Outlook June 2019
Investors continue to fret about the growth outlook. The impact of the trade war is beginning to be felt and the recent escalation, caused by Trump's move to lift Chinese tariffs to 25%, compounds the issue. Even though economists predict that the economic effects of the dispute should be mild, the pain is appearing across important sectors of the S&P 500. While the first quarter US GDP print was strong at 3.2%, this may have been flattered by a low deflator reflecting the delayed response to the collapse in the oil price in Q4. Remember, the economy is still supposed to be benefitting from the effects of last year's stimulative package and this will soon start to wane. Some of the leading indicators such as the PMI/ISM have weakened (albeit from high levels) although consumer confidence remains buoyant.
Today's supply chains are complex and international, industrial businesses in places like Japan and Germany have felt the consequences of the US-China trade dispute. For instance, the German manufacturing PMI slumped to 44.1 in May, a fifth consecutive month that the index has indicated contraction. Global freight indices reflect this slowdown in trade.
The tone of the trade talks appears to be deteriorating and the Chinese appear quite content to dig their heels in as we approach the US Presidential Elections. Perhaps they're the ones who really know the 'Art of the Deal'. Markets may become more nervous if the situation does not improve by the time of the G20 summit at the end of the month. However, this dispute is not only about trade but reflects a gradual shifting in the geopolitical sands towards the East. Even in the Obama Administration, concerns were emerging about the theft of US software IP. Huawei has been blacklisted from doing business with US firms and Trump is pressuring his European allies to do likewise on security grounds. Ironically while there have been suspicions for many years about Chinese hacking malfeasance, it is only the Americans who have been caught bugging the German Premier. It will be interesting to see which way Europe jumps.
The rise in tensions in the Gulf is a further worry. Sabre rattling against foreign powers generally goes down well with domestic audiences. The Ayatollahs will be thankful of a distraction away from their collapsing economy and Trump is embarking on his re-election campaign. We can only speculate on how serious this will get but the Iranians are now bound to attempt to renew their nuclear programme. Thankfully, the surge in shale oil production in the US has reduced the geopolitical importance of the Middle East, at least for the American's. US crude oil production now exceeds Saudi's and astonishingly the nation is close to achieving oil independence.
Markets have joined Trump in shouting at the Fed to cut rates. The FOMC members are showing signs of 'avian fluidity' as hawks become doves, and the market is now almost fully discounting two rate cuts over the remainder of the year. Germany has just issued a 10 year bund on a record low yield and French OATs are also now priced to lose money. US Treasuries are currently hovering around 2%, while gilt yields have tumbled to 80 bps. Japan increasing looks like the road map that we are all heading down. While we can see this in Europe, we doubt this is the case in the US. Here the banking system is restored and the demographics different. The budget deficit may yet become an issue for Treasury buyers though no one appears to be giving it the slightest concern at the moment. It is difficult to be optimistic about the UK sitting on Europe's dreary doorstep under a dark Brexit cloud. With hindsight we missed an opportunity last year to pick up gilts on twice the current yield. However, the reality is that these yields are still tiny and the short-term capital pay-offs are tremendously asymmetric. We don't believe that these are what private clients are looking for.
The UK continues to be plagued by political uncertainty. Whatever Brexit permutations are put before Parliament, they are voted down. The nation is just as divided and the polarised views are becoming increasingly entrenched the longer that this goes on. The May show is thankfully over but now the clowns are being brought on. All the candidates are shamelessly pandering to the aging Party membership - Brexit and tax cuts for the wealthy. Is this really what society requires? The risks of a disorderly Brexit are escalating as too is a socialist Labour Government. We are now entering the worst case scenario for the UK, which is not necessarily a hard Brexit, but lingering uncertainty with the overhanging shadow of a hard Brexit.
We are nudging European equities down to 'avoid' in our matrix. We have never been big fans of Europe and have been a little underweight in our portfolios for some time. The foundations of the currency union were never soundly laid and we expect crises to flare periodically as a result. The strains are now being felt in Italy and while a crisis may not be imminent, that may be looming.
We suspect that markets will continue to trade within their current range. We would be a little surprised if they managed to make much further headway this year. There are plenty of flash points which could create short term volatility (aren't there always) though there is nothing to suggest that the wheels are about to come off. We make no other change to our positioning. We considered Japanese small caps and concluded that these are too racy for our client base, particularly following a good run in the growth names.
