The Multi-Asset Process

January 2019 Market Review

Following a dismal December and fourth quarter overall, January saw something of a recovery in most markets despite the economic questions that dominated 2018 still lingering. A month ago, anything seemed able to drag equities down but markets were better able to take things in their stride in January, again highlighting the importance of ignoring short-term noise as far as possible.

The dreaded recession word – one of three Rs we are watching, of which more later – has begun to rear its head in certain countries, including Germany, and fears continue to rise about China’s slowing growth and growing debt crisis. As the three-month trade ceasefire between the US and China comes to an end, all eyes are on the world’s two largest economies, particularly with the former engaged in the longest federal government shutdown in history for much of January.

A first encouraging sign came at the World Economic Forum in Davos, where Chinese vice president Wang Qishan said the country’s relationship with the US is indispensable and “confrontation harms the interest of both sides”. Talks began at the end of the month and both parties came out hailing progress, with China pledging to buy more US soybeans. If we end up without an arrangement in place by March – one of two potential no deals culminating during that month – US tariffs on $200bn of Chinese goods will increase from 10% to 25%.

A positive take on trade, as optimists have suggested throughout, is that US and China will step back from the brink before doing serious damage. Beyond squabbling over tariffs however, there is a counter argument that the spat actually highlights a deeper fracture in the relationship as the US learns to deal with a shift away from decades of global hegemony.

This has been referred to as the Thucydides Trap after the Athenian historian, a theory that when one great power threatens to displace another – the rise of Athens culminated in the Peloponnesian War of 431-404 BC against the Spartans – conflict has proved inevitable. These stories bring back fond memories for me as the house system at my school was based upon Athens, Sparta, Tuscany and Troy: for the record, I was a Trojan.

Where there have been rare exceptions down the centuries – the US overtaking the UK at the turn of the twentieth for example – strategic imagination was required to sidestep catastrophe and we can only hope the participants this time are able to follow suit.

As has become the norm, Brexit soured another month in the UK, with the Prime Minister losing the vote on her Withdrawal Act by a huge margin and then winning the subsequent vote of no confidence in the government, continuing the sense of impasse that surrounds the situation.

Notwithstanding the view of one of our underlying fund managers that every 10 minutes spent talking about Brexit is 10 minutes wasted, we felt things have played out as expected in recent weeks.

Theresa May knew she was likely to lose the vote on her Plan and yet felt confident enough to indulge in a spell of brinkmanship with Jeremy Corbyn. Labour duly lined up to trigger a vote of no confidence in the government but, like Turkeys unwilling to vote for Christmas, few Conservatives were keen to vote themselves out of power and hand Corbyn the keys to number 10.

Later in the month, the Prime Minister won a vote to resuscitate her deal and will head back to Brussels with “alternative arrangements” to the dreaded Irish backstop. A range of other proposed amendments were voted down – including Labour-led plans to extend Article 50 – and some sort of cross-party arrangement looks necessary to get a deal through. Meanwhile, Parliament said it would not support the government if it pursued a no-deal but we have no idea what that would mean in practice: in the meantime, another month passes with no resolution to a situation that may have already done generational damage to faith in the political classes.

Across the Atlantic, patience appears to have become the new motto of the Federal Reserve, seemingly featuring in every speech from an official since Q4’s market turmoil, and comments at the end of the month bore this out as the Bank appeared to suspend plans to keep hiking rates over 2019.

Just a few weeks ago, supporting the December rate rise, Fed officials said they forecasted two further hikes in 2019, stressing that further "gradual" increases were appropriate. In an apparent U-turn sure to delight President Trump after months of criticising policy, Fed Chair Jerome Powell now says the Bank has the luxury of patience – that word again – in deciding whether to raise rates. “The case for raising rates has weakened somewhat,” he added, pointing to sluggish inflation, slowing growth in Europe and China, and the possibility of another government shutdown and stressing the Fed’s overarching goal to sustain the economic expansion.

As we have written recently, 2018 saw a rare confluence of fear and greed, with the majority of the former in the US as it continued to surge ahead. Over the coming year, we expect the growth gap between the US and the rest of the world to narrow, with factors such as tightening policy and weaker oil prices playing a part – and it remains to be seen how that impacts global markets. We have been underweight the US for some time on valuation grounds, which was a drag on our portfolios through last year as technology stocks outperformed.

Looking to the rest of 2019, we have long said the global economy has entered the latter stages of the cycle – albeit with the US some distance ahead – but late-cycle phases can last a while and we continue to see no substantial signs of broad global recession. As Pimco wrote in its recent 2018 outlook, the “expansion is old but it has been ageing gracefully so far”.    

As we saw from the final quarter of 2018 however, broader recession is not needed for markets to enter panic mode and a noise-cancelling mindset may become ever more necessary in the months ahead. Ultimately, and as promised, I feel the year will depend on the outcome of three Rs: rates, as the Fed and other central banks either accelerate or decelerate monetary tightening, recession, whether or not we fall into prolonged slowdown, and resolution can those lingering questions we mentioned at outset be resolved successfully?

For a comprehensive list of common financial words and terms, see our glossary here.

 

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Friday, February 8, 2019, 11:43 AM