Commentary on August 2018
August witnessed the US bull market officially become the longest in US history, having gone through a record 3,452 consecutive days without declining 20%. The US market celebrated the event by touching all-time highs for the first time since late January. The same can’t be said of other stock-markets; whilst the wider US stock-market gained over 4% in sterling terms, European shares fell by around 2% and shares in the UK lost between 1-3%, with larger companies taking the bigger hit.
The US dollar rallied to 2018 highs, driven by the Fed’s policy of gradual interest rate increases, with the next 0.25% rise expected in September. But it was Argentina that gave a no-nonsense lesson in monetary policy, increasing their benchmark interest rate from 45% to 60%, with a commitment not to cut rates before December, this in a desperate attempt to halt the slide in their currency.
Emerging markets saw contagion from a few idiosyncratic situations (Turkey, Argentina, Brazil) to the wider market; the benchmark index entered bear market territory in early September, having fallen 20% from its January peak.
The Trump Twitter feed complained about the Federal Reserve raising rates, labelled China and the EU ‘currency manipulators’, threatened to pull the US out of the World Trade Organisation, and authorized the doubling of tariffs on steel and aluminium imports from Turkey; an announcement on further tariffs on Chinese goods is imminent!
In Europe attention focussed on the forthcoming Italian budget, which will be presented to the EU in mid-October. Finance Minister Tria reiterated his plans to produce a budget that falls within EU rules, but this was greeted with some scepticism as it would require both coalition leaders to rein in their spending and tax-cut proposals. In the UK, fear of a ‘No deal’ chaos was dispelled as governor of the Bank of England, Mark Carney, announced that he would consider extending his contract in order to ensure a smooth Brexit!
Economic data remains generally positive, though there are signs that the rate of growth is slowing. The stand-out exception is the United States where the expansion is more emphatic. The paradox here is that the stronger the US, the tougher life becomes for emerging markets in particular.
The first casualty of dollar strength was Turkey, but it was soon joined by Argentina (possible stagflation), Russia (US sanctions) and South Africa (recession); others, such as Indonesia, Brazil and India saw their currencies plummet. One of the effects of QE has been that many emerging markets have feasted on the artificially low cost of debt over the past decade. Most of this debt has been issued in dollars, creating the potential for a funding crisis should their local currencies depreciate against the value of their debt.
There are signs that this ‘risk-off’ sentiment is feeding through to developed markets; OK, the UK is suffering from the lack of direction on Brexit negotiations, but Europe and Asia have also suffered recent losses. The beneficiary has been the US, perceived as a safe haven with stronger growth and higher interest rates.
The fear that is tempering markets might also save them from the worst scenarios as these fears have, by and large, prevented some of the excesses of previous cycles. However, the fact is that monetary policy is now tightening, albeit gradually, and the supportive central bank back-stop is diminishing.
How are we currently positioned?
The fixed interest switch from emerging markets to a global macro bond fund, effected in May, is currently showing a gain of around 3%.
Following recent underperformance emerging markets are now at a significant valuation discount, but we may see even cheaper levels as Fed tightening and US$ strength continue to bite. Longer term, valuations always speak for themselves, but we await more extreme levels for an entry point.
Looking forward, bull markets tend to out-last rationale analysis. For this reason, we have to date been reluctant to reduce our overall exposure too aggressively. Rather we have opted to mitigate the risk by avoiding inflated areas such as technology and high-priced growth stocks, owning more out of favour markets such as Japan and the UK, while gradually increasing exposure to out of favour value and defensive stocks.