Global Markets to 16 September 2019
- The global economy continues to suffer the effects of the ongoing trade war, but central bank policy remains sympathetic and supportive.
- Recent optimism over US-China trade talks gives global equity markets a boost.
- The European Central Bank reasserts that rates will remain low: it cuts interest rates and confirms that it will resume its bond-buying programme.
- In the UK, the stock market and sterling continue to make provision for more turbulent times ahead.
- The Federal Reserve Bank will – in all likelihood – cut interest rates this week, but the financial markets are really interested in any potential statements that Chairman Powell might make.
- Overall, we remain positive about global equities, but cautious regarding government bonds following their strongest rally in 20 years.
Global Market Summary
The global economy and the financial markets continue to suffer the effects of the trade war, political uncertainties and fears that central banks might disappoint investors. Each week, the global equity markets brace themselves for investor mood swings catalysed by roller-coaster new stories and the daily noise that plagues the marketplace.
The delicate balance between bonds and riskier assets (such as equities) has continued to underpin the investment rationale for asset allocation – and for one very good reason: historically, both have provided global investors with the growth and income – or total return – that they desire. However, the recent aggressive rise in bond prices and the collapse in bond yields have left this safe-haven asset class rather expensive and precarious.
At the most expensive end of the fixed-income market are sovereign bonds, such as German bunds, UK gilts and Japanese government bonds, which are at their highest valuations since November 2004. Meanwhile, emerging market bond investors have seen a third of their total universe of euro-denominated EM debt fall into negative yielding territory. This has never happened before, and is an indication of the irrational market conditions that global investors are currently experiencing.
Needless to say, the valuations on some equity markets are now rather expensive, adding to the list of challenges for global investors. Over the past decade, financial markets have benefited from quantitative easing, dovish central bank policy and – at times – government intervention. This has created a decade of incredible investment returns, punctuated by periods of irrational exuberance.
Corporate profitability has also been sound, with sectors such as global technology delivering exceptional investment returns, while the global consumer has remained robust. But there can be no doubt that as the global economy slows down, the markets face a more challenging time.
Recent optimism over the US and China striking a possible trade deal could give the financial markets a boost – as would a favourable outcome to Brexit. But for the time being, global investors seem to be revisiting their anxieties over a possible global recession, while the central banks start addressing the weakness in the global economy.
In Europe last week, the European Central Bank confirmed that interest rates would remain low for a long time and that it would resume buying bonds. Given this state of affairs, I would expect bond yields to remain low, without necessarily plummeting to new depths. ECB president Mario Draghi may only have a few supporters within the eurozone, but his package of sweeping measures were warmly greeted by the White House – and by US President Trump in particular.
His immediate reaction was a tweet reading: “European Central Bank, acting quickly, cuts rates 10 basis points. They are trying, and succeeding, in depreciating the euro against the VERY strong Dollar, hurting US exports…. And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!” Clearly another show of anxiety from the president directed at his Fed chairman.
Federal Reserve Chairman Jerome Powell now faces an unusual dilemma: how do you fend off a recession, while at the same time dismissing fears that one is on the horizon? Following the Fed‘s committee meeting this week, Jerome Powell is expected to announce an interest rate cut.
However, for a number of weeks now, US central bank policy-makers have been emphasising that the US economy is in good shape and that its future is bright. Powell himself even confirmed this in remarks that he made earlier this month in Zürich. The market will be looking for a quarter percentage point rate cut at the very least, as well as – more importantly – reassurance from Powell that he remains positive regarding the economic outlook in the US.
Global economists will be looking for clues in the Fed statement that which will look beyond September, as well as for signs of future rate cuts. Also of interest will be any references to Trump‘s recent attacks on the central bank. Trump has issued 42 Fed-bashing tweets since the Fed cut rates on 31 July, even stating that he thought Powell was a greater enemy of the US than China‘s President Xi Jinping.
In the UK, meanwhile, the stock market and sterling are already preparing for the turbulent times ahead, engendered by a highly uncertain political backdrop. While UK equities listed in London are underowned by global investors and sterling is verging on a multi-decade low, the situation could become even more volatile if no solution is found to the Brexit paralysis. And if Prime Minister Johnson were to succeed in securing the general election that he so needs, UK-sited assets could find themselves exposed to even more turmoil.
The City is manifestly opposed to a no-deal Brexit. This has been reflected in the currency markets: sterling strengthened on the news that Boris Johnson had lost his majority in the House, triggering further resignations among party members. A Corbyn premiership would also be damaging for the City, given Labour‘s plans to reverse the privatisation programme put in place by Margaret Thatcher.
But perhaps the most controversial Labour policy of all is the Inclusive Ownership Funds (IOF) proposal. If implemented, this would require that any company with more than 250 employees transfer 1% of its shares every year into a trust fund for its workforce – up to a total of 10% of its total equity.
But in the meantime, the global equity markets have started to rally again on hopes of a trade war agreement or compromise, and the belief that interest rates are on their way back down again. This optimism is seen in global investor sentiment for risk assets, pushing Wall Street back up towards its all-time highs, while yields on government bonds rise. However, the widely anticipated cut in interest rates from the ECB and the Fed has triggered further bond buying in high-yielding bonds.
Overall, we remain positive about global equities, but cautious regarding government bonds, following their strongest rally in 20 years. Risk assets, such as equities, will undoubtedly continue to be momentum-driven – particularly when many of the leading global central banks are cutting interest rates and talks between the US and China appear to have resumed. But in the long term, a global recession cannot be ruled out and much will depend on what happens with Brexit, as well as on the outcome of the trade talks.
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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