Commentary on January 2019
Investors entered the New Year with a ‘glass half-full’ mind-set, buoyed by an apparent reversal in US monetary policy, the resumption of US-China trade talks and the naïve hope that Brexit negotiations would be concluded. In local currency terms, US and European shares gained 8% and 6% respectively, though the stronger pound translated into sterling gains of closer to 4%. Shares in the UK rallied between 4-7% with smaller companies making up some of the lost ground from last year. Bonds rose by 1-2%.
The rose-tinted rally in stock-markets was in stark contrast to the slew of disappointing economic data. The JP Morgan Global Manufacturing PMI survey dropped to a 2 ½ year low, reflecting slowing growth across Europe and many developing countries. Italy fell into a technical recession (two consecutive quarters of negative growth) and survey data suggested that German manufacturing growth was contracting. Similar surveys, released in early February, pointed to growth stagnating in the UK, unsurprisingly attributing this to the lack of clarity on how we intend to leave the EU.
The US Federal Reserve appeared to make a dramatic U-turn, saying that the case for raising rates had weakened somewhat, and that they would be patient in monitoring data before making further adjustments in policy. Mario Draghi, President of the European Central Bank (ECB), warned that risks surrounding the outlook for growth in Europe had moved to the downside, citing geopolitical uncertainties, protectionism and vulnerabilities in emerging markets.
The Trump Twitter feed provided further relief, hinting that the US had no wish to impose further trade tariffs on China, and announcing further talks aimed at averting a trade war. US government employees returned to work after an extended Christmas break, though President Trump warned that this was only a 3-week ceasefire unless the budget to build his wall was approved.
With no sense of irony, the EU charged eight banks with manipulating interest rates in the European bond market!
Opinion is divided on whether the US Federal Reserve ‘bottled it’, and succumbed to pressure from market participants after December’s sell-off in risk assets, or whether they exercised pragmatic judgement, given that economic data had been weakening at the time. Certainly, investors were cheered by the change of rhetoric and, ironically, several US data releases since the Fed’s latest meeting have pointed to a steadily growing economy.
Two things to say about the Fed’s latest statement. Firstly, they haven’t performed a ‘U-turn’ in the sense that they haven’t indicated a cut in interest rates; they’ve said that they will now pause and watch the data for a while, before deciding their next course of action. Secondly, the great economist, J.M. Keynes, used to say that, “When the facts change, I change my mind.” Recent worryingly poor data from China, combined with the possible effects on the economy from the US government shutdown, justify watching and waiting for a while, especially given the luxury of a subdued inflationary background.
It’s interesting that, despite an end to monetary stimulus (QE), fixed interest bond yields remain low; 40% of the Eurozone government bond market has a negative yield, the same level as in April 2018 when QE was still very much in evidence. The fall in yields in December was attributed to a ‘flight to safety’ as fears over slowing growth sent stock-markets lower. But January’s strong rise in ‘risk-on’ assets, equities and low-quality bonds, had little effect on bonds.
One explanation is that we have returned to the ‘Goldilocks era’ of slow, but steady, growth (more evident in America) accompanied by low/ falling inflation. An alternative theory is that investors feel re-assured that, once again, central bankers have their backs and that the balance of risks favour being invested. Potential pit-falls, geo-political and economic, are likely to test this thesis in the coming months. For now, we feel that after a reasonable correction, we’re prepared to cautiously monitor the move higher.
How are we currently positioned?
Having used the late-year sell-off to increase risk, we remain overweight UK equities, which have suffered with the Brexit uncertainty, but which we think offer better value than most other markets over the longer term.
We remain underweight fixed interest, preferring equities and alternative investments. Where we do hold fixed interest, we mostly use funds that have limited exposure to rising interest rates.
With so much uncertainty around the world, accompanied by record levels of debt, we believe there is a strong case for running well-diversified portfolios, investing in actively managed funds with sound investment processes.