Commentary on May 2019
Fears of a renewed, and expanding, trade war hit stock-markets but saw government bonds benefit from a flight to safety. Shares across developed markets fell by 2-3%, in sterling terms; in local currency terms American and European shares lost a further 3%. Government bonds gained 3% with the yield on the UK 10-year bond falling below 1%.
President Trump followed through on his threat to increase tariffs on a further $200bn of goods made, or partially made, in China; this provoked the Chinese into announcing retaliatory measures. In a busy month for the US President he postponed a decision on tariffs likely to hurt Europe but announced new measures against Mexico and India.
The contest to succeed Theresa May re-opened the prospect of a ‘No Deal’ Brexit, seen as the most damaging option for the domestic economy. After faring so poorly in the European elections, it was thought that Conservative and Labour MPs would have little appetite for a general election this year; the prospect of losing their own seat outweighing the desire to govern.
Economic data was mixed but tended towards the more forward-looking surveys signalling slower growth around the world. The common theme was uncertainty surrounding global trade tensions, and in Europe the unresolved Brexit issue, causing subdued activity, order books and hiring intentions. Official inflation numbers remained below target.
Chair of the US Federal Reserve said that the board was monitoring the impact of trade tensions on the economic outlook and would ‘act as appropriate to sustain expansion’. Though a fairly obvious, and neutral, statement for a central banker to make, markets took heart that the tone was more dovish than previous comments and that lower rates were on their way. One US rate cut by December was fully priced into interest rate markets, with the strong likelihood of an additional cut by the year-end.
Stripping out the scary headlines, May’s market fall looks no more than a necessary correction after the emphatic bounce from December’s sell-off. At the time of writing, stock-markets are 1-3% higher than May’s nadir, and year-to-date returns, in sterling terms, range from +5% in emerging markets to +14% in the US. We are seeing more frequent emotional overshoots in both directions, paradoxically exaggerated by emotionless robotic trading systems.
None of this is to trivialize very real concerns about the escalating geopolitical fallout or its effect on the world economy. There is a genuine risk of a Twitter-led descent into recession as increasing concerns about Trump’s threats to further restrict global trade cause businesses to cancel, rather than defer, investment projects, hiring intentions and new orders. Further, markets are gradually coming alive to the risk that the conflict between the US and China is stretching beyond tariffs, and will be harder to resolve than a straight-forward trade dispute.
On the plus side, there’s a feeling amongst investors that ‘the Fed’s got our back’; recent comments from the US Federal Reserve persuaded investors that the central bank is more open to cutting interest rates if it feels that economic growth in the US is sufficiently threatened by the evolving trade war. The European Central Bank issued further words of comfort following its monthly meeting, though notably committed to keeping rates on hold rather than reducing them. The risk here is the negative market reaction if central banks fail to follow the path of rate cuts mapped out by optimistic bond markets.
It looks likely that the major political issues will persist for much of this year; the UK will remain mired in uncertainty as Theresa May’s successor attempts to negotiate a Brexit deal, with the possibility that further set-backs open the door to a Corbyn-led coalition. Globally, President Trump’s focus is on the 2020 election. This suggests further conflict during this year with resolutions and a higher stock-market targeted for 2020. In the meantime, we expect further bouts of volatility during the year.
How are we currently positioned?
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.
Trading in one of our holdings, the Woodford Equity Income fund, was suspended; this action was taken to protect the interests of long-term clients and was in response to heavy outflows forcing sales of the underlying assets at prices detrimental to the fund.
Whilst disappointing, this shows why we run well-diversified portfolios; for example, the Woodford fund is just one of between four and six UK equity funds held across our portfolios. While Woodford has been a poor performer, other core UK funds such a Liontrust Special Situations, Trojan Income, Unicorn Income and Unicorn Smaller Companies have all been strong performers over the past 12 months.
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. An example of this is the Gravis UK Infrastructure fund, a unique vehicle which invests in public sector infrastructure and clean energy projects. The fund offers excellent diversification (with a low correlation to equities and bonds) and has an attractive inflation-linked yield above 5%; this fund is up 12.5% over the past year.