Commentary on January 2020
January newsflow lurched from concern as the U.S. stumbled towards war with Iran, to optimism over data pointing towards a rebound in growth, to panic on the outbreak of the Wuhan coronavirus.
Stock-markets began the month in positive mood, encouraged by signs of a pick-up in global growth. But news of the outbreak of the coronavirus caused a swift reversal on consideration of the potential impact on the Chinese economy and ultimately global trade. American stock-markets, which had gained nearly 5% to hit record highs earlier in the month, ended flat in sterling terms; shares in Europe dipped by around 2% whilst UK shares relinquished over 3% of December’s gains. The move was even more marked in emerging markets which suffered from their reliance on Chinese trade and flipped from +4% to -4%. UK government bonds rose by up to 4%.
Global Composite PMI data offered further signals of growth bottoming out at the start of 2020. More localized business surveys in the UK and Eurozone pointed to a return to expansion, albeit at a subdued rate; the United States had continued to grow throughout last year. Global inflation remained subdued.
British households showed increasing confidence in their financial situations, and house prices rose by a record amount for January, according to surveys, which added to other signs of a brightening mood in the economy since last month’s election. Employment was at a record high, average wages increased by more than inflation and borrowing costs were close to record lows. The CBI survey of 300 manufacturing firms reported a significant improvement in business optimism, with a record proportion expecting to authorise capital expenditure to expand capacity. However, there were strong concerns that a shortage of labour could hinder this expansion over the coming year.
Major central banks left interest rates on hold. The US Federal Reserve said that its policy was appropriate for now and signalled a period of unchanged rates ahead of the US election. Despite strong hints earlier in the month that the Bank of England’s Monetary Policy Committee would vote to cut rates, expectations were ultimately disappointed by an unchanged stance at their subsequent meeting.
For the past year (at least) investors have been trying to price in the risks surrounding Brexit, geopolitical tensions and, of course, the US-China trade dispute. Opposing views attach different probabilities and values to the outcomes, but at least the risks are out there to consider in making one’s investment decisions. A black swan is an unpredictable event that has potentially severe consequences; the coronavirus is such an example.
Black swan events turn well-intentioned, well-paid economists into ‘experts’ in unfamiliar fields. The coronavirus is a case in point with the internet awash in projections based on previous epidemics of which the SARS outbreak was seen to be most relevant. We have no way of quantifying the effects of this virus; we can hope for all concerned that it is contained and, on a financial front, that the green shoots of growth are allowed to continue.
For now, we have to view the economic effects of the coronavirus as an unknown risk. The apocalyptic view portends China grinding to a standstill as quarantine measures shutdown work and travel. Currently, two-thirds of the Chinese economy remains in shutdown after the extended New Year holiday; this is already impacting export orders from abroad and the shutdown of overseas businesses dependent on components from China. Potentially this could get far worse. However, stock-markets have rallied since the month end, with US markets hitting record highs (again), suggesting a more sanguine view that the virus is, by and large, contained. The problem for all arguments is the distrust of data coming out of China.
So, until we get more useful information on the virus, the backdrop remains one of extended stock-markets (though less so in the UK) based on signs of subdued economic growth supported by extremely loose monetary conditions and the perception that rates stay lower for longer and that any moves are more likely to be to the downside. The US-China trade talks and Brexit transition negotiations will continue to add to stock-market volatility but with cash rates close to zero there remains a lot of money looking for an alternative home.
How are we currently positioned?
Around 75% of proceeds from the Woodford Equity Income fund were returned to portfolios; the remainder will be released once the less liquid portion of the fund has been realised. This effectively increased the portfolios’ cash levels pending better buying opportunities.
We are closely monitoring market levels with a view to reducing our exposure to global equities. It’s worth noting that our portfolios already hold significant cash levels, as well as gold as a hedge against falling markets.
We remain underweight fixed interest and continue to prefer the relative value offered by UK equities.