Investment Outlook

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July 08, 2019

Investment Outlook

Tom Elliott

Market sentiment: Calmer. Following the G20 leaders' summit in Osaka, at which Presidents Trump and Xi Jinping discussed their differences on trade, fear of an imminent hike on a further $300bn of Chinese exports to the U.S have receded, giving a boost to global stock markets. U.S stock markets recorded new highs last week. Strong U.S jobs data on Friday suggests that the American economy is in decent health and that a cyclical downturn is not around the corner. The likelihood has been reduced of an interest rate cut from the Fed later this month, despite continued pressure from Trump on the central bank for a ‘rocket boost’ of cuts to be given to the economy. Core government bond yields are up a little (and so their prices are down), in response to the jobs data. In Europe, a new team of E.U leaders has been chosen who appear to favour further integration – something that may help lead to greater fiscal union, and so help secure the long-term future of the euro. The MSCI World Index of developed stock markets is up 1.3% in USD terms since the start of July. 

The U.S/ Chinese trade war. This remains the single most pertinent geo-political issue facing investors. True, Trump has declared a truce while discussions between the U.S and China take place. However, a resumption of hostilities is likely, given that the cause of the dispute goes well beyond the initial complaint of Trump, which focused on the narrow area of America’s trade deficit with China. It now includes such thorny and intractable problems as the role of state control and subsidies in China’s leading companies, the Renminbi (the U.S does not want to see the currency fall to RMB 7 to the dollar), technological transfer and trade agreement compliance inspections. 

Many analysts still believe that Trump wants a deal, even if a superficial one, so he can boast of it in his re-election campaign. However, he faces the danger of a narrow, quick, deal blowing up in his face if there is no visible change in the trade deficit with China and on the other topics which are now in American voters’ conscience.

The Fed. The June figure of 224,000 new jobs was somewhat startling, coming after May’s very modest 75,000. It suggests that current GDP forecasts for the second quarter need upgrading (after many economists slashed forecasts in May and June), and that the U.S economy does not, perhaps, need the three interest rate cuts from the Fed that the market had begun pricing in. It may be that no rate cuts are needed this year given that the U.S is approaching ‘full employment’ by almost any measure. It may be only a question of time before wages (currently increasing by 3.4% y/y) and inflation (up 1.8% y/y) both start to grow. A halt to talk of Fed rate cuts would be dollar-positive, but bad for emerging markets and gold.

Christine Lagarde and fiscal union. The market was relieved on the news that IMF head Christin Lagarde is to be the next head of the ECB, from 1st November -not least because it means the post will not go to Jens Weidmann, who heads the German Bundesbank.  A French politician and New York-trained lawyer, rather than an economist, Lagarde’s political skills will be needed as she attempts to strengthen the institutional framework that supports the euro. Draghi may well have saved the single currency with his ‘whatever it takes’ speech, and subsequent policies of negative interest rates and quantitative easing. But he was unable to persuade north European politicians -particularly in Germany- to sign up to closer fiscal union. This is something that is seen, by most economists, as a crucial component of creating a viable monetary union. 

Unlike other monetary areas, such as the U.S, U.K, or Japan, the euro zone does not have a system of fiscal transfers in place. This would allow a region that is suffering from an economic downturn to be supported with taxes raised in healthier parts of the euro zone. There is no central Treasury, that can borrow money under its own name, to be spent as the Commission, European Parliament, or the Council of Ministers, see fit. Lagarde’s main competitor for the ECB job, Weidmann, had been a persistent critic of both Draghi’s ‘whatever it takes’ policies and of fiscal union and centralised bond issuance. 

If Lagarde can persuade northern euro zone politicians that concerns over fiscal union are misplaced, then we might well see progress on an issue that Macron has made a personal crusade. The effect on European stock markets would be electric if a fiscal union with a common borrowing function were to be established, as it would substantially reduce the risk of further eurozone crisis such as we saw earlier this decade. 

A U.K general election ahead of a no deal Brexit? Boris Johnson is likely to beat Jeremy Hunt in the forthcoming Conservative Party leadership contest. The winner will become Prime Minister of a government that has failed to push a Brexit deal through a fractious House of Commons. Boris has explicitly promised a no deal Brexit on 31 October if the E.U will not renegotiate the Irish backstop (something the E.U is unlikely to do). But around 12 Conservative M.Ps have threatened to trigger a vote of no confidence in his government should he try a no deal; this would almost certainly bring down the government and trigger a general election. There is, therefore, a growing view that Boris will himself call a general election in September or October, to drive the political agenda at home and to try to secure a majority in Parliament of pro-Brexit M.Ps, who will then allow a no deal Brexit to proceed. If so, we can expect a lot of anti-E.U rhetoric from Boris. It would be a great gamble for him, particularly if the Labour Party decide to change to an explicitly Remain party over the next six weeks. But having been a key Leave campaigner and vowed to take the country out of the E.U on 31st October, he may feel he has few options.

Last week’s June purchasing managers index (PMI) for U.K manufacturing showed the steepest contraction in the sector in six years, while -separately- construction activity was reported to be at a 10-year low. The U.K economy is expected to have seen no GDP growth over the second quarter. However, consensus estimates for 2019 GDP growth are for 1.3%, well below the 2.2% expected in the U.S but slightly ahead of the eurozone at 1.2%. A no deal Brexit is likely to be met with an interest rate cut from the Bank of England, and emergency government spending from the £27bn ‘war chest’ Chancellor Philip Hammond has set aside. 

A multi-asset portfolio for the long term. Many long term investors favour investing in a combination of global equities and bonds since the two asset classes have a relatively low correlation with each other and so offer diversification benefits. Below is an illustration of a typical 60% equities/ 40% bonds fund. The exact ratio of equities and bonds will reflect a client’s risk profile and investment horizon.

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