Liquidity post the Woodford event is likely to feature ever more highly as a concern for our clients and competitors. Liquidity has always been a key consideration in the way that we manage money and we are delighted to be out of UK small cap and property. It is tempting to be drawn to the premium offered by illiquid assets at a time of low yields but experience teaches the dangers of doing so especially as a bull market matures.
Today's supply chains are complex and international, industrial businesses in places like Japan and Germany have felt the consequences of the US-China trade dispute. For instance, the German manufacturing PMI slumped to 44.1 in May, a fifth consecutive month that the index has indicated contraction. Global freight indices reflect this slowdown in trade.
The tone of the trade talks appears to be deteriorating and the Chinese appear quite content to dig their heels in as we approach the US Presidential Elections. Perhaps they're the ones who really know the 'Art of the Deal'. Markets may become more nervous if the situation does not improve by the time of the G20 summit at the end of the month. However, this dispute is not only about trade but reflects a gradual shifting in the geopolitical sands towards the East. Even in the Obama Administration, concerns were emerging about the theft of US software IP. Huawei has been blacklisted from doing business with US firms and Trump is pressuring his European allies to do likewise on security grounds. Ironically while there have been suspicions for many years about Chinese hacking malfeasance, it is only the Americans who have been caught bugging the German Premier. It will be interesting to see which way Europe jumps.
The rise in tensions in the Gulf is a further worry. Sabre rattling against foreign powers generally goes down well with domestic audiences. The Ayatollahs will be thankful of a distraction away from their collapsing economy and Trump is embarking on his re-election campaign. We can only speculate on how serious this will get but the Iranians are now bound to attempt to renew their nuclear programme. Thankfully, the surge in shale oil production in the US has reduced the geopolitical importance of the Middle East, at least for the American's. US crude oil production now exceeds Saudi's and astonishingly the nation is close to achieving oil independence.
Markets have joined Trump in shouting at the Fed to cut rates. The FOMC members are showing signs of 'avian fluidity' as hawks become doves, and the market is now almost fully discounting two rate cuts over the remainder of the year. Germany has just issued a 10 year bund on a record low yield and French OATs are also now priced to lose money. US Treasuries are currently hovering around 2%, while gilt yields have tumbled to 80 bps. Japan increasing looks like the road map that we are all heading down. While we can see this in Europe, we doubt this is the case in the US. Here the banking system is restored and the demographics different. The budget deficit may yet become an issue for Treasury buyers though no one appears to be giving it the slightest concern at the moment. It is difficult to be optimistic about the UK sitting on Europe's dreary doorstep under a dark Brexit cloud. With hindsight we missed an opportunity last year to pick up gilts on twice the current yield. However, the reality is that these yields are still tiny and the short-term capital pay-offs are tremendously asymmetric. We don't believe that these are what private clients are looking for.
The UK continues to be plagued by political uncertainty. Whatever Brexit permutations are put before Parliament, they are voted down. The nation is just as divided and the polarised views are becoming increasingly entrenched the longer that this goes on. The May show is thankfully over but now the clowns are being brought on. All the candidates are shamelessly pandering to the aging Party membership - Brexit and tax cuts for the wealthy. Is this really what society requires? The risks of a disorderly Brexit are escalating as too is a socialist Labour Government. We are now entering the worst case scenario for the UK, which is not necessarily a hard Brexit, but lingering uncertainty with the overhanging shadow of a hard Brexit.
We are nudging European equities down to 'avoid' in our matrix. We have never been big fans of Europe and have been a little underweight in our portfolios for some time. The foundations of the currency union were never soundly laid and we expect crises to flare periodically as a result. The strains are now being felt in Italy and while a crisis may not be imminent, that may be looming.
We suspect that markets will continue to trade within their current range. We would be a little surprised if they managed to make much further headway this year. There are plenty of flash points which could create short term volatility (aren't there always) though there is nothing to suggest that the wheels are about to come off. We make no other change to our positioning. We considered Japanese small caps and concluded that these are too racy for our client base, particularly following a good run in the growth names.
Liquidity post the Woodford event is likely to feature ever more highly as a concern for our clients and competitors. Liquidity has always been a key consideration in the way that we manage money and we are delighted to be out of UK small cap and property. It is tempting to be drawn to the premium offered by illiquid assets at a time of low yields but experience teaches the dangers of doing so especially as a bull market matures.
