By Harry Hill, Hottinger Investment Management
May 2019 marked another month in which markets were more driven by political noise than by fundamentals, however, that’s not to say that fundamentals were completely ignored.
As Theresa May handed in her resignation effective June 7th, Donald Trump fuelled the fire by slapping further tariffs on the Chinese and surprised markets with 5% tariffs on Mexico in his latest attempt to curb ‘illegal aliens’ crossing its territory. May was therefore an eventful month to say the least. Global equities were down 5.66%, making May the first month this year that has exhibited negative returns. The VIX, a measure of volatility, reached a 4-month peak at 20.55, which compares to a broader average of 15.8 since January.
Theresa May’s departure announcement did not come as a huge surprise, but the uncertainty around her successor, the likelihood of a general election and the possibility of a no-deal Brexit outcome have had noticeable effects on the currency market. The currency movements of sterling demonstrate investors’ indecisive predictions surrounding Brexit. The depreciation of sterling began on the 3rd May at $1.317, following the collapse of cross-party Brexit talks and the results of the UK local elections, which saw big losses by the Conservative party. The GBP-USD rate currently sits at $1.267.
Unlike the aftermath of the 2016 referendum, depreciation in sterling no longer proves to be the tailwind it once was. The FTSE 100 fell 3.5% in May, which is counter-intuitive given that a large portion of these companies’ incomes are repatriated from overseas and as such should feed through to enhance bottom-line growth. This move reflects broader concerns about policy changes such as re-nationalisation of utilities should Labour win a general election.
The UK 10-year gilt started the month yielding 1.15% but has subsequently fallen to 0.87%. This is more of a flight to safety trade given the political environment and a broad consensus that interest rates will remain stable at 75bps until the Brexit situation has been resolved. The 10-year gilt will likely remain a safe haven, with longer-dated bonds at risk of inflation – even more of a risk now given the currency depreciation.
Meanwhile, overseas the spat between the US and China continues. Donald Trump raised tariffs on $200bn worth of goods from 10% to 25%. The tariffs have so far slowed global trade and reduced business confidence as corporations hold back from investment. Purchasing Managers’ Indices (PMIs) in the US, EU and Japan all continued their downward trend, suggesting a sluggish outlook for manufacturing. Whilst the current figures are not a material cause for concern, any additional policy potentially used in retaliation, which may include non-tariff measures such as discouraging consumers from buying US goods, could be worrying. Ironically, US exports to China are down 30% year-on-year compared to Chinese exports to the US, down only 13% year-on-year. Should the talks escalate, Donald Trump has threatened to impose tariffs on all Chinese imports, covering over $530bn of goods.
Politics aside, labour markets and consumer sentiment continue to be strong with modest fiscal support in China and Europe, whilst the US Federal Reserve remains dovish. Data for the month of May showed encouraging job growth in the US, EU and Canada. Europe continues to be heavily reliant on export demand from China, so it comes as no surprise that it has been caught in the crossfire between US-China trade talks. Risk asset valuations look reasonable at current levels following negative returns over the month, compared to a rally in sovereign bonds across the developed world (except for Italy). US Investment Grade and High Yield spreads widened by 15bps and 75bps respectively, according to JP Morgan, reinforcing the move into low risk assets. Most major developed markets ended the month down 5%-8%, with technology stocks leading the decline. Defensives outperformed cyclicals.
Performance during May was undoubtedly driven by political headlines, namely Brexit and US-China talks. Volatility is unlikely to go away and as bonds continue to deliver a negative real yield, investors will continue to look to risky assets for returns.