Following a dismal final quarter of 2018, in the first three months of 2019 markets staged a dramatic turnaround in performance, with many international indices advancing as much as 10% in sterling terms. Indeed, our own domestic market fell just shy of this hurdle. Of course, much of the explanation behind these outsized gains lies in the recapture of previously lost ground, but there are fundamental developments at play too. As this report will go on to explain, policy makers across America, Europe and Asia have each moved to support a more troubling growth outlook.
Markets have taken comfort from these efforts, casting aside disappointment in recent data, determining life will improve as the policy stimulus weaves its way into the global economy.
It’s been a difficult tenure for the most recent appointee to the post of Federal Reserve Chair, Jay Powell, but the job was never likely to be straightforward. Not only would Powell have to deal with a somewhat more outspoken President, he must also manage an economy far more advanced in its business cycle. This challenge requires Powell to dab the brakes, in order to avoid overheating, but softly enough to avoid starting a recession. Thus far the report card for the new Chair, on this unenviable task, is mixed.
The most likely catalyst for both the market’s and Powell’s travails began in October last year when the Fed Chair declared interest rate policy was “a long way from neutral”. Such stark language suggested several interest rate hikes would be needed to meaningfully arrest inflationary pressures within the economy. He intended to reassure markets, showcasing his confidence in the economy by emphasising its resilience to future interest rate hikes; but talking to the market is like walking on eggshells. In a matter of days, investors had determined the Fed’s strategy of monetary tightening was on ‘auto pilot’. Such a dogmatic approach meant only extremely poor economic outcomes would derail the Fed from a glide path of one interest rate hike per quarter. With the Fed having flipped from investors’ ally to antagonist, market anxieties grew, with a vicious circle ensuing as selling begot more selling.
The market action eventually broke the Fed’s nerve and in December it communicated a slower pace of interest rate hikes for 2019. Selling continued until even more conciliatory language from the Fed in the new year. By March, following some less convincing job creation and consumption data, the Fed were communicating interest rate hikes were completely off the table for the remainder of the year, with only one hike expected in 2020.
Though markets have been encouraged by this show of policy support, the round trip has been quite an unsettling ride. It is no easy task, but the experience might encourage a more cautious approach to future attempts to slow the economy which, itself, may lead to some alternate unintended consequences?
Although US interest rate policy remains extremely important, and moves to guide to lower rates in are generally supportive for risk taking, it has not been the solitary driver of the equity market recovery this year. Adhering to the thesis that ‘size matters’, efforts from Chinese policy makers to ameliorate their economic performance have also played a crucial role.
In a noble attempt to tackle corruption, environmental degradation and a swelling shadow banking system, Chinese authorities accelerated much needed reform in 2018. They did so, however, a little over-zealously, slowing the economy too much. Through its various channels the State is now attempting to reignite moribund levels of demand. At the National People’s Congress in March, the Chinese authorities confirmed a more supportive policy for the year ahead. The more expansive program would take the form of tax cuts for both consumers and businesses, as well as increased spending on areas such as infrastructure.
Further supporting Chinese demand, we saw the authorities ease back on regulation as we moved through 2018, freeing up the banking sector to do a little more lending. So far, and although too early to call a trend, the efforts are bearing fruit with Chinese credit growth outstripping expectations year to date.
Never far from investor’s concerns are the simmering tensions in US and Chinese trade relations, however, a more constructive narrative is emerging. Though no agreement was determined over the first quarter, the running commentary from the respective parties reveals an increasing sense of goodwill. This more convivial approach suggests neither side is particularly comfortable with talks breaking down. Indeed, rather than offer an unpalatable ultimatum in the run up to the most recent March 1st deadline, an extension to the negotiation was secured and talks remain ongoing. At the very least the current narrative points to a lower probability of deal collapse. This has been good news for global trade and, therefore, markets.
Europe Tries Again
Continuing the trend of 2018, the data emanating from the continent has remained uniformly grim in 2019. In January, it was revealed that Italy had entered a recession in the final quarter of 2018 whilst Germany, the beating heart of the European economy, only narrowly avoided a similar fate. Survey data over the quarter offered little hope of an imminent reversal in performance.
The string of geopolitical challenges plaguing Europe, ranging from a radical Italian government to protests on the streets of France, could be attributed to the absence of a competitive labour market and as a symptom of prior efforts to reform. Just as easily, perhaps, it might be considered just plain bad luck. Regardless of the drivers, the European Central Bank has decided it must do more to help lift the region out of its funk. In early March the ECB reinstated a program offering cheap funding to banks on the basis the capital is used to support lending. This will be of particular assistance to Italian and Spanish institutions where loan growth is looking particularly sclerotic.
Of additional benefit to Europe, should it transpire, would be any increase in economic activity in China as per the earlier discussion. Via its exports of machines, autos and luxury goods, the fortune of the European economy depends to a far greater extent on China than it does for the more closed structure of the US economy.
The Brexit saga is moving fast, and keeping pace with MPs’ preferences and scope for compromise has become quite the game of chance. In order to maintain relevance, therefore, we would simply conclude that a ‘no deal’ scenario remains our least likely expectation, whilst recognising it is not impossible.
If ‘no deal’ is avoided, then we are looking at an economy with high levels of employment and decent wage growth. Under this scenario, and despite a less certain housing market, it would appear the Bank of England would be compelled to raise interest rates once, maybe twice, before year end. This should prove a supportive backdrop for sterling assets.
Under a ‘No deal’ outcome we can expect increased levels of short-term equity market volatility but, ultimately, for UK stocks to perform reasonably well. As evidenced by the weeks and months following the 2016 referendum, any ensuing weakness in sterling is likely to translate into earnings upgrades for our internationally facing businesses.
More broadly, whilst Brexit might seem the only show in town given domestic news flow, we are sure clients appreciate the relative insignificance of the UK contribution to global growth when compared to the global super powers such as the US and China. In both examples we have seen the architects of policy make concerted efforts to keep the economic cycle going. Markets have responded in kind.
“All animals are equal, but some animals are more equal than others”
George Orwell, British Author, 1903-1950
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