Monthly Market Update, June: Volatile Europe
Read our full Monthly Market Update June 2018
Global stocks were mixed last month. A combination of slower global growth, negative trade news and political volatility in Italy and Spain weighed with investors, many of whom chose to reduce their risk levels from more volatile regions. Performance was greatly affected by currencies, as the US Dollar gained more than 3% versus the GBP and the Euro, boosting assets denominated in that currency, such as global stock and emerging market indices. The Yen also rallied, causing Japanese stocks to fall. The result was tighter bond yields and wide dispersion in the equity markets. UK stocks gained 2.8%, with industrials leading the way, as manufacturing continues to benefit from the overall weaker Pound and becomes the biggest driver for a UK economy now growing at a mere 1.2% per annum. In Sterling terms, global stocks gained 4.2% (0.6% in USD), US stocks gained 6% (2.4% in USD), European stocks lost 1%, EM stocks lost 0.1% (-3.5% in USD) and Japanese stocks gained 2.2% (-1.7% in Yen). Following April’s rally, oil performance was thwarted, losing 2.2% last month. The UK 10 year bond yield fell from 1.42% to 1.23% during May, along with its US and European counterparts, as investors rushed into safer asset classes following political upheaval in Italy, when the President rejected the new government’s appointment of Finance Minister, almost driving the country into another election. In economic terms, global data suggest that Europe, which had been leading global growth at the end of last year, is now slowing down, mostly due to capacity constraints, but also due to consumer apprehension. Global trading patterns suggest that the slowdown in the global economy is not due to bad weather, as some commentators suggested. The silver lining came from an improvement in US manufacturing data, with internal demand driving the country’s industries. Global inflationary pressures intensified, partly due to higher energy prices and partly due to wage growth pressures, especially in the US. Central banks remained largely silent, with the US Federal Reserve still en route to deliver 3-4 rate hikes this year.
May confirmed data indicating that the global economy has been slowing down, compared to the rates it was growing at last year. Europe, last’s year’s economic champion, saw a weaker pace of growth, while the US experienced acceleration. Higher oil prices and capacity constraints have resulted in an inflation build up in most of the developed markets. Meanwhile employment conditions continued to improve across most developed economies.
Volatility continued in May, as European politics and a few more trade salvos from the White House upset traders. Return dispersion persisted, with the US outperforming after a very good earnings season and Europe weaker on heightened risks after the Italian election.
Global equity valuations continue to hover slightly above historical averages but shorter term metrics do not signal heightened valuation risks. Investors are aware of the potential impact of political gridlock, especially as the US mid-term elections draw nearer, as well as a growing trend of protectionist and isolationist policies which could further hamstring global growth.
Given the extent of uncertainty surrounding Brexit we remain cautious on the UK, despite attractive valuations, as the overall economic picture continues to deteriorate. Aside from an underweight UK position, we have no strong geographic preferences, favouring large-caps.
In our portfolios, lost performance was due to an underweight in US small caps and an overweight in European stocks. Conversely, gains were made from an overweight to US stocks and global bonds. At the January 2018 investment committee we decided to take some profits and reduce our equity overweight to “neutral”, acknowledging early that high valuations could lead to a correction, and increase our cash holding. In April, we decided to use half the exposure in cash to buy gold as a hedge against more volatility. We still believe that the cycle, for the time being, remains intact but it is showing signs of maturity.
Global economic performance has slowed, while inflation pressures have intensified. We are already seeing some of the risks that we highlighted at the beginning of the year play out. Markets are now mostly focused on risks stemming form protectionism and volatile European politics. Global debt levels continue to be alarming in the world’s biggest economies. Supply chain constraints, which have not been met with an increase in output and capacity also threaten growth. Central banks continue to tighten to tighten monetary conditions, ending the “Whatever It Takes” era, as inflationary pressures increase. Fed Chair Jay Powell appears less inclined to confirm the “Fed Put”, while central banks in the UK and Europe are using more hawkish rhetoric. There is also the risk that falling sentiment due to the market sell-off and concerns about future regulation of tech companies could lead to a de-rating of equity valuations.
In the US the main risk is a policy mistake, especially if rates increase and inflation fails to keep up. Additionally, investors have yet to discover the true depth of recent tax reforms, which could put additional strains on the budget, with debt issuance expected to rise.
In the UK we have seen some of the impacts of Brexit in the form of slower growth, dented consumption and a slowdown in house prices. Inflation has stabilised but is still outpacing wage growth and thus is lowering disposable incomes. This trend could accelerate should businesses decide to bring forward their Brexit contingency plans.
In Europe, there is renewed fears over the political fate of the EMU, after new governments in Italy and Spain seem set to challenge the dictums of EU institutions.
We feel that short-term systemic risks are mostly manageable and liquidity is still ample. However, there is now less probability of a pick up in private investment and capital expenditure supporting growth acceleration over the medium term.
As markets celebrate Congress’s decision not to self-immolate, investors should reflect on how low the bar for rational behaviour by policymakers is, and whether risk premiums reflect the present political and geopolitical tectonic shifts. Despite the recent stock market rallies, which is really a one sector story, technology and AI, risks remain high.
