Global Markets to 22 July 2019
- The US stock market struggles as we enter the corporate earnings season. The situation is likely to worsen as more companies report over the coming weeks.
- The market starts to speculate about whether or not the Federal Reserve Bank will cut interest rates at the end of this month and on how much US GDP will have fallen in the second quarter.
- Geopolitical tensions, trade agreement uncertainties and Brexit all negatively impact financial assets, but we remain in a positive momentum-driven market.
- Crude oil prices surge after the US Navy shoots down an Iranian drone and a British tanker is seized in the Strait of Hormuz.
- A change in European Central Bank policy and upheaval within the Italian government’s ruling coalition parties create a bond and equity market sell-off in Rome.
- Impressive first half-year global equity market returns lead to questions about whether or not this appetite for risk assets can continue until the end of the year.
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Global Market Summary
The US stock market struggled to maintain its positive momentum last week following a number of early disappointments at the start of the second quarter corporate earnings season. The situation is likely to worsen over the next few weeks as corporate results are published by some of the largest companies in the world, including Amazon, Alphabet, Facebook, Tesla and McDonalds. Microsoft has already posted upbeat profits on the back of growth in its cloud computing business with its shares hitting a record high. But BlackRock, the world’s largest asset manager, reported a 6.5% fall in second-quarter profits, while Netflix blamed subscriber losses on its weaker-than-expected numbers.
Since early tariffs introduced between the US and China are now beginning to affect global businesses, the market will now start to focus more on how these will impact trade over the next few quarters. It will also turn its attention to future key economic data, such as Friday’s second-quarter US GDP numbers, which are likely to confirm that the economy has slowed down.
Other economic data – such as sales of existing homes and new homes – will be digested by market analysts. Most traders, however, will be wondering what actions the Federal Reserve Bank will take at the end of this month. The market is currently engaged in a debate – not about whether or not the Fed will cut interest rates, but by how much: by 0.25 or 0.50 percentage points?
Sluggish US economic data and disappointing corporate earnings growth are likely themes for the weeks ahead, and Fed officials will most likely take this into account when they make their policy decision on 30-31 July. The Fed Fund futures are currently predicting a 43% chance of a 50 basis point cut, but a 25 basis point reduction by the central bank is more likely.
In advance of the Fed’s meeting, the stock market will therefore focus on the corporate earnings results. But in the longer term, they will continue to be influenced by the direction of interest rates. The two most important factors driving market sentiment are therefore still likely to be future Fed fund policy and trade talks.
Elsewhere, the downing of an Iranian drone in the Gulf by US forces and the seizure of a UK-flagged tanker in the Strait of Hormuz have significantly escalated the crisis between the Islamic Republic and the West. Recent events in the Gulf have placed the UK and Iran on a collision course at a time when both Britain and its European allies had been working on a plan to de-escalate tensions.
The White House has said that it is aware of reports that Iranian forces have seized a British oil tanker. But US sanctions are already crippling the Iranian economy, sending it into deep recession and preventing it from exporting oil. Iran is therefore more likely to retaliate by further disrupting oil and petrochemical traffic through the Strait of Hormuz.
Should these hostilities continue, crude oil prices are liable to become more volatile over the coming weeks. And any military action could cause them to surge dramatically. But now that Trump’s re-election campaign is firmly under way, he is unlikely to have much enthusiasm for another military engagement in the Middle East.
In Europe, there is a relatively widespread belief that the European Central Bank will follow the Fed’s example and cut its interest rates very soon. The likelihood that the ECB could reduce its deposit rate from -0.4% to -0.5% has increased since talk began of a Fed interest rate cut.
Since the global financial crisis, central banks have believed that it is better to take preventive measures, rather than wait for a disaster to happen; and it has become very clear that any of the Fed’s policy signals influence other central banks’ courses of action – hence the greater likelihood of an ECB response.
Tension between Italy’s ruling coalition parties has flared up into open conflict, fuelling speculation that the unstable alliance that came to power last June could now be faltering. Matteo Salvini – Italy’s Deputy Prime Minister and leader of the far-right Lega Nord party – is threatening to disrupt his party’s alliance with the anti-establishment Five Star Movement. This could have ramifications for Europe and the EU at a time when Brexit has yet to be resolved and a new UK Prime Minister has only just been elected.
Inevitably, this upheaval affected market sentiment last week: Rome’s FTSE MIB index – Italy’s main equity market – fell on news of these political developments. Bond investors took a comparable view and sold Italian government debt with the yield on 10-year bonds rising.
The financial markets are very difficult to predict at the best of times. But if you add political uncertainty into the mix, they become virtually impossible to read. Geopolitical events in the Gulf, Brexit and now Italy are three factors that could further affect market sentiment over the coming months.
However, so far this year, bad news has been good news for stock markets: momentum drove the markets higher over the first six months of the year, keeping the equity bull market intact.
Global equity and bond markets have been thriving on weaker economic data, sensing that the central banks will take measures to prevent a second global financial crisis, support the global economic recovery and encourage the longevity of this bull market.
The markets are likely to receive a further sugar rush later this month with a July interest rate cut from the Federal Reserve Bank, as well as possibly from the European Central Bank. Expectations that the trade war between the US and China might end have cooled in recent weeks, which could further weaken the US economy over time. And a mixture of good and bad second-quarter corporate earnings will ensure that market movements over the rest of the summer keep investors a little apprehensive.
Finally, the rest of the year is likely to be a little less generous than the first half as far as returns are concerned. However, there is still cause to be optimistic – although it is becoming much more of a stock pickers’ market with a greater need for patience and tolerance.
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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