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A fortnightly look at global financial markets
Market sentiment: Confident, though jittery, after recent events in the Gulf. The assassination of the Iranian general Qassem Soleimani has dented the almost universal optimism over risk assets that we saw at the end of 2019. However, in retrospect, the killing may be seen more as a Trumpian ad hoc action than a prelude to outright war. Other actions by Trump do not indicate a desire to become more involved in the historic rivalry between Saudi Arabia and Iran for dominance in the region, or a will to curb Turkish and Russian influence.
Global investors see stronger U.S economic growth in 2020, and a weaker dollar, leading to improved U.S corporate earnings growth and stimulating a pick up in the global economy. Meanwhile, low inflation means global interest rates and bond yields are likely to remain at current low, or negative, levels. This is a positive combination for risk assets. But with the Fed perhaps already at the end of its easing cycle, investors will be more sensitive to any corporate earnings disappointments, as well as to political news flow.
Investors have reason to be optimistic about the global economy and stock market outlook for 2020. This suggests a bias towards equities over bonds and cash. But we should always hold a broad range of assets to protect ourselves against negative shocks, such as those found in multi-asset funds.
Two of the three factors driving U.S, and global, stocks will not be repeated this year. Last year’s 31% return for U.S stocks, and the 22% return for the World ex-U.K index (MSCI), were driven by three factors. Only one of which will be repeated this year.
First, the starting point was low, after the sell-off in the final quarter of 2018. Global stock markets had probably become oversold by 1st January 2019. Second, and fuelling the recovery rally in the first quarter of 2019, was the surprise U-turn by the Fed in its monetary policy. Three rate cuts in 2019 followed. The Fed’s own ‘dot chart’, from its last policy meeting in December, indicates no further rate cuts are anticipated in the current cycle. Indeed, analysts point to a happy equilibrium for the Fed this year: record low unemployment of 3.5% and moderate wage growth, yet core PCE inflation at just 1.6% (below the 2% target).
But one other driver of stock market gains will remain with us: share buybacks. These will remain controversial, with critics accusing company managers of using them to manipulate stock prices in order to justify bonuses. But the habit, born in the U.S, is spreading to Europe and has been useful support for stock market progress over the last decade.
Politics. If the Fed is going to be boring this year, with no further cuts, investors’ attention will increasingly be on political news. U.S/ Chinese trade tension will persist, irrespective of whether the Phase One trade deal is signed, and will continue to disrupt supply chains. The impact is already being felt globally, on account of manufacturing companies’ complex supply chains. Global trade volumes have begun to fall, with some analysts forecasting a long-term reversal of globalisation with negative consequences for global economic growth.
Any economic recovery in the eurozone this year is vulnerable to Trump widening his tariff weapon to include the region’s exports. This is not only because many European manufactured goods contain some Chinese-made parts, or because of Chinese presence on several large European companies’ shareholder registers. Trump is also looking to retaliate against the E.U over the measures that France, and other countries, are taking against U.S tech companies over tax and privacy issues -despite his historic antipathy to Silicon Valley.
The Middle East looks set to continue to provide shocks to global investor sentiment. However, the oil price may prove softer than expected given the political pressure that Trump will exert on Saudi Arabia to keep prices down in a U.S election year. There is also an increasing overhang of available supply from North American shale as the price rises, and the OPEC and Russian voluntary supply cut agreement can be suspended at the turn of a tap.
The likely pick-up in the U.S economy this year will help Trump in his bid for re-election in November. This may bring relief to some sectors that Democrats wish to regulate, such as healthcare and Wall Street.
Attempts to break up Big Tech, and better regulate privacy issues, are likely to persist, however, as traditional Republicans -no fans of Silicon Valley- increasingly complain about the evolvement of monopoly businesses in the technology sector.
2019 saw investors start to mark down equity and bond prices from environmentally polluting sectors. For instance, last month the Swedish central bank sold its holding of bonds issued by the Australian state of Queensland, and the province of Alberta in Canada. It said both regions are major contributors to climate change. This trend is likely to gather momentum in 2020, as a mix of environmental-related legal issues, alternative energy sources, and activist investors, all exert pressure on investors to limit exposure to polluting companies.
The new U.K government. Prime Minister Boris Johnson, armed with his 80 seat Conservative Party majority in the House of Commons, looks set to oversee economic policies of a socialist inclination (eg, ending fiscal austerity, state support for industry and increased spending on the welfare state), and so turning his back on the economic policies of the Cameroon and May years. Will the gilt market be as forgiving of large budget deficits, as the U.S Treasury market has been of Trump’s rising deficit?
Meanwhile, social policy will be traditionally conservative in tone (eg, Brexit, law & order, a points-based immigration system). The combination is specifically intended to appeal to the new working-class Conservative constituencies of northern England, where voters voted Conservative often for the first time in their lives.
On the international stage, his government will be torn between a strong inclination to establish closer relations with the U.S, with whom they will hope to conclude a trade agreement and the economic necessity of retaining cordial relations with the E.U in order to win tariff and quota-free access into E.U markets. Yet Trump’s unreliability as an ally, and the stated desire of Trump and Congress to include agriculture and drugs in any U.S trade deal, complicates the picture. As does the E.U’s insistence that the U.K continues to observe E.U product and environmental standards if it wants a free trade agreement. For many Brexiters the ability to diverge from E.U standards is core to the concept of ‘taking back control’.
Brexit and U.K financial assets. Johnson’s self-imposed deadline of 31st December 2020 to conclude trade negotiations with the E.U plays into the hands of E.U negotiators. It is in their interest to delay offering a deal of any sort until the last moment, knowing that Johnson will be forced to accept it, or suffer the potential chaos of a no-deal rupture with the E.U and years of uncertainty for business as Johnson attempts to negotiate his preferred ‘Canada minus’ deal with an unwilling E.U. Johnson’s promise to his Brexit-supporters, that he will not seek an extension of the period for talks in July, the last available date to do so, has put additional pressure on himself.
The result is that the U.K might be bounced into a poor deal with Europe, in the eyes of Brexit supporters. For example, by signing up to E.U product regulations that would make a U.S trade deal hard to negotiate, continuing to allow access to U.K waters for E.U fishing boats, or agreeing to contribute to the E.U budget in exchange for access to the single market.
However, sterling and other U.K financial assets would prefer continuity and therefore will rally on newspaper headlines of a ‘bad deal for Britain’. The uncertainties of a no-deal break with the E.U in a year’s time do not appeal to investors, and neither does the idea of ‘Canada minus’ deal – since business likes uniform regulations with trading partners, which allows trade to flourish.
The Bank of England may be faced with a difficult choice if a no-deal Brexit appears likely. It will be urged by politicians to cut interest rates in order to support the U.K economy, but at the same time, it will be mindful of the impact that rate cuts might have on sterling and for inflation. Monetary policy will become particularly tricky should the government chose to substantially increase public spending over the coming years, adding to the inflation risk.