Our key theme since the beginning of the year is that the world is a volatile and unpredictable place. To be fair, this could have been our theme every year since 2006 and we would have still hit the mark. But this is not garden-variety volatility.
If investors collectively believe in the second coming of QE, then at some point, we should expect a severe market retrenchment. But what if markets are more sanguine than that? What will be the major catalyst, to unleash market forces for risk assets to escape their narrow bands?
One of the key risks we persistently flagged in the second part of last year has been the swiftly rising risks in the bond market. Bond risks are not like equities. They are not linear, which means that they can escalate very quickly.
Even if we recognise that the world has profoundly changed, we try to analyse it with the eyes of the past. Instead of trying to forecast with the past’s eyes, we need to acknowledge how the present has changed, and develop the right tools to analyse the future properly.
The British Autumn drama entered its third act, and the worst seems behind us. The UK has what may pass for an equivalent to the Euro-crisis technocratic governments in Italy and Greece. That particular playbook would, at this point, see market volatility ebb. Having said that, the play usually hides an unsurprising fourth act.
Quantitative easing is the ultimate tool to pacify markets. Once it was applied with success, it became very difficult for policymakers to consider other options to restore market calm. They can stop QE, and even reverse it for a while, but the moment markets become too wobbly, they will not hesitate to deploy it.
Investors worry about equity volatility. However this is, by and large, transient. Instead, we should all be cognisant that we are in a paradigm shift. If growth falters and inflation doesn’t break, the central banks’ mandate and independence may be up for review.
At the end of June our Investment Committee convened to decide the asset allocation for the third quarter. There were no changes to asset allocation, however some duration has been restored to the fixed income allocation. We continue to hold a neutral position in equities, an underweight position in fixed income and an overweight position in alternatives.
Ostensibly, everything about the latest rally in equity markets screams “Bear Market rally”. After all, how can we call an end to the Bear Market when Quantitative Tightening, the great process to unwind some of the Fed’s recent purchases, hasn’t even begun?
It takes a confluence rather than individual risks to cause catastrophe, as any veteran of the Global Financial Crisis will attest. We believe that there’s a mounting probability that we are seeing such a confluence of risks now, one that could significantly hurt growth:
Cancelling a person, right or wrong, is no small feat, and there are repercussions. “House of Cards” was a series that literally made Netflix, yet it features much less prominently after Kevin Spacey’s cancellation. The cancelled actor/celebrity will have worked with other people, who will now see their incomes reduced as works of art are withdrawn and themselves smeared by association.
The Omicron variant was not much of a surprise. We have already seen many mutations of Covid-19. But a hawkish Fed? We haven’t experienced one since 2018. As the potential of a new outbreak emerges, Fed Chair Jay Powell surprised markets by insisting that the US central bank would accelerate asset purchase tapering in December. Instead of customarily intoning the ‘Fed Put’, as per usual in times of crisis, Mr. Powell added fuel to the fire, causing unusual, for December, equity volatility.
A new, more transmissible variant, and a surprisingly hawkish Fed brought some of the most volatile trading days in months.
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With the continued escalation of threats of tariffs between the US and China, markets suffered another week of negative returns. Global equities were down -1.0% in Sterling terms, dragged lower by US equities which returned -1.8%. Emerging Market and Japanese equities also suffered, down -1.1% and -1.0% respectively. European equities were relatively unscathed with a […]
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Read our Monthly Market Update February saw the return of volatility for stocks after nearly two years, as a confluence of catalysts affected equity markets: US Bond yields breaking critical levels above 2.55%, a new more hawkish and uncertain Fed, the deterioration of the global trade climate and renewed political uncertainty in Europe and the UK. […]
Over the last month global equity markets have sold off; since the 15th of January the MSCI AC World Index has fallen -4.12%, the S&P 500 -4.22% and the Japanese Nikkei -6.0%. The UK market similarly has tumbled with the FTSE 100 plummeting -6.36% over the last 4 weeks1. With stocks cheaper compared to a […]
Concerns over US Government debt levels, softening global macro data and a potentially hawkish Federal Reserve once again lead to negative equity returns after a significant sell-off in the previous 2 weeks. All global equity markets are now in negative territory for the year in both local and Sterling terms. Last week US markets were […]
Read our Monthly Market Update Global equity markets were positive again, registering a 5.3% performance in January, benefiting from the positive sentiment and the passing of the US tax reform at the end of 2017. The macroeconomic environment was less supportive, however, as some key indicators suggested that global economic momentum was slowing down in […]
Last week saw a 3.5% pullback for global equity markets, the first since 2016. One reason is a deterioration in global economic data. The second factor is the Federal Reserve, who’s stronger language on inflation and growth, driven by the corporate tax cuts, has made investors realise that its consensus opinion of 2 rate hikes […]
Equities suffered their worst week since 2016 and subsequently fell over 4% on Monday as concerns over rising US Government bond yields spilled over into risk assets. As of Monday, US 10Y Treasury yields were at 2.84%, having increased from 2.4% at year end, resulting in a total return of -3.1% over the period. The […]
Last week marked a 3.5% pullback for global equity markets, the first since 2016. The move comes after a very good month, January, during which equities rose to fresh highs, gaining 5.2%, prompted by exuberance related to the US tax reform. However, the arrival of February marked fresh concerns for investors. First and foremost, economists […]
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