The Weekly - He said, Xi said

13/08/2019
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In this world of political tweeting, we, as investors, now have to consider an additional input over and above the official channels of communication from World leaders. Some leaders conform to historical protocol and rarely tweet, if at all. Others appear to use it outside of their advisers and any official press office, and it’s this that can move markets. As an example, various members of the Federal Reserve Bank have hinted at a more hawkish or dovish view on interest rates compared to the Chairman’s official press release, markets have seized upon the comment as it has gone viral. 

As an investor, it is important to decide what is fact, fiction, off the cuff, conjecture, and ‘mis-spoken’, the latter of which seems to be the most frequently used phrase when a loose-lipped official gets their knuckles rapped and has to backpedal rapidly. 

Unfortunately, the two biggest current influences on investors trying to run globally diversified portfolios are the Chinese trade war and Brexit. Both are mired in social media tweets, sound bites on the hoof and media frenzy. We have a US leader whose advisers often appear to be playing catch-up and seem to be learning things about policy changes from social media. We, as investors, have the challenge of not knowing if information is genuine and ‘official’, or whether it will change over the next 48 hours. As ever, long term is the mantra, but when it comes down to the Chinese trade war, social commentary is often all we have to go on when we are trying to assess whether the latest talks are progressing well or not at all. 

Closer to home, we have a new Prime Minister still finding his feet and his appointment feels like the introduction of a new administration, as most officials in key positions have changed. He has inherited the same Brexit problems that previously existed but is approaching them in a very different way. The key influence here is the behaviour of sterling. Theresa May announced on 24th May that she would resign on 7th June, but sterling started markedly weakening from 6th May - it has continued to do so and is now over 8% weaker against both the US Dollar and Euro (Source: FE Analytics). 

Previously, as sterling has weakened, the UK equity market and especially the FTSE-100, has strengthened as the overseas earnings influence offsets on translation, being 75% of the total. However, this now appears to have been somewhat overtaken by sentiment as the odds of a no-deal Brexit and a general election have increased. Further muddying the waters has been the ongoing trade dispute between the US and China which has intensified and affected global markets at the same time. Finally, we are right in the midst of August summer holidays and thin trading, which can often be volatile and confusing. This all adds up to a highly confused picture. 

What we do know is that from 30th April 2019 to last Friday, the US equity market in sterling is up by 7.4% (Source: FE Analytics), which is all down to the aforementioned 8% weakness in sterling. Elsewhere, the Nikkei in Japan is up 5.1%, the European market is up 3.9% whilst Hong Kong is down -3.7% and Emerging Markets are down -0.6%. The last two will have been hit the hardest by the escalating Chinese trade war with Hong Kong also having its own internal influences with the domestic protests. Separately within the UK, over the same period, the FTSE-100 is down -0.8%, the mid-cap 250 is down -2.8% and the FTSE Small Cap is down -4.5% as the last two of these have the least overseas currency translation support and are more sensitive to any impending UK economic slowdown, fears over which have increased as a no-deal Brexit has become more likely. Much of this makes sense but constructing a tactical investment strategy through this fog is challenging.

As we look through the noise and rationalise, we can observe the level of the VIX or S&P 500 Volatility Index which is a universally accepted fear gauge. This increased sharply on 26th July from a figure of 10, which is low and consistent with progressive markets and good market sentiment. It peaked at 24 on 5th August as the US talks with China appeared to break down and the US announced more tariffs followed by China announcing the cessation of US agricultural commodity purchasing. The US has further countered this with the suspension of any business dealings with Huawei, which had previously been relaxed. We await China’s next move. The VIX is now at around 20 which is reflective of the heightened degree of risk within the markets in the absence of any further moves from China. To put this in perspective, this is not as high as the market falls in December where the index peaked at 30 but is the highest this year. 

However, there are overriding motivations which provide some comfort and may go some way to explain why the markets have generally not collapsed and are only mildly weaker. Firstly, and most importantly, we know that President Trump uses the US equity market as his benchmark, and he knows this is closely aligned with the ‘happy gauge’ of many voters. At the time of the next election in November 2020, he will want to be able to show that he has added wealth to voters who have 401(k) pension schemes, which are similar to the UK’s Self-invested personal pensions, the majority of which are linked to the performance of the stock market. We would not underestimate President Trump’s ability to give the market what it wants to hear, namely interest rates cuts, robust economic growth, full employment and a Chinese trade deal which is fairer to the US (even the Democrats are behind this). 

