Investment Outlook

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February 04, 2020

Investment Outlook

Tom Elliott

Market sentiment: Nervous, with little appetite for risk. All the gains made on global stock markets in early January have been wiped out. The Chinese CSI 300 index is down 8% today, although Wall Street opened strongly, following good ISM manufacturing data.

The risk-on sentiment that dominated financial markets, from October to mid-January, has sharply reversed. The reason is fear that the outbreak of coronavirus in China may become a global pandemic and severely impact on Asian and -to a lesser extent- global economic output. Global confirmed cases are over 17,200 (estimate from John Hopkins University, on Sunday), while deaths so far number over 300, which exceeds the number of deaths recorded in the 2003 SARS outbreak.

Many parts of central China are in lock-down. Last week a Chinese government official suggested coronavirus will, at the least, knock a percentage point or two off China’s GDP growth this year. Friday’s Economist magazine speculated that first quarter Chinese GDP growth could be as low as 2%, from the forecasted 6% (annualised growth rate).

Investment analysts are forecasting reduced profits for traded goods sectors around the world. Emerging market stocks -always particularly sensitive to changes in global growth sentiment- are underperforming developed market stocks, while core government bonds and traditional safe haven currencies are up.

Coronavirus is affecting asset classes differently, and demonstrates the wisdom of a multi-asset approach to investing. In the near-term, sectors that look particularly vulnerable -along with all Chinese stocks- are the Australian miners, luxury goods, tech hardware manufacturers, and parts of the travel / tourism industry that caters for Chinese visitors. Meanwhile the U.S dollar, Swiss franc, the yen, gold and core government bonds have all rallied, considered safe haven asset classes in times of uncertainty. A multi-asset portfolio will, in all likelihood, have exposure to all of these asset classes – so offering some protection from stock market weakness.

Unlike SARS in 2003, the coronavirus outbreak is occurring after an extended bull run on many stock markets. Some analysts naturally wonder if the coronavirus may be the catalyst for a wholesale market correction. But until we have evidence that coronavirus is becoming a global pandemic, it would be rash to assume that a significant correction has begun. Too often investors get scared into believing the next recession or market downturn is imminent, only to then scramble to buy back into the market, sometimes buying back stocks at higher prices than they sold them for. We saw this happen a recently as last September and October, when leading economic indicators fell sharply -only to recover again.

Furthermore, what would one buy? Unlike in 2003, there are few other asset classes to invest in that offer a real yield (ie, above inflation), which is a support to stocks and other risk assets. For example, the 1.6% yield on a ten tear U.S Treasury is well below the U.S CPI inflation rate of 2.3%. And frustratingly for the market bears, central banks – notably the Fed and the ECB- have all shown themselves very willing to intervene to support growth, and this policy bias looks set to persist. The People’s Bank of China is doing its part, last week it injected RMB1.2 trillion ($173bn) of liquidity into the financial system, to boost lending and to support the roll-over of maturing debts. This is the largest intervention of its type in China since 2004.

The message to investors must surely be to stay invested in the same multi-asset portfolios, which are designed to maximise long term returns while reducing short-term volatility.

Coronavirus and U.S/ China trade talks. Slower Chinese growth will limit the country’s ability to buy $200bn more U.S goods, as promised in the Phase One trade deal. However, it is unlikely that in the current circumstances the U.S will be adamant on this point – particularly given that there exists in the deal a clause that allows the deal to be put to one side in the event of a national emergency.

But what coronavirus wont do is relieve pressure on Beijing to discuss Phase Two, which the U.S will want to engage in as soon as the virus is contained and no longer dominates the Chinese government’s agenda. Phase Two is less about tariffs and quotas, and more about the U.S trying to limit China’s technological goals, and the manner in which it seeks to achieve them (such as the use of state subsidies to private companies). Even before the coronavirus outbreak, China was thought unwilling to negotiate on many of these issues, and instead would play for time.

Central bank policy reviews – helicopter money is needed. The Fed and the ECB are both undergoing policy reviews. They wish to raise inflation expectations, to then allow a ‘normalisation’ of interest rates back to pre-financial crisis levels. This is because current ultra-low (and negative) interest rates hurt banks’ lending margins, and so hamper loan growth and economic growth. It is also because interest rates need to be higher so they can be cut to stimulate activity should recession strike. Quantitative Easing (Q.E) has failed to do this, but has contributed to the rise in wealth inequality due to its impact on asset prices. And ultra-low, and negative, interest rates have been misunderstood by consumers and businesses as being a symptom of a weak economy rather than an incentive to invest and spend.

