Global Markets to 25 March 2019
Weak economic data affects the overall sentiment for global assets.
Wall Street suffers its worst day since January.
The inversion of US bond yields sparks fears of an imminent recession in the US.
Germany sees its 10-year government bond yield fall below zero.
Sterling rises after the European Union extends the Brexit deadline.
Stocks tend to see double-digit growth on average in the 18 months following yield inversions.
Global Market Summary
Last week’s financial markets were negatively affected by two major factors: firstly, weaker economic data, and secondly, a bond yield inversion which usually signifies that a recession is imminent.
This created turbulence towards the end of the week, resulting in Wall Street registering its worst day since January: the Nasdaq Composite retreated by 2% and the S&P 500 and Dow Jones Industrial indices both fell by 1.5%.
In Europe, equity markets pulled back under similar influences, with the announcement that German manufacturing had contracted at its fastest rate in more than six and a half years. In France, according to a separate Purchasing Managers’ Index survey, the private sector has contracted. However, Germany’s economic slowdown is the biggest source of concern for the eurozone.
This negative European economic data has gradually filtered through into the equity markets, pushing down Germany’s main index – the Xetra Dax –, together with the wider continental index – the STOXX Europe 600. From a broader perspective, the global economy is clearly under some stress from trade tariffs and dominant domestic influences.
Accordingly, some economists have cut their global growth forecasts for this year, but an easing of US–China trade tensions, more flexible central banks and weaker oil prices could stabilise activity later on in the year, perhaps generating global growth for 2020.
However, it was the US bond yield inversion that spooked the markets last week. For the first time since 2007, the yield on the US 10-year government bond fell below that of the 3-month Treasury yield, and in Germany, their 10-year government bund yield fell into negative territory.
The spread between the 3-month Treasury bill and the 10-year bond falling into negative territory on Friday was troublesome. However, the more widely watched part of the yield curve is the yield gap between the US’s two-year and ten-year debt, and that has yet to invert. Unfortunately, however, that is likely to happen quite soon.
This movement in bond yields occurred after the Federal Reserve Bank downgraded the US’s economic outlook, signalling that there will be no rate hikes this year. This sparked fears on the trading floor that a recession could be on its way. The fallout has not been limited to the bond market: it has spilled over into the equity markets.
However, although this is concerning, global equity investors should not worry too much in the short term: history tells us that following bond inversions, stocks tend to rally about 15% on average in the 18 months following any inversion. The testing time for investors comes about 24 months after the yield curve inverts.
Also worth pointing out is the fact that the actual timing from yield curve inversion to a recession is very inconsistent and has varied significantly over the past 50 years – anything from 14 to 34 months. The most recent recession in 2008 came 24 months after the 2-year and 10-year yield curve inverted, which was on 30 December 2005.
But perhaps more disturbing is that the US Central Bank might have missed a trick and an opportunity to raise interest rates sufficiently over the past 12 months so that it could then cut them quickly – should doing so prove necessary – in a bid to stave off a more severe recession.
From a monetary perspective, the central banks will continue to be the equity markets’ “best friend”, adding further wealth to both the markets and their grateful investors. However, on fundamentals, valuations are now trading at close to the levels at which they were trading at the height of the market rally –just before last December’s “flash crash” when they bottomed out at levels close to their lowest multiples since 2013.
Therefore, valuations in some markets – and stocks – are less appealing than they once were, meaning that future corporate earnings will be important in order to safeguard against further short-term frustrations and stock market stress. Some global investors have remained on the sidelines since becoming somewhat disillusioned at the end of 2018. Consequently, support for cash and bonds increased over that period as global investors scrambled back into defensive positions.
In the short term, a mixture of weakening economic data and disappointments in the run-up to first-quarter earnings season is likely to be an issue for the markets, but the counterbalance to this will be a dovish monetary backdrop, a possible trade deal announcement and the conclusion of the Brexit process.
This should give further stimulus to the global equity markets, particularly as money sitting on the sidelines finds its way back into the equity markets, hunting for higher investment returns than can be currently achieved by holding cash deposits or bond markets.
Finally, European Union leaders have agreed to the UK government’s request to delay Brexit, although the extension is less than Prime Minister Theresa May had requested. The PM has manifestly failed to secure the required support from Parliament in order to deliver Brexit before the stated withdrawal date of 29 March 2019. Extending the deadline seemed prudent, but as things currently stand, it is only a postponement.
The preferred outcome for both the UK and the EU remains a deal. But this would require a measure of flexibility from the EU – something which does not appear to be forthcoming. A no-deal Brexit is therefore still on the table – even though neither side appears to understand the full implications of the UK crashing out without an agreement.
There have been suggestions over the weekend that some MPs might reluctantly back Theresa May’s deal if she stands down before the next stage of negotiations with the European Union. Chancellor Philip Hammond ventured, however, that neither changing prime ministers nor changing the party of government at this delicate stage of the proceedings would help.
Time has now run out and an extension has been agreed by both parties in the negotiation process. Although Brexit remains the probable outcome, it would still leave the United Kingdom among the world’s top eight largest economies. It goes without saying that relationships with the rest of the world will be challenging, and that new trade deals will take considerable time to strike. But if Brexit is finally delivered, this will be the new normal.
As far as the UK market is concerned… volatility will continue. But any final outcome regarding Brexit should offer guidance in managing portfolio asset allocation expectations for sterling assets, as well as offering insights into sterling’s direction.
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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