By Hottinger Investment Management
November saw global equity markets bounce back after the global correction seen in October, suggesting that in many regions the negative sentiment was felt to be overdone. Emerging markets benefitted after having registered year lows in October gaining 4.06% over the month despite a flattish US dollar but assisted by a 21% fall in the price of oil to $59 and policies to stimulate the flagging Chinese economy. From a developed market perspective the bounce largely benefitted the US S&P500 (+1.79%) and Japan’s Nikkei 225 (+1.96%) but largely missed Europe and the UK.
The Chinese have been trying to stimulate their economy by cutting reserve ratios for small and large banks after earlier efforts to tighten monetary conditions and de-lever banks’ balance sheets hit industrial companies and state-owned enterprises hard. Chinese factory growth has stalled, with the index for manufacturing purchasing managers falling to 50.0; the index for Chinese manufacturers’ import orders also shrank, from 47.6 to 47.1.
This matters for Europe because over the last few years the continent in general and manufacturing countries such as Germany, Switzerland and Italy in particular, have relied upon export growth which is largely driven by China not the US, and easy money from the ECB in order to make up for weak domestic demand. At the end of the year, that stimulus from the ECB will come to an end, with Governor Mario Draghi committing only to roll over maturing bonds. With Eurozone growth falling significantly since the summer and headline inflation heading down along with the oil price, any indication that the ECB will follow the Federal Reserve in 2019 in tightening policy could harm Europe at a time when external demand is weakening and compensatory fiscal policy action is made difficult by the EU’s intergovernmental rules. The second estimate of Q3 GDP growth was lower than expected due to a persisting slowdown in vehicle production and slowing industrial production in Germany. European PMI’s for November were also disappointing and on-going political uncertainty will no doubt dampen corporate activity.
Fed Chair Powell upset markets in October with his directness but the November meeting proved largely uneventful. There exists an 80% probability in markets for a US December rate hike but the expectation for further hikes next year has receded again after Powell’s speech at the Economic Club in New York spoke of rates being “just below” the neutral level. However, we are worried that markets may still be too sanguine; the Federal Reserve’s own models of inflationary pressures indicate that those pressures are still increasing and interestingly, the spread between US Libor 3M and Euribor 3M has approached 300 basis points. The last times US interest rates became this detached from European rates were before the Dot Com crash and the financial crisis. The effects of higher rates on the US consumer typically suppress US import demand, which by its nature has a knock-on effect on other countries.
We still believe UK markets are unloved and have been discounted since the Brexit referendum. UK economic expectations are still wholly conditional on the type of Brexit agreed by parliament. Although unemployment rose slightly to 4.1% in September wage growth is slowly picking up while headline inflation is steady at 2.4% yoy. We note that the single biggest driver of UK economic growth since the Great Recession has been population expansion driven by increases in net migration, the risks to the British economy as a result of a chaotic no deal Brexit are not just trade frictions but also negative net migration both as a result of political choice and due to the active choice of persons responding to the new economic climate. The FTSE All-share and FTSE 100 indices both fell 2.04% in November indicating that there was no real outperformance by different size companies which may be due to the fact that sterling only declined 0.36% or that the whole market is reacting to the political news flow.
We believe the more defensive approach continued during the month of November remains the right course of action as market volatility; price discovery and the uncertain economic outlook create a more uncomfortable environment for capital preservation. The relatively solid fundamentals being reported today are being undermined by fears of corporate earnings slowdown in the future and there is little doubt that the geopolitical environment that includes Brexit, China-US trade tensions, Italian budgetary issues and Middle Eastern tensions are leaving investor risk appetite subdued.
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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