Investment Review: Justifying the strong start to the year for risk assets – February 2019

By Hottinger Investment Management

Three factors that weighed on markets in 2018 were the trade tensions between China and the US which caught Europe on the crossfire, the significant slowdown in the Chinese economy that can only partially be attributed to tariff actions, and the fear of the Fed over-tightening interest rates in 2019. During January, Fed Governor Powell reversed his hawkish position and in February the US-China trade negotiations dominated global financial news. Enough progress was made to stop the planned increase in tariffs scheduled for March 1. If the promise of Chinese stimulus turns into fact, then it could be argued that the 3 factors have all been reversed during Q1 2019, which probably explains the optimism that currently surrounds risk assets.

The S&P 500 returned +2.97% in February, while the Nasdaq is currently undertaking its longest daily winning streak since 1999  – having gained 3.44% on the month outperforming the wider MSCI World Index that gained 2.82%. European equities gained 3.87% despite signs that economic momentum is still weaker, the ECB’s growing challenge to raise inflation to 2% and Eurozone politics continuing to cloud the issue as Spain becomes the latest country to call snap elections. On the positive side, the weaker euro – especially against sterling – will help earnings as already seen in the Q4 earnings reports. Any signs that the Chinese economy is recovering will be important to the European countries. However, our recent report on China suggested that without a US trade deal, fiscal stimulus and / or a more relaxed monetary policy we believe the negative momentum from China could persist with consequences for the global economy but particularly for emerging market recovery and the Eurozone.  Furthermore, the continued strength of oil, which returned +6.38% in February, pricing Brent Crude back at $65pb, became a focus of Presidential tweets suggesting that the global economy remains fragile and calling on OPEC to be vigilant.

The questions now being posed by market commentators are whether the significant slowdown in global economic growth in Q4 2018 (to approx. 3.4%) will prove to be a short-term trough and whether the continuing strength in labour markets will buoy consumer spending to underpin a recovery despite a general lack of capital expenditure depressing industrial activity.

Much depends on the direction of the dollar, which was stronger by 0.6% during February, leaving the dollar index flat on the year. Trading analysis indicates that the 50-day moving average for the dollar may be about to cross the 200-day moving average on the downside. This usually indicates that there is a selling momentum that would mean that the dollar is more likely to weaken than strengthen over the coming months. Nevertheless, the US remains a safe haven and if the world economy continues to weaken over the year, there could be a return to dollar strength that undermines the outlook for emerging markets. Equally, with the Federal Reserve’s Dot Plot forecast for interest rate changes still considerably more hawkish than the market expects, and with US fundamentals looking strong, there is a large amount of upside risk to the dollar. Dollar upside risk exists even despite the fact that Fed Chair Jay Powell suggested – during his semi-annual testimony to the Senate Banking Committee – that the central bank is willing to run the economy above the level required to deliver the Fed’s 2% inflation target.

Brexit uncertainty continues to weigh on business activity and UK financial markets. The FTSE All-Share index has bounced back at half the rate of other developed markets, gaining 1.65% in February, leaving it up only 5.82% on the year. The March 29 deadline is looming and there are a number of parliamentary votes mid-March that will clarify the view of the House of Commons. The market is increasingly convinced that an extension to Article 50 is likely and the currency, which has reflected the financial markets views all through this tortuous episode, strengthened 1.65% in February to bring the Pound Index’s year-to-date gain to 4.21%.  UK risk assets remain unowned and unloved but there are signs that they may be significantly under-valued should the outcome be more optimistic than what is currently priced in. A combination of relatively cheap assets and a strengthening currency could attract foreign investors back to the UK financial markets.

A solid Q4 earnings season in the US and Europe has underpinned the move back to optimism for risk assets, but company guidance has remained cautious. We retain a neutral stance towards equities in the belief that the snap back has once more brought shares back to the expensive valuations that caused us concerns in September. Without further catalysts, we feel it is hard to justify current levels.

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