A fortnightly look at global financial markets
13 April 2018
Market sentiment: Still apprehensive. A fresh fear is lurking on global capital markets, and it is not about trade wars. It is that global GDP growth may have peaked in the current growth spurt, that began in early 2016. Add to this the 1) ongoing fear that a trade war will break out between the U.S and the rest of the world, 2) apprehension that a new wave of regulation will impact on the business models of some of America’s largest quoted companies (eg, Facebook, Google and Amazon), and 3) warnings by Russia of ‘serious repercussions’ should the U.S attack Syrian bases, and one can understand investors’ current nervousness.
However. Fundamentals remain supportive for stocks. Consensus estimates for global corporate earnings growth in the first quarter are at 15% over the previous year, while for the S&P 500 index it is 17%. The beleaguered U.S tech sector is expected to see 22% earnings growth, which will help sooth investors’ nerves. Despite the prospect of two, maybe three, more rate hikes from the Fed this year, and probably one from the Bank of England in May, monetary policy remains loose by historic standards in all the main economies. This supports risk assets, buy keeping borrowing costs low for companies and their customers, and by keeping ‘risk free’ rates low and unattractive relative to the expected returns from stocks.
Peak growth? Last week’s U.S jobs data revealed slightly weaker-than-expected March jobs growth, at 103,000. Wage growth was at 2.7% y/y, while unemployment fell a little to 4%. To market bulls, this fits a story of a broadly expanding U.S economy. The current GDP growth rate of around 2.5% annualised will pick up to 3% as the year progresses thanks in large part to the fiscal stimulus of Trump’s tax cuts. Recent Fed minutes appear to support this view.
Others smell the beginning of the end of the current global growth spurt. In mid-March JP Morgan reacted to disappointing retail sales in the U.S in both January and February by reducing its estimate of the current rate of expansion of the U.S economy to around 2%. Elsewhere we have seen weak retail sales reported in Europe and China, and purchasing manager indices (PMIs) in most major economies have cooled down – though most are still indicating growing demand.
Flattening yield curve. The U.S yield curve continues to flatten, as the Fed pushes up short term interest rates but long term rates yields remain stable. If bond investors thought growth and inflation were going to rise, the reward for holding long term debt should be rising – not, as it has been, broadly unchanged over the last six weeks. Some economists interpret the narrowing of the spread between 2yr and 10yr Treasuries as a warning of potentially weak economic activity ahead.
Trade war. Trump is seeking better access for U.S companies in the Chinese market, protection over the intellectual property (IP) that American companies bring when they invest in China, and a reduction of around $100bn in the annual $375bn trade deficit that the U.S runs with China. Following both sides tit-for-tat tariff announcements in recent weeks, Xi Jinping made a conciliatory speech mid-week. Trump gratefully hailed this as ‘the end of the trade war’, even though the speech was largely a repetition of previous announcements by Beijing. Xi did, however, promise to make it easier for U.S companies to enter certain sectors, such as finance. This is likely to end with Trump claiming a great victory for himself and for America, with China having given away little – still pursuing mercantilist, rather than free, trade policies.
Sterling and Brexit. Sterling looks set to benefit from 1) a rate hike in May from the Bank of England, which would lift interest rates to 0.75%, and 2) increasing confidence that the Brexit negotiations will result in a relatively smooth breakup. Both sides appear confident that a free-trade deal of some sort can be agreed by the October deadline, though thorny problems such as the Irish border issue persist. Michael Bernier, the E.U’s chief Brexit negotiator, has offered the U.K the possibility of remaining in both the single market and the customs union, while being formally out of the E.U. Such a contortion will mortify the Brexit elite, but probably satisfy the House of Commons should it be given a meaningful vote.
A multi-asset portfolio for the long term. We favour a long-term multi-asset approach to investing, whereby investors choose a suitable combination of global equities and bonds (depending on their risk profile and investment horizon), and leave the portfolio unchanged. Regular re-balancing ensures winners are sold and losers are bought – which financial history, and common sense, supports. The chart below shows a typical long-term balanced portfolio based around 60% global equities and 40% global bonds. Financial history shows this combination to offer good returns relative to risk (ie, volatility). Investors should try to be as diversified as possible, perhaps using the 60/40 model as their guide. Multi-asset funds based on this principle are available, often with different ratios of bonds and equities depending on the level of risk suitable for an investor. Note that the chart shows neutral weightings for the long-term investor, it does not incorporate the near-term weighting suggestions of the previous paragraph.