picking up (which would subdue inflation), then it is possible that the long recovery will not be choked off by monetary policy. However, we have yet to see enough evidence that this is indeed the dominant Fed view; combined with the tightening bias in other regions and concerns over debt and the easiness of financial conditions, we still think that monetary headwinds will strengthen in 2019, creating less favourable and more volatile conditions for risk assets.
Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.
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