Commentary on August 2019
Economies and stock-markets suffered as both sides upped the ante in the US-China trade dispute and the UK looked increasingly likely to leave the EU without a deal. In sterling terms, Japanese shares lost 2%, the US and Europe fell by 3% and the UK dropped almost 5% as government bond markets signalled the strong possibility of recession. Global bonds rose by 1% on average.
President Trump threatened further tariffs on imports from China; the threat of retaliatory tariffs led to the postponement of some of these measures, but hope of a trade agreement looked further away than ever. Trump’s heightened rhetoric against the Federal Reserve saw him asking his Twitter followers whether his appointee to the U.S. central bank was “a greater enemy than China’s leader Xi Jinping”!!
The impact on the UK economy of the uncertainty surrounding plans to leave the EU worsened; official data showed growth contracting in the second quarter and forward-looking data pointing to more of the same over the ensuing months. The recent manufacturing survey reflected not just delays in new orders but also reports that overseas clients had been seeking new supply lines ahead of the Brexit deadline.
The US Federal Reserve delivered its 25bp cut in interest rates but the accompanying statement, which referred to the cut as a ‘mid-cycle adjustment’, implied a more restrained path of rate cuts than had been expected by investors, and demanded by the President.
Government bond yields repeatedly made record lows, reaching levels previously unimaginable. Over $17bn of global bonds now have negative yields, including all German government bonds. Just to be clear, this means that borrowers are paying for the privilege of lending the government money!
For now, we view August’s sell-off as no more than a limited correction. The move was driven by a technical signal from the bond market, an ‘inverted yield curve’ (when the US 10-year bond yields less than the 2-year bond), which had a good track-record in predicting previous US recessions. This may yet prove correct, but it’s important to note that government bond markets have changed. In the past, pricing (and therefore yields) was determined by large investors such as life and pension funds; now markets are controlled by central banks, whether by their bond-buying programmes or by driving down interest rates. In our view this makes bond yields’ prophetic powers of future growth less reliable.
The economic background offers positives and negatives; on the plus side record numbers of people are in work and, on average, their earnings are increasing by more than inflation. Borrowing costs are at, or close to, record lows and asset prices are stable to rising (including house prices outside London).
The negative view is that employment data is backward-looking and one of the last indicators to turn, low borrowing costs have failed to stimulate growth significantly over the past decade, and business and consumer confidence is dying a slow death under the twin vexations of Brexit and the US-China trade dispute.
The problem in relying on central banks to tackle the economic slowdown is that whilst their monetary measures have successfully boosted asset prices, progress in stimulating the real economy has been sluggish at best. Record low borrowing costs should incentivise governments to boost the economy with new infrastructure projects, funded by issuing long-dated bonds.
With the exception of the UK, stock-markets aren’t reflecting the same fear of recession as implied by bond markets. This could point to a more convincing sell-off at some time in the future. Alternatively, this suggests that the demand for income is stronger than the fear of a major economic slowdown.
How are we currently positioned?
Gold continued to rise, driven higher by political tensions and falling bond yields. Our holdings in the Merian Gold & Silver fund gained a further 7% over the month.
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.
The UK doesn’t look in a good place, but more bad news is already priced into its shares than in other developed economies. This will not protect the UK in the event of a global sell-off, but we believe it provides a more compelling case when the search for value returns.
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.