Global Markets to 03 June 2019
- Global equity markets suffer in May with the MSCI World Index retreating by 6%.
- A month of tariff tantrums between the US and China makes for a nervous backdrop for risk assets.
- The decline in global sovereign bond yields accelerated noticeably last month.
- The price of Brent Crude Oil fell by more than 10% over the month, pushed downwards by mounting trade war fears.
- Prime Minister May resigns, Boris Johnson becomes the clear favourite to take over and the likelihood of a no-deal Brexit increases.
- This year’s strong market rally comes to an abrupt end and questions are asked about the longevity of this bull market.
Global Market Summary
Global equity markets experienced their worst month of the year so far, with the MSCI World Index recording a loss of just over 6%. Trade tariff turmoil throughout May was considered the main reason for the abrupt market correction. Negotiations between the US and Chinese presidents took a turn for the worse, while yet more tariff tension was generated when President Trump unexpectedly threatened to levy tariffs on Mexican goods.
Over the weekend, China released a white paper in which it blamed the United States for the trade war – evidence of the widening gap between the two superpowers. In the paper, issued on Sunday, China claimed that the United States was an untrustworthy negotiator and that the Chinese government wanted constructive talks that were equal, mutually beneficial and trustworthy.
The Chinese authorities also state that trade disruptions – which, it is claimed, were initiated by the US – negatively affect the whole world. This is obviously an unhealthy backdrop for further negotiations and the US media is reported to have said that Beijing has now backed out of all negotiating points.
Earlier this month, the US president announced an increase of between 10% and 25% in trade tariffs on US$200 billion worth of Chinese goods. The US authorities have also begun to investigate whether a further US$300 billion worth of Chinese goods could be subject to tariffs.
Another contentious issue is the use of technology and the US preventing Chinese telecom giant Huawei from conducting business with American companies. This is now being seen as the start of a serious tech war between the two countries: China has supposedly retaliated with threats to restrict US access to rare earth minerals. China is currently the world’s largest producer of rare earths – extremely important components used in the manufacture of products ranging from smartphones to electric vehicles.
Technology is where the real battle will be won and lost – an area in which the US currently enjoys supremacy, but one in which China is fast catching up. The situation has unquestionably worsened, but presidents Trump and Xi Jinping could still strike a deal in relation to straightforward trading goods. This could happen at the G20 Osaka Summit scheduled for the end of June, if not before.
Regrettably, however, even if a bilateral deal were signed, it might not spell an end to the trade war: global technology dominance is the big prize for the future. Some technology experts believe that over the next decade, two major operating systems could emerge at global level: one developed by the US, and the other by China. Then real supremacy will result from the territorial adoption of one or both systems.
While global equity markets were declining as harsher investment conditions took hold, global investors were taking shelter in safe-haven assets, pushing global sovereign bond yields back down towards levels that had not been seen for many months. When government bond markets begin to invert – creating periods of discord – sentiment begins to change.
At this stage, it is difficult to predict whether a far longer period of trade tensions and the ongoing Brexit paralysis will eventually lead to a further slowing down of the global economy. However, if sovereign bond yields continue to fall amid fears of a US recession or a deterioration in growth, the Federal Reserve Bank might consider cutting interest rates to help offset any meaningful weakness in the domestic or the global economy.
Currently, of course, the US consumer and service sector is still in good shape, so there is no need for the Fed to panic. More importantly, of all the leading Western central banks, the Fed is the only one that has the luxury of being able to cut rates – the others do not really have that option.
In the commodity markets, the price of Brent crude oil lost more than 10% over the month of May as the US-China trade war worsened. However, we could see a recovery in oil prices if these tensions begin to ease. In reality, the physical market remains extremely tight, but the spot price is currently being weighed down by global events and fears over US shale growth. The mood in the energy market is similar to that of the equity markets: definitely risk-off.
The month of May also saw the resignation of the UK prime minister, having failed to secure the country’s exit from the European Union, firing the starting pistol on a frenetic Conservative party leadership race and increasing the likelihood of a no-deal Brexit.
Within hours of her resignation came the news that Boris Johnson and many other Tory leadership rivals had entered the race for Downing Street. As the various contestants began to emerge, former Foreign Secretary Boris Johnson and current favourite declared “We will leave the EU on the 31 October 2019, deal or no deal”. He went on to say that “… the job of our next leader has to be getting the UK properly out of the EU, putting Brexit to bed”.
It is clear that there are numerous factors capable of derailing the current global economic recovery. These include the apparently escalating trade tensions – no longer exclusively between the US and China or Europe, but now between the US and Mexico. Similarly, there is still no end in sight to Brexit. In fact, the Conservative party leadership contest is likely to take centre stage over the coming weeks. And in Europe, the Italian situation appears to be boiling up again with the EU and Rome going head-to-head over Italy’s fiscal position.
Therefore, it is no surprise that the global equity markets have become nervous and that May saw a sell-off in favour of sovereign bonds and cash. To summarise, we might be in for a few more weeks – or even months – of volatility and weakness in risk asset prices. Investors’ appetite for such assets has clearly diminished over the last four weeks, but any sniff of a trade deal or a change of sentiment in relation to the current demanding geopolitical backdrop could encourage global investors to venture back into the equity markets, creating a V-shaped recovery, such as the one we saw following the December sell-off.
While we remain reasonably optimistic regarding global equity markets, we will be watching for positive surprises that might quickly turn investor sentiment around – particularly since it is not in the best interests of either the United States or China to break the global economy at a time when we have yet to see bond yields and interest rates normalise in the Western world.
Peter Lowman is the Chief Investment Officer at Investment Quorum, a Director of the company and an integral member of our investment committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.
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