Secondly, the very fact that the Federal Reserve Bank and most of the major Central Banks are increasing liquidity if not loosening interest rates suggests that the authorities are ahead of the economic curve and mindful of the deteriorating economic environment. This is comforting and has been a major supporting influence ever since the credit crisis. A reminder that the ‘Fed put’ remains in place no matter how dark the economic outlook serves to reassure. 

Thirdly, equity markets are not expensive. Of course, with the degree of risk and negative sentiment around, this is no surprise. However, as we have said many times before, the idea is to buy low and sell high and, in order to do the former, you have to be brave and get comfortable with the risks that will be present in order for the market to look attractive at a lower valuation. 

Finally, the US markets have not yet started thinking about the US election and are instead being absorbed with the daily tweets over trade from the US and the official responses from China. If President Trump can pull off the above feat of lower interest rates, a favourable deal, record markets and a robust economy, this will be presented as a lifetime achievement, and his re-election becomes ever more likely. 

The short-term tit-for-tat between the respective leaders looks likely to continue for some time until something gives. The fact that the recent downward lurch following the Yuan currency devaluation move has been partially recovered suggests many remain calm and are focusing on the political end game as expounded above. It is much easier to be bearish than bullish and many will miss out on a rally by dwelling on the negative. There is probably also a significant degree of hand sitting whilst many are on the beach so beware complacency as well. 

Equities lose ground as currency markets endure volatility 

Most major equity markets recorded losses last week during a volatile period. The US S&P 500 suffered its worst single day’s trading of the year as it shed -3.0% on Monday, extending its slide form the previous Friday. However, a resurgence in technology shares on Thursday saw the US index claw back ground to close the week down just -0.5%.

Currency weakness in China triggered heavy selling across global equity markets last Monday. Widely seen as a means of propping up its struggling exporters following the latest round of US trade tariffs, Chinese policymakers allowed the Yuan to weaken past the symbolic milestone of CNY7:$1 on Monday for the first time since the financial crisis. 

The FTSE 100’s late-week rally was only modest as UK blue-chips succumbed to a weekly loss of -2.1%. Economic data released Friday showed that the British economy shrank in the second quarter for the first time since Q4 2012 with a preliminary Gross Domestic Product reading of -0.2%. Having stockpiled during Q1 in the run-up to the initial Brexit deadline, companies winding down inventory levels detracted from Q2 economic growth. Sterling slumped further on the news, down -1.5% and -0.6% against the Euro and the US Dollar respectively, compounding fears of a no-deal Brexit that have led the Pound to depreciate just shy of -8% against both currencies over the last three months. 

Reports last week suggested that a no-deal Brexit was now the European Union's base case. Furthermore, Italian bond spreads widened Friday on concerns that a right-wing government is now more likely and could clash with the EU over budget deficits. European equity markets lost ground in a similar vein to their US and UK counterparts as trade fears hit early in the week before a modest recovery. 

India, New Zealand, Thailand and the Philippines added to the global trend of loosening monetary policy last week. The Reserve Bank of New Zealand cut the most aggressively with a 50 basis point (bp) drop, whilst the Reserve Bank of India cut rates for the fourth time this year. The Bank of Thailand and the Central Bank of Philippines each cut rates by 25bp. 

The week ahead 

It’s a busy week for domestic data, kicked off tomorrow with the latest ONS jobs release. Unemployment is expected to have held firm at 3.8% whilst wage growth is forecast to have accelerated during the three months to the end of June. The report is followed by CPI inflation (Wednesday) and retail sales covering July (Friday). Inflation and retail sales numbers are also the standout releases in the US whilst the housing sector also comes back into focus with new building permits and housing starts figures due later in the week. 
On the Continent, the second reading of Q2’19 GDP is released on Wednesday although no change to the initially calculated +0.2% quarterly growth figure is expected this time around. Meanwhile in Asia, it’s a busy week for Chinese macro data with fixed asset investment, industrial production, retail sales and unemployment numbers all published during the early hours of Wednesday morning. Industrial production is also the standout release in Japan on this occasion. 

The value of an investment with Rowan Dartington may fall as well as rise. You may get back less than the amount invested. 

Past performance is not indicative of future performance. 

Source: FE Analytics (information correct as at 12 August 2019) 

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