Investment Outlook

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November 18, 2019

Investment Outlook

Tom Elliott

Market sentiment: Limbo. Investors are waiting for many issues to resolve themselves. In this sense, the recent rally in risk assets that began in September can be described as being nervously supported. Nonetheless, stocks are in favour. Led by the U.S, where the S&P 500 reached another new high on Wednesday, the MSCI World index of developed stock markets is up 1.5% in USD so far this month. The Bloomberg Global Aggregate index of investment-grade bonds is, as can be expected from this ‘safe haven’ asset class, down slightly at 0.1% in USD. 

Waiting. The U.K election and, more broadly, Brexit are obvious examples of issues that investors are waiting to clear before going long U.K stocks. Global investors are also waiting for a U.S/ China trade agreement that rolls back the tariffs imposed since last summer, and which will end the damaging spat between the two countries. And they are waiting for Angela Merkle to step down as a lame duck chancellor of Germany, which might help domestic politics escape the current log jam. Investors would like to see a fiscal reflation program and support given to French plans to strengthen the structures supporting the eurozone ahead of the next eurozone crisis. And we are still waiting to see if the Chinese authorities can reign in credit growth without triggering a sharp slowdown in growth.

Fear of an imminent U.S and the global economic downturn has abated in recent weeks. On Thursday Jerome Powell, chair of the Fed expressed confidence in the outlook for the U.S economy. But market analysts are not wholly confident the risk has gone away. They wait for further confirmation that the recent drop in global manufacturing output has now plateaued and that the U.S consumer -who drives 70% of total demand, in the world’s largest economy- continues to increase spending, supported by real wage growth and high employment levels. Today’s U.S retail spending data will be looked at closely.

Green central banks. Thankfully central banks everywhere are keeping monetary policy loose (Norway excepted), thanks in large part to low global inflation low. This supports risk assets, as we wait for the above issues to resolve themselves. 

But a new challenge to central banks is emerging. How ‘market neutral’ should their bond purchases be? Before quantitative easing, this question never arose. Now, with all major central banks buying private sector assets of one type or another, it is pertinent. 

The Bank of Japan has been buying Japanese stocks ‘blind’ by purchasing ETFs. Western central banks have been buying corporate bonds based on their index weightings. This has put them in the line of fire of environmentalists since energy companies and power utilities are large issuers of debt. Christine Lagarde, now head of the ECB, was greeted on her first day at work with a banner reading ‘If the Earth was a bank you’d rescue it’. The irony is that Lagarde is their ally, she has spoken in favour of central banks using monetary policy (such as QE) to pursue green objectives, arguing that climate change represents a profound risk to the global economy. Mark Carney at the Bank of England has made similar comments.

Should central banks have green agendas? More conservative central bankers (ie, the Bundesbank) think not. They have good arguments, the principal one being that monetary policy should remain politically neutral or it risks becoming entangled with fiscal policy and politics. And anyway, whose debt do you choose to buy (so increasing its price), and whose do you not buy? 

Never ones to hang about on environmental issues, the Swedes have made the news with their central bank -the Riksbank- announcing earlier this week the sale of its holding of bonds issued by the province of Alberta in Canada, and Queensland in Australia. On the grounds that both states’ carbon emissions are too high.

This is a debate that is likely to continue for some time, but the speed with which unfashionable ideas in economics gain ground appears to be constantly shrinking (to my mind), and in a few year’s time we might wonder why a green agenda was ever questioned. 

Stocks, Harry Potter, and the trade war: the IMF have calculated that a basket of global stocks exposed to the U.S/ China trade war is down 2% since May 2018, when Trump ramped up tensions over trade. The sectors most affected are autos, metals, and technology. Meanwhile, the rest of the global stock market is up 8% over the same period.

Many companies around the world have blamed the trade war as a reason for disappointing sales growth this year. This now includes the Harry Potter publisher, Bloomsbury. Bloomsbury is a U.K company with globalised supply chain, caught out by the dispute between the U.S and China. The new 15% tariff introduced by Trump on $300bn worth of Chinese imports into America, from 1st September, applies to around 50 Bloomsbury titles that include their Harry Potter books. While expected to only marginally dent U.S sales, the company said it is apprehensive over any further tariffs. It is, meanwhile, seeing strong growth in its China sales. Companies in such a position are treading carefully.

It is surely time for Harry Potter to cast a spell. It would lead to the U.S and China agreeing to finance, support and obey the existing WTO rules on tariffs, quotas, state aid to industry and the treatment of inward investors. Both in letter and in spirit.

Saudi Aramco. Crown Prince Mohammad bin Salman, known as MbS, is looking for a valuation of $2 trillion on the kingdom’s flagship energy company Saudi Aramco. The U.S banks that are leading the sale of up to 3% of its stock have suggested anything between $1.3 trillion and $2.3 trillion. The vendor is doing its best to stoke up demand, from asking elite Saudi families to support the offer, to offering a massive $75bn dividend on the stock (which would give it a yield of 3.75% at $2 trillion valuation). The world’s largest listed company is Apple, valued at $1.16 trillion, after having overtaken Microsoft last week.

But independent analysts suspect the final valuation, at the end of the book-building process, will be at the bottom end of the range when announced (possibly on Sunday). The current yield on rival energy giant Texaco is 3.9% and on Shell, it is 6.3%, with both offering more transparent governance and information on reserves, with lower geopolitical risk. And even if an initial $2 trillion is attained, what good would it do to the reputation of the Saudi government, and the Tadawul (the stock exchange), if this large and important IPO fell in value over subsequent months, or years, as lock-in periods expired? Investors will be circumspect over future privatisation issues.

Better, surely, to use the current book building period to establish a market price that is likely to be stable, and supported by the company’s fundamentals, over the long term. This will then make it easier to sell more of the company, should the Saudi government wish to do so. Money will be needed to help finance the countries’ ambitious ‘Vision 2030’ program of infrastructure building, and economic diversification. A modest valuation on the first, small, sale of Saudi Aramco stock could prove a good investment over the longer term if it encourages future interest in the Kingdom’s privatisations from overseas investors.

Northern Ireland/ Brexit. In an effort to win over the Protestant and business community of Northern Ireland to his Brexit deal, Prime Minister Boris Johnson explained while on a visit to the province last week that: ‘Northern Ireland has a great deal. You keep free movement and access to the single market but you also have unfettered access to Great Britain’. Which begs the question… 

Conservative Brexit supporters understand that the Northern Ireland aspect of the deal is its Achilles Heel. It effectively separates N.I from the rest of the country as physical controls are introduced to check documents, while the argument used to sell the deal to the province implies that remaining in the E.U might be a good idea for the whole of the country! Ministers fear the longer that the deal takes to go through Parliament (assuming a Conservative majority after the election), the more opposition against the deal will solidify around the N.I aspect. Remainers from the opposition parties, N.I protestants and unionists from within the Conservative party might all find common cause.

Investors can help protect themselves from market uncertainty through exposure to a broad range of assets, currencies and geographic regions. The mantra of an investor should always be ‘diversification’ – this is especially pertinent in today’s uncertain market conditions. 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. 

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