Following a year of ubiquitous calm for stock markets, 2018 wasted little time in returning to a state of heightened volatility, or, dare we say, normalcy. The catalysts for such a transformation centred on the returning threat of inflation coupled with a more aggressive trade policy from Washington. We shall return to each of these crucial topics later, however, market performance can rarely be explained by such a tidy narrative. No doubt a level of over-confidence on the part of investors had also set in. Such positioning leaves a market vulnerable to selling pressure should economic data fall short of some lofty expectation, as indeed, it began too.
It Always Comes Back to the Economic Cycle
Given economic data is so vast and challenging to collect, hard evidence of broad economic performance is only available some weeks after the given period being measured. To offer a lead on the results of this ‘hard data’, however, various bodies extend surveys to business leaders requesting a level of confidence in areas such as orders and employment. It is these surveys, such as the Purchasing Managers Indices (PMIs), that have revealed growth, whilst still robust, is starting to lose its shine and likely peaked in the final quarter of 2017.
Alone, such an outcome, doesn’t look particularly troubling; as whilst growth might have plateaued, the prospects of a recession remain unlikely. As we have regularly referred to in these reports, the global jobs market is in rude health, with record levels of employment prevailing across the developed world. As previously mentioned, however, this growth wobble has come at a time when inflationary pressures are also beginning to build. In February, the market was most concerned by the US Average Hourly Earnings print, revealing wages were growing at their fastest pace in 9 years.
The combined momentum, for both jobs and inflation, leaves the world’s central banks with far less flexibility to respond to prevailing market anxieties. In the not too distant past, when inflation remained on its knees, it was far easier for central banks to extend their accommodative policy settings, or at least talk about doing so, when trouble brewed. In the absence of quite such an immediate layer of defence, equity markets have staged a modest revolt.
Percolating since Trump’s election victory, beyond the more positive efforts relating to tax reform and deregulation, has been the more worrying dimension of trade protectionism. And so, with polls seemingly pointing to a challenging midterm election in November, it appears Trump has at last been compelled to execute on the more populist, and less economically liberal, elements of his agenda. Indeed, outside of a myriad of policy confusion, it seems the one thing we can be clear on, in relation to Trump’s economic ideology, is that he dislikes free trade. In a CNN interview in 1989, on the subject of Japan’s infiltration of US markets, Trump pleaded “You tax the hell out of all of them - 20% on oil, 20% on the cars, 20% on the VCRs".
It is these long held views that leave the world in a precarious place. Though budgetary and legislative reform require congressional approval, the President wields tremendous authority over trade policy. Following his succession of tariff announcements from solar panels to washing machines to aluminium, global leaders have been scrambling to respond; with the EU, Canada and Mexico, three of the US’ closest trading partners, all managing to secure exemptions. But it is these exceptions that leave Asia, and particularly China, feeling ever more isolated. The Chinese leadership have been consistent in their keenness to avoid the threat of a trade war, with both the President and Premier espousing the virtues of globalisation. However, despite this ideology, leading personnel within the Chinese leadership (such as the Chinese ambassador to the US) have indicated China would respond with the ”same scale and intensity” to any measures levied upon their traded goods.
Trade skirmishes are underway but offering some hope that a trade (or even cold) war can be avoided, we have seen China renew pledges to open its economy to inward investment and to protect intellectual property rights. US Treasury Secretary, Steve Mnuchin, has responded with very positive noises about the prospects for a truce. What is fascinating is that amidst the haze and bluster of a world exhibiting creeping nationalism, not least in the voting chambers of Germany and Italy, China continues to evolve into the flag bearer for globalisation and free trade.
Real Progress in the UK
Brexit remains the most emotive topic across the political spectrum, within the media, throughout the business sector, and at the dinner table. The pound recovered more ground based upon modest progress being made in the negotiations. Whilst the solution to the Irish border challenges remain aspirational, the framework for the implementation period has now been agreed. Distilled to its core it would seem there will be very little difference between the implementation period and the current arrangement, barring the UK being granted freedom to negotiate and ratify its own trade deals. Such progress offers further hope that both sides are willing to behave constructively and that, ultimately, a fair deal can be struck.
It is perhaps the absence of any immediate anxieties relating to Brexit, that explains the Bank of England’s increased confidence in communicating the trajectory for interest rates; though there are, of course, other reasons. The ongoing strength from the labour markets is the primary factor, particularly as wage increases edge beyond inflation, and in so doing, provoke a modest swelling in the consumers’ wallet. But not all is rosy in the garden, many challenges lie in wait for the UK economy. Clearly Brexit negotiations could yet sour, we are seeing fading confidence in the manufacturing sector and house price falls within the M25 are starting to raise anxiety nationally. Pulling all this together, we would expect the Bank of England to move very cautiously in its ambition to raise interest rates.
Outside of anxieties over trade and Russian espionage, there was some tangible good news on the geopolitical stage that, for a fleeting moment, will give investors one less thing to worry about; namely the thawing of relations between North Korea and the US. It is hard to determine, or indeed trust, the comments being made by the North Korean leader, Kim Jong-un, but in a remarkable volte face, it appears he is willing to commit to denuclearisation if the US and South Korea can create an atmosphere of peace. There is even the prospect of a meeting between the two outspoken leaders; as soon as May this year. What a mouth-watering, if a little unnerving, spectacle that would be.
“I won’t rule out direct talks with Kim Jong Un, I just won’t… As for the risk of dealing with a madman is concerned, that’s his problem, not mine”
U.S. President Donald J. Trump, March 4th 2018
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The opinions expressed in this document are not necessarily the views held throughout Brewin Dolphin Ltd.