US records contrast sharply with emerging-market stress
August saw the US bull market become the longest in US history, with the broader market gaining over 4% in sterling terms and touching all-time highs for the first time since late January. Outside the US, however, conditions were markedly different: European shares fell around 2%, UK equities lost between 1% and 3%, and emerging markets saw contagion spread from a few idiosyncratic situations into a wider sell-off.
US strength and emerging-market weakness define the divide
The wider US stock market gained over 4% in sterling terms, but European shares fell by around 2% and UK equities lost between 1% and 3%, with larger companies taking the bigger hit. The US dollar rallied to 2018 highs, driven by the Fed's policy of gradual interest rate increases, with the next 0.25% rise expected in September.
It was Argentina that gave a lesson in monetary policy, increasing its benchmark interest rate from 45% to 60% with a commitment not to cut before December, in a desperate attempt to halt the slide in its currency. Emerging markets saw contagion from a few idiosyncratic situations, notably Turkey, Argentina and Brazil, spread to the wider market. The benchmark emerging-market index entered bear-market territory in early September, having fallen 20% from its January peak.
Italian budget fears and Brexit uncertainty weigh on sentiment
In Europe, attention focused on the forthcoming Italian budget, due to be presented to the EU in mid-October. Finance Minister Tria reiterated his plans to produce a budget falling within EU rules, but this was greeted with some scepticism as it would require both coalition leaders to rein in their spending and tax-cut proposals.
In the UK, fears of a no-deal exit were somewhat eased as Governor of the Bank of England, Mark Carney, announced that he would consider extending his contract in order to ensure a smooth Brexit. The Trump Twitter feed, meanwhile, complained about the Federal Reserve raising rates, labelled China and the EU "currency manipulators", threatened to pull the US out of the World Trade Organisation, and authorised the doubling of tariffs on steel and aluminium imports from Turkey. An announcement on further tariffs on Chinese goods was said to be imminent.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
Dollar strength and the emerging-market dilemma
Economic data remained generally positive, though there were signs that the rate of growth was slowing. The stand-out exception was the United States, where the expansion was more emphatic. The paradox was that the stronger the US became, the tougher life grew for emerging markets in particular.
The first casualty of dollar strength was Turkey, but it was soon joined by Argentina (possible stagflation), Russia (US sanctions) and South Africa (recession). Others, such as Indonesia, Brazil and India, saw their currencies plummet. One of the effects of quantitative easing has been that many emerging markets feasted on the artificially low cost of debt over the past decade. Most of this debt was issued in dollars, creating the potential for a funding crisis should their local currencies depreciate against the value of their debt.
There were signs that this risk-off sentiment was feeding through to developed markets. The UK was suffering from the lack of direction on Brexit negotiations, while Europe and Asia had also posted recent losses. The beneficiary was the US, perceived as a safe haven with stronger growth and higher interest rates. The fear tempering markets might also save them from the worst scenarios, as it had, by and large, prevented some of the excesses of previous cycles. However, the fact remained that monetary policy was now tightening, albeit gradually, and the supportive central-bank backstop was diminishing.
Monetary policy is now tightening, and the supportive central-bank backstop is diminishing.
Bull markets tend to outlast rational analysis. For this reason, we have been reluctant to reduce our overall exposure too aggressively. Instead, we have opted to mitigate the risk by avoiding inflated areas and gradually increasing exposure to out-of-favour value and defensive stocks.
Emerging-market bond switch
The fixed interest switch from emerging markets to a global macro bond fund, effected in May, was showing a gain of around 3% at the time of writing.
Awaiting better emerging-market entry levels
Following recent underperformance, emerging markets were at a significant valuation discount, but we expected to see even cheaper levels as Fed tightening and dollar strength continued to bite. Longer term, valuations always speak for themselves, but we were waiting for more extreme levels for an entry point.
Avoiding inflated areas, favouring value
We avoided inflated areas such as technology and high-priced growth stocks, preferring more out-of-favour markets such as Japan and the UK, while gradually increasing exposure to value and defensive stocks.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
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