A strong equity rally set against a weakening economic backdrop
Investors entered the new year with a glass-half-full mindset, buoyed by an apparent reversal in US monetary policy, the resumption of US-China trade talks and the hope that Brexit negotiations would be concluded. The rally in equities, however, stood in stark contrast to a slew of disappointing economic data from across the globe.
Equities surge despite weakening manufacturing surveys
In local currency terms, US and European shares gained 8% and 6% respectively, though the stronger pound translated into sterling gains of closer to 4%. Shares in the UK rallied between 4% and 7%, with smaller companies making up some of the lost ground from 2018. Bonds rose by 1% to 2%.
The rally in equities was in stark contrast to a slew of disappointing economic data. The JP Morgan Global Manufacturing PMI survey dropped to a two-and-a-half-year low, reflecting slowing growth across Europe and many developing countries. Italy fell into a technical recession, defined as two consecutive quarters of negative growth, and survey data suggested that German manufacturing growth was contracting. Similar surveys, released in early February, pointed to growth stagnating in the UK, unsurprisingly attributed to the lack of clarity on how we intend to leave the EU.
The Fed signals patience as the ECB warns of downside risks
The US Federal Reserve appeared to make a dramatic change of direction, saying that the case for raising rates had weakened somewhat and that it would be patient in monitoring data before making further adjustments in policy. Mario Draghi, President of the European Central Bank, warned that risks surrounding the outlook for growth in Europe had moved to the downside, citing geopolitical uncertainties, protectionism and vulnerabilities in emerging markets.
The Trump Twitter feed provided further relief, hinting that the US had no wish to impose further trade tariffs on China and announcing further talks aimed at averting a trade war. US government employees returned to work after an extended Christmas break, though President Trump warned that this was only a three-week ceasefire unless the budget to build his wall was approved.
With no sense of irony, the EU charged eight banks with manipulating interest rates in the European bond market.
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
A pause rather than a reversal, with pitfalls ahead
Opinion is divided on whether the Federal Reserve succumbed to pressure from market participants after December's sell-off in risk assets, or whether it exercised pragmatic judgement given that economic data had been weakening at the time. Investors were cheered by the change of rhetoric and, ironically, several US data releases since the Fed's latest meeting have pointed to a steadily growing economy.
Two things are worth noting about the Fed's latest statement. First, it has not performed a reversal in the sense of indicating a cut in interest rates; it has said it will pause and watch the data for a while before deciding the next course of action. Second, as J.M. Keynes used to say, "When the facts change, I change my mind." Worryingly poor data from China, combined with the possible effects of the US government shutdown on the economy, justify watching and waiting for a while, especially given the luxury of a subdued inflationary background.
It is interesting that, despite an end to monetary stimulus through quantitative easing, fixed interest bond yields remain low. Some 40% of the Eurozone government bond market has a negative yield, the same level as in April 2018 when QE was still very much in evidence. The fall in yields in December was attributed to a flight to safety as fears over slowing growth sent equity markets lower, but January's strong rise in risk-on assets, equities and low-quality bonds, had little effect on bonds.
One explanation is that we have returned to the Goldilocks era of slow but steady growth, more evident in America, accompanied by low or falling inflation. An alternative theory is that investors feel reassured that, once again, central bankers have their backs and that the balance of risks favours being invested. Potential pitfalls, geopolitical and economic, are likely to test this thesis in the coming months. For now, we feel that after a reasonable correction, we are prepared to cautiously monitor the move higher.
The rally in equities was in stark contrast to the slew of disappointing economic data from across the globe.
Having used the late-year sell-off to increase risk, we remain focused on the areas of the market where we see better long-term value, while maintaining broad diversification across asset classes and investment styles.
Overweight UK equities
We used the sell-off late last year to increase risk and remain overweight UK equities, which have suffered with the Brexit uncertainty but which we think offer better value than most other markets over the longer term.
Underweight fixed interest
We remain underweight fixed interest, preferring equities and alternative investments. Where we do hold fixed interest, we mostly use funds that have limited exposure to rising interest rates.
Well-diversified portfolios
With so much uncertainty around the world, accompanied by record levels of debt, we believe there is a strong case for running well-diversified portfolios, investing in actively managed funds with sound investment processes.
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.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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