In another turbulent quarter for global politics, where the level of drama matched that of a Netflix mini-series, stock markets were rocked but, ultimately, showed their resilience. Indeed, despite the multiple sources of angst, from both within and without politics, global stock markets finished the period with marginal gains. These modest returns were amplified for sterling investors, as our own domestic risks issues weighed on the currency, translating into enhanced performance from overseas investments.
Though it has been a relatively dull quarter for investment returns, year to date stocks are still higher. It’s always more reassuring when the reason for strong equity returns is better economic growth, but current conditions reveal a somewhat more nuanced position. On the one hand the services sector around the world continues to perform well. This reflects the general good health in labour markets globally, with high levels of employment, reasonable wage increases and very modest levels of inflation, further strengthening consumer confidence and purchasing power. By contrast the manufacturing sector provides a more downbeat narrative. Here, we can be fairly confident in ascribing a large portion of the blame to the ongoing trade tensions between the world’s two major superpowers; China and the US. Not only do the associated tariffs have an immediate bilateral impact on demand, but it also drains confidence from boardrooms globally.
Despite the economic data not firing on all cylinders, we would caution against becoming too despondent. On the trade front we should remember the motivations for both nations to strike a deal. For Trump, history paints a grim picture for incumbent presidents seeking re-election during, or immediately after, a recession. Creating one from an otherwise booming economy would, therefore, hardly be befitting of a “very stable genius”. As for China, whilst Xi Jinping enjoys immunity from democratic accountability, he still has a clear desire to oversee a vibrant and stable economy. Any significant disruption from trade will need to be offset by increased stimulus and more borrowing. Such a debt-laden strategy runs opposed to the longer-term ambitions for sustainability. An imminent grand bargain, covering all the legitimate concerns in relation to trade and technology transfer, seems out of reach, but a cosmetic arrangement, that permits an immediate respite, offers far more potential.
It is also worth noting that the manufacturing sector took a downturn before the US-China trade disagreements erupted. Following the global synchronised recovery of 2017 this sector of the economy has universally slowed. Such a path fits neatly with a classic manufacturing cycle. Specifically, as businesses grow confident, so their warehouses fill with increased levels of inventory to meet burgeoning demand. Any subsequent knock to demand, therefore, will result in a double blow to manufacturers i.e. falling consumer purchases weigh on production activity, as will the preference for businesses to run down elevated levels of inventory. Typically, this is followed by a period in which said manufacturers realise they have insufficient stocks and need to crank up production once again; especially if squabbling superpowers can make peace!
Central Banks Remain Crucial
As has been repeated many times in these reports, actions undertaken by central banks remain crucial to the fortunes of the economic cycle and stock markets. Inherent in our investment approach is that in the months approaching a recession, stock markets tend to endure their worst relative performance. Those recessions have typically followed over-zealous efforts by the central bank to slow the economy down. That risk was writ large at the end of 2018 but investors have taken heart as central banks around the world flipped to a more generous policy setting; a strategy intended to extend the current economic cycle and stave off recession. Why don’t they do this in perpetuity? There is not always such flexibility.
When demand is strong, and inflation is high, such conditions can lead to a self-reinforcing cycle of additional demand and higher prices. But with inflation expectations having fallen dramatically, along with a slowdown in the manufacturing sector, it is now entirely in the gift of central banks to set policy to a more accommodating course. Over the third quarter we saw the US cut interest rates for a second time, the European Central Bank announce it will relaunch its quantitative easing program, and even the more hawkish members of the Bank of England conceded an interest cut might be appropriate even if a Brexit deal were concluded. The majority of the central bank fraternity are attempting to be as generous as possible with policy to help lift the economic cycle out of its funk, cutting interest rates and sending bond prices soaring.
A Crude Awakening
Mid-September bore witness to a significant drone assault on Saudi oil production and, in so doing, the largest single day spike in the price of oil since Saddam Hussein’s invasion of Kuwait. The US has blamed Iran for the attack on Abqaiq, a site that prepares almost 70 per cent of the kingdom’s crude for export. In response, the Saudi Oil Ministry has been keen to impart how soon operational capacity can be restored, supported by regular reports of progress. Such action, or perhaps communication, has allowed the oil price to cede some of its gains, but fear remains that hostilities may return.
Where the oil price goes next is one of the financial market’s imponderables. The number of variables is just so vast that one must treat even the most coherent of narratives with caution. Instead, it is better to be cognisant of the impact oil can have. A high price over a sustained period is a substantial tax on consumers and a hefty input cost for businesses. The associated knock to activity would weigh heavily on the global economy and, most likely, stock markets as well. For the time being, therefore, we are reassured by the price reversion; but remain vigilant.
Brexit developments moved at a pace over the third quarter as our new PM, Boris Johnson, was duly crowned. Johnson’s strategy has not so much been a total reworking of that of his predecessor, more it’s seen greater application and enthusiasm for the original moniker, ‘No deal is better than a deal’. In order to make this position clear to the EU, and to the electorate, Johnson is alleged to have attempted an unusually long suspension of Parliament; a manoeuvre the UK Supreme Court has since deemed unlawful.
With the soap opera in Westminster unfolding in an unpredictable manner, yet more surprises are sure to come. Thus far Parliament has been able to reaffirm its opposition to ‘No deal’ but the sustainability of this obstruction is uncertain. A general election may (or may not) change the voting mathematics and so, despite the recent victory for Europhile rebels, no deal possibilities remain. Investors should note the resilience stock markets present to such an outcome. Should sterling weaken in this environment, as is widely anticipated, then overseas earnings from the global businesses that dominate our FTSE 100, will translate into more pounds. This translation impact is even more helpful when investing in international stocks, as is the case with the global portfolios constructed at Brewin Dolphin.
In the final act of the quarter we see US Democrats attempting to build a case against President Trump in order to bring about impeachment proceedings. Evidence thus far seems unlikely to be sufficient to convince the Republican-controlled Senate. A 2/3rds majority is required to remove a sitting president, so it’s hard to imagine so many Republicans turning on their man in the White House.
It might be prudent to be a little cautious of this thesis, however. Speaking at the 2019 Texas Tribune Festival recently Jeff Flake, a Republican Senator until January of this year, was asked to comment on suggestions that if there was a secret vote in the Senate, at least 30 Republicans would back impeachment, “That's not true. There would be at least 35," Flake said.
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