Global Markets to 19 August 2019
- It’s a wild week for Wall Street traders as bond yields invert and recession worries spook equity markets around the globe.
- President Trump and the Federal Reserve Bank continue to agree to disagree about setting interest rates, paving the way for a further period of uncertainty.
- The US delays further tariffs on Chinese imported goods following discussions held between Washington and Beijing in a bid to resolve the current situation.
- The UK economy contracts in the second quarter, sparking fears of additional weakness over the coming quarters, which might eventually lead to a recession.
- In the commodity markets, the price of cobalt leaps 30% following the announcement of plans to close the world’s largest mine.
- The global economic outlook has weakened over the past quarter as a result of a mid-cycle slowdown in manufacturing across the developed world exacerbated by the Trump administration.
Global Market Summary
Although widely predicted, last week’s inversion of the US yield curve still rattled global stock markets. This rare phenomenon has achieved cult status: historically, it has been a very reliable forward indicator of an impending recession. In the past, it has told us that once the 2- and 10-year US Treasury bond yields invert, more often than not, a recession is only 12 to 18 months away.
And in recent times, US bond yield inversions have always preceded recessions. Examples include 2007 (just after the global financial crisis), 2000 (after the dot.com bubble burst) and 1989 (just ahead of the US recession), as well as on several occasions in the 1970s.
Even the 3-month Treasury is currently yielding more than the 10-year, and it may not be too long before the 30-year bond yield is below that of 3-month paper. Indeed, on Thursday the 30-year US Treasury actually fell below the psychological 2% level for the first time ever. This happened after China accused the US of a “severe violation” of their previous trade agreement and threatened countermeasures.
The US is not the only country in which this has occurred. In fact, nearly US$17 trillion worth of global bonds are now trading with sub-zero yields; or to put it another way, about 27% of the global bond market. Currently, there are negative interest rates in Japan and Europe; and many investors are willing to buy negative-yielding bonds for the supposed security of a safe-haven asset as fears for the outlook of the global economy take hold.
President Trump has been quick to react to this unusual event, blaming the “crazy inverted yield curve” on the Federal Reserve Bank’s failure to lower interest rates faster. Former Federal Reserve Chair Janet Yellen discounted the inversion, saying that she thought the US would avoid a recession. She did, however, accept that the overall odds had risen and indicated that she was less comfortable with the current US economic backdrop.
Many agree that yield curve inversion has been a fairly good indicator of impending recession in the past, but it might become a false indicator. Much will depend on future central bank policies and how Washington and Beijing behave regarding trade tariffs.
Needless to say, the recent global economic slowdown is cause for concern and recent economic data from regions such as China, Germany and the UK has done little to calm market anxiety. So last week’s news that the US had decided to delay tariffs on certain Chinese goods while taking others off the list altogether was warmly welcomed by Wall Street, triggering a healthy jump in the Dow Jones Industrial Index.
This could not have come at a better time after Wednesday’s 800-point fall on the Dow – its worst percentage drop of the year and the fourth largest point drop of all time (February 2018 being the worst, when it fell by 1175 points). There can be no denying that it was a wild week for Wall Street traders and a nervous time for investors.
In the UK, recent disappointing GDP data revealed a contraction in the economy over the second quarter, increasing the risk of a technical recession. A sharp drop in manufacturing output over the quarter was the main reason for this decline, together with a contraction in the construction sector. The service sector, however, managed to record a very small growth increase.
Overall, these figures are disappointing and with a no-deal Brexit on the horizon, the likelihood of a technical recession seems significantly greater. We should, however, wait and see how the Government and the Bank of England react in the coming months before drawing any firm conclusions.
In the commodity markets, precious metal prices have been climbing in response to recession fears. The price of gold bullion has risen by nearly 20% since the start of the year. And the price of cobalt has soared by more than 30% since Glencore announced its intention to close the world’s largest cobalt mine earlier this month.
Cobalt is used to make lithium-ion batteries for mobile devices, as well as – increasingly – electric cars. It is also used in alloys for jet engines, gas turbines and magnetic steels, as well as in the healthcare sector.
The global economic outlook has weakened over the past quarter as a result of a mid-cycle slowdown in manufacturing across the developed world, aggravated by the Trump administration and its enforcement of trade tariffs in pursuit of its trade policy.
In the financial markets, investors are facing a real dilemma: while the bond markets suggest a recession may be in the offing, Wall Street (particularly the technology sectors, which are driving change through disruption) is predicting further growth.
Given this backdrop of economic weakness and fears of a possible recession, central banks are likely to reduce interest rates aggressively over the next 12 months. They might even re-start other measures – such as asset purchases – or consider new lending facilities to banks, should they deem it necessary.
This is likely to support global equity markets, but we should not expect the same returns that we saw in the first half of the year. Nor indeed should we expect the market to rise continuously without a meaningful correction at some point.
With better dividend yields available than most bond yields, global equities appear to be better value from a medium- to long-term perspective. Any further weakness created by trade talks or recession fears could therefore present investors with further buying opportunities. However, this strategy is only for those investors who can embrace equity risk.
Given the likelihood of a further slowdown in the global economy over the coming months, alternative assets are another likely beneficiary for investment; indeed, we have already seen increases in the prices of precious metals – such as gold and silver – as recessionary anxieties persist.
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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