Commentary on March 2019
Global equity markets continued their move higher in March, allowing the UK stock-market to deliver its biggest quarterly total return in six years. A busy month saw the Brexit deadline extended, manufacturing activity for the eurozone fall at its fastest rate in six years and the US Federal Reserve signal no planned rate hikes for 2019. In sterling terms, most stock-markets gained between 3-4%; UK bonds rose by 2-3%.
March saw no resolution to either of the two key political issues, US-China trade talks and Brexit negotiations though, at the margin, the underlying rhetoric was taken as positive. The biggest factor influencing asset prices was further evidence of a change in policy stance by two of the world’s most prominent central banks. The US Federal Reserve (Fed) signalled that it would extend its pause on raising interest rates for 2019 and would lessen the amount of quantitative tightening in May, before stopping altogether in September.
At its latest monthly meeting, the European Central Bank (ECB) combined cutting its growth forecast for the EU with announcing that interest rates were on hold until at least the year-end, and that it would provide new cheap funding for the banks. Initially, both central bank moves were poorly received, the argument being that things must be worse than thought to prompt these policy changes. But as the month progressed, investors took heart from some encouraging data and the prospect of a prolonged period of low interest rates.
Brexit paralysis affected growth on both sides of the English Channel; business confidence in the UK was at its lowest since 2009, with investment and spending either being deferred or cancelled. The rise in manufacturing was dismissed as a build-up in inventories ahead of a possible ‘No Deal’ Brexit. Meanwhile Germany witnessed a collapse in manufacturing, although blame for the 8% year-on-year fall in orders was directed more towards the slowdown in China than the UK.
There’s a saying that it takes two views to make a market, and at the moment these views demonstrate disparity between asset classes. Recent analysis by investment bank JP Morgan showed share prices discounting only a 15% chance of near-term recession in the US, compared to a more emphatic 80% probability reflected in US Treasury (bond) prices. US bond investors also disagree with the Federal Reserve’s indication of one more interest rate hike in 2020; bond markets are already discounting a cut this year.
After one of the strongest starts to the year on record, it’s reasonable to expect a pause whilst investors take stock and ponder the merits of further buying at these levels, given the economic and geo-political background. Recession, or a slowdown from above-trend growth? The debate continues. The latter applies more readily to the US and possibly China; the former is becoming a concern for Europe and the UK, stagnating amidst the ongoing and tedious Brexit bickering.
Growth in the US is slowing as the one-off impact of Trump’s tax cuts fade; the President is well aware of this, and of the fast-approaching Presidential elections in 2020, which is why he’s increasing pressure on the Federal Reserve to loosen monetary policy immediately. He may have a point, even if for the wrong reason. With the US-China trade talks apparently going well, though far from concluded, Trump has returned to threatening tariffs on European goods; not a total shock but something the EU could well do without.
Cash levels have been rising in anticipation of an end to the current economic cycle and a consequent fall in markets. If central bank policy changes prove to have been in time to arrest the slowdown, then it’s a question of how patient these investors will be, bearing in mind that cash yields next to nothing, before returning to the stock-markets. In the near term, some markets need to negotiate technical resistance levels, after which there’s room for a move higher. But with risks in either direction finely balanced we expect bouts of volatility to remain.
How are we currently positioned?
On our lower and medium-risk portfolios, we reduced the holding in M&G Optimal Income fund in favour of the Rathbone Strategic Bond fund. This fund is establishing a solid history of steady performance for a lower level of risk.
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.
In equities, our preference remains the UK, where we think valuations already reflect concerns over an economic slowdown and yields compare favourably with other asset classes.
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.