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Market sentiment: Uncertain, as coronavirus continues to unsettle investors. But the continuing strength of the U.S economy, coupled to a belief that central banks around the world stand ready to ease monetary policy further if necessary, has limited the damage done by the virus to global stock markets.
Coronavirus. There remains the ‘black swan’ risk of coronavirus becoming a 1919 Spanish flu-like pandemic. Perhaps investors should invest accordingly – and buy core government bonds, safe-haven currencies such as the U.S dollar, Japanese yen and Swiss franc, and also own some gold. But financial history is littered with false signals, that at the time were thought to herald a recession. Bearing this in mind, it perhaps makes more sense to stay still for the time being. A multi-asset portfolio, that contains global equities and bonds, might be the most appropriate response.
Certainly the initial panic by investors has ceased. Over the past 14 days, global investors have been buying back stock market positions that they had sold in late January and early February. They appear to believe that the economic impact of coronavirus will be in the form of a short, sharp, shock, largely confined to the Asia-Pacific region. And that central banks will react by loosening monetary policy further in the event of a wider shock. Indeed, China’s central bank has already reacted with a massive Rmb 1.2tn ($173bn) liquidity injection into the banking system a fortnight ago, and on Monday it reduced the interest rate on its lending facility to banks. Meanwhile strong U.S economic data has helped reassure investors that increased spending by the American consumer will help reduce the overall hit to global GDP coming from a weaker China.
Having fallen 12% from its mid-January high by 3rd February, the domestic Chinese CSE 300 stock market index was down only 3.4% at the close of business on Monday. U.S stock market indices, such as S&P 500 and the NASDAQ, have had a succession of new all-time highs in February, led by tech stocks. The Stoxx Europe 600 index has also reached new highs, led by a rally in bank stocks after a positive results season.
Assuming a bounce-back in the Chinese economy once the coronavirus is dealt with (as we saw in 2003 after the SARS outbreak), S&P Global Ratings last week suggested China might see GDP growth of 5% this year, down from a previous estimate of 5.7%. Goldman Sachs are now forecasting global GDP growth this year of 3%, the same as in 2019. If correct, these forecasts do not suggest a ‘run for the hills’ approach to investing this year.
The U.S economy. Talk of the American economy in a Goldilocks scenario is premature. But certainly, it is enjoying higher GDP growth, at just over 2% annualised, than most other developed economies, and there is little evidence of inflation that might lead to the Fed raising interest rates, and to a cooling of demand growth.
Key to the U.S economy is household spending, which comprises around 70% of total U.S GDP, more than in any other major economy. And currently the American consumer is in a strong state. January’s jobs report showed 225,000 new jobs were created last month – impressive, given that unemployment is at a multi-decade low of 3.6%. Consumer demand is being given an additional boost from wage growth, up 3.1% year-on-year in January.
U.S deficit financing. The combination of tax cuts (albeit mostly benefiting the rich, who spend less of their income) and increased military spending, has helped support the economy and has led to a federal government deficit equivalent to 4.6% of GDP. This compares to budget deficits in Japan of 3%, the eurozone of 0.9% and the U.K of 4.3%. Some economists fear that when the next downturn occurs, there will be little room for extra fiscal stimulus. That the bond market will become alarmed at the increased supply of Treasuries, and a much-awaited bear market in bonds will start. Perhaps this will happen. But at the moment there remains insatiable domestic, and global, demand for Treasuries.
Greek debt falls below 1%. Credit where credit is due. Solid GDP growth (Q4 GDP came in at 2.3% year-on-year), and a business-friendly government after last year’s elections, have helped transform investor appetite for the country’s sovereign debt. 10 year government bonds now yield less than 1%, for the first time in the country’s history – having touched 30% at the height of the debt crisis. For investors in the euro area, 1% is an attractive yield, given the ECB’s negative interest rate policy. There is also the hope that the country’s debt will be upgraded from high yield (aka: junk) to investment grade, so being included in the ECB’s asset purchase scheme and in global investment-grade bond indices, which many bond funds mirror.
U.K government policy: out goes austerity and little love for the union. Two indications of government policy emerged from last week’s cabinet reshuffle, which included the resignation of chancellor Sajid Javid, who had promised a balanced budget by 2022, and Northern Ireland secretary Julian Smith, who had succeeded in getting Ulster politicians to agree to return to the Stormont parliament.
One is that Prime minister Boris Johnson, and his advisor Dominic Cummings, want the Treasury to be more relaxed on government spending in order to finance infrastructure projects and increase day-to-day current spending. To achieve this they intend taking direct control of Treasury functions. The 11th March budget will now reflect Johnson’s political priorities, with the Treasury’s priorities taking a back seat.
The second is that the government is unwilling to use political capital to shore up the union of Northern Ireland with the rest of the U.K. Johnson had faced criticism from military-connected Conservative MPs and popular newspapers for signing-off on Smith’s Stormont agreement, which include following up accusations by Sein Fine of state collusion in the killing of Catholics during the height of the Troubles. So he fired Smith, who had won praise from both unionist and republicans in Northern Ireland for his diplomacy and understanding of the issues involved. A referendum on a united Ireland seems to be coming closer, given the demographics of Ulster and the E.U Withdrawal Agreement that Johnson secured with Brussels, which makes it easier for Northern Irish businesses to trade with the Republic than with mainland U.K.
Meanwhile in Scotland, the SNP continues to demand a second independence referendum, with support for the cause aided by the perception that Brexit is an English project which a majority of Scots voted against. Indeed, a survey of Brexit supporters last summer found that a majority who also voted Conservative would prefer to lose Scotland from the Union rather than forego Brexit.
U.K/ E.U trade talks – the fighting starts. All three U.K government ‘heavyweight’ figures (ie, Boris Johnson, Michael Gove and Dominick Cummings), together with David Frost, the U.K’s senior trade negotiator, have made clear in recent weeks their refusal to consider alignment with E.U regulations in return for quota and tariff-free access to the E.U. Let alone a role for the European Court of Justice in policing U.K laws. The U.K government has insisted that Brexit must mean full independence from the E.U, and cite the Canada/ E.U trade deal as a model they wish to follow.
The E.U replies that any watering-down of rules on state aid, workers rights, food, pharma and environmental standards would lead to an uneven playing field for the U.K in its trade with the E.U, which is substantially more in value, and in breadth, than that with Canada. Should the U.K wish to have its own regulations, then quota and tariff-free access may be denied. And in any case, the Canada trade deal is peppered with tariffs and quotas – though much reduced. We are still in the early stages of the fight, which is expected to become more earnest when formal U.K/ E.U negotiations start next month.
Multi-asset should be at the heart of investing. The continuing uncertainty over the direction of stocks and other risk assets suggests multi-asset portfolios may continue to be the asset class of choice amongst global investors, given that they offer a welcome diversification of risk as well as of return.