Increased public spending is one solution, but speed and equity work against the idea. The slow pace of infrastructure spending means the construction spending and the supply-side benefits take years to come through. Meanwhile tax cuts and increased welfare spending tend to be biased towards the rich (as in the U.S), who spend a relatively lower proportion of their income than the poor, and to elderly voters who vote more than younger ones, but also spend less.

To escape this log-jam, what is surely needed is un-abashed ‘helicopter money’. This would consist of direct transfers of freshly created central bank money, into households’ bank accounts. It would be administratively complicated, and open to legal challenges (since central banks would be straying well away from their key mandate of price stability). But it remains the great untried option, by which we can restore normality to monetary policy. Timeliness is not a problem, transfers could be made almost as soon as the policy had a green light. Aside from problems relating to the poor who are unbanked, the proposal has the advantage over tax cuts/ increased welfare spending of being a universal credit that will go, everyone, irrespective of the strength of their political voice.

Trump, Louis IX, and Super Tuesday. Conventional wisdom has it that the longer Trump’s impeachment goes on, the more damaging it will be for his re-election chances. This is because the trial will be extended if more witnesses are called, and number one on the Democrats’ list of potential witnesses is John Bolton, former national security advisor to Trump. Bolton will be asked to repeat comments he’s already made, which heavily implicate some of Trump’s closest aides as knowingly carrying out illegal acts.

The Republican defence as to why Bolton should not be called is interesting. It runs along two lines, first that calling Bolton to repeat claims he has already made will be a national security risk. Surely, then, the risk is already out there? Second, is the defence used by Louis IX of France, ‘the Sun King’, who observed that his total power -which he believed was given to him by God- meant that he was the state, and by definition could not do anything to undermine the state. In his own words: ‘l’etait, c’est moi’ (‘the state, its me’). A large number of Republican Congressmen, in common with many conservative politicians elsewhere around the world, do actually believe that autocratic behaviour by the executive is justified by circumstances, and that checks and balances can at times be put to one side. That liberal democracy is not suitable for countering modern-day threats that come from autocrats abroad, such as Putin’s Russia and Xi’s China. The ironies are obvious.

If Trump emerges un-impeached after a short trial, he and other Republicans may feel empowered to use the ‘l’etait, c’est moi’ defence for further undermining of other branches of U.S government. He will have another four years in which to do this if a progressive Democrat, rather than a moderate, comes out with a clear majority at the 3rd March Super Tuesday primaries. Against Bernie Sanders, Trump is likely to run a campaign for the presidential election along the lines of ‘vote for me, I’m the moderate’, which he may well win.

The biggest risks for Trump as he seeks re-election are first, damning testimony given by Bolton and others at the impeachment, which may not convict him but significantly damage his standing amongst swing voters. Second, the early emergence of a moderate Democrat (perhaps following Super Tuesday), which will limit the subsequent in-fighting between Democrats and allow more money to be focused on one leading Democratic candidate and their fight against Trump.

Sterling remains a Brexit plaything. The Bank of England kept interest rates at 0.75% last week, and sterling rallied slightly. The continued pause in rates appeared to contradict comments made last month, by Governor Mark Carney, that he was sympathetic towards a cut. But it was appropriate given the recent improvement in business and consumer confidence. Nonetheless, markets are pricing in a 75% chance of a rate cut by September. Everything else being equal, sterling will fall if the does Bank cut interest rates.

Weaker growth is the Bank’s key fear, particularly if the U.K fails to agree on a trade deal with the E.U by the end of the year, with no extension for further talks in place. Through this mechanism (failed trade talks, weak business, and consumer confidence and no pick up in actual growth data leading to a rate cut) sterling will continue to be vulnerable to Brexit. The currency’s weakness today (Monday) following a public spat between the E.U and the U.K government over the degree to U.K rules will be ‘aligned’ to E.U rules, demonstrates this.

Multi-asset should be at the heart of investing. Last year was a good one for many multi-asset portfolios, as both stocks and bonds made gains. The continuing uncertainty over the direction of stocks and other risk assets suggests multi-asset portfolios may continue to be the asset class of choice amongst global investors, given that they offer a welcome diversification of risk as well as of return.

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