The Multi-Asset Process

June 2019 Market Review

As we headed into the summer months, the global economy remained as plagued by uncertainty as it has been for much of the last three years. While stock markets are in good shape, having recovered losses from the chaos of the last part of 2018 and hitting record highs once again, manufacturing activity remains sluggish across much of the world with inventories still high.

Tensions continue to rise in the Middle East and the trade situation between the US and China has yet to be resolved. As we have discussed before, the situation seems to stretch beyond mere trade – if something stretching into the billions of dollars can be called mere – and is actually more about these countries’ respective places in the world. On some measures, China is expected to become the largest economy in the world in 2020 and we can expect this changing relationship to dominate global geopolitics for years to come.

Where this will likely coalesce is in technology and we have seen early shots fired with the US moving to ban Huawei. Looking forward, this techno rift will likely force companies to choose whether to take US technology as their standard or Chinese, and many believe this will ultimately mean a decades long ‘war’.

Even if we do see a trade deal thrashed out in the coming weeks, the relationship is likely to remain on shaky footing after the tit-for-tat tariffs – and a cynic might think President Trump is committed to maintaining this situation as a means of showing his strong man credentials heading into next year’s election. Against this backdrop, all eyes were on the latest G20 leaders’ summit in Osaka at the end of June, where Presidents Trump and Xi Jinping met to try to break the deadlock. Without a deal, the US has threatened to apply tariffs on yet another $300bn of Chinese goods.

Despite no actual rate activity in June, it was an interesting month on the policy front, with the Federal Reserve, European Central Bank (ECB) and Bank of England all making announcements. Although he has no actual power over rates, Trump’s large and clumsy footprint was all over the situation, accusing the ECB of trying to prop up the European economy and gain an advantage over the US. As several commentators have said, for someone who sees the world in such binary terms as Trump, the complex world of economics is reduced to a zero sum game: if another country is winning, the US must somehow be losing.

Trump directed his criticism at ECB President Mario Draghi, who said in a speech that additional stimulus will be required to help Europe withstand economic challenges, including mounting protectionist threats stemming from the US/China trade war. Draghi’s statement not only talked about plural rate cuts but also said the Bank’s focus is now on how to implement stimulus rather than whether it should.

While this should be an obvious fillip for risk assets, critics have said the Bank needs to tread carefully to ensure lower rates do not put further pressure on the banking industry and also to move away from the perception that quantitative easing just boosts asset prices for the wealthy. Europe looks the most vulnerable region to trade war fallout, with Trump already making noises about the auto industry and, despite the Draghi put, scope for policy support looks limited. 

Meanwhile, Trump also continued his attacks on his own central bankers, urging Fed Chair Jerome Powell to cut rates and restart crisis era stimulus programmes, threatening demotion if he ignores this ‘advice’ – and there are signs this barrage might be starting to bear fruit. While the Fed left rates on hold, policymakers said uncertainties about the outlook have increased and they will act as appropriate to sustain the expansion, with one member of the FOMC (Federal Open Markets Committee) advocating an immediate cut. Powell faces a massively difficult task, with the June meeting showcasing how he is having to chart a course between a truculent Trump on the one hand and bond markets on the other – and the fact he came through it without overly antagonising anyone is some achievement. 

His task looks set to become ever-more challenging in the coming months, especially with an election on the horizon. We are now in a situation with the Fed and market are seriously out of sync: bonds rallied significantly on trade fears but the Central Bank currently sees zero chance of a US recession. Some commentators now believe we could see as many as three rates cuts in the second half of this year; it was only six months ago the Fed was predicting a couple of hikes in 2019. It remains to be seen how much longer Powell can maintain his Phillippe Petit act, especially with the President shaking the wire.

Despite fears the Bank of England may continue in a lone hiking furrow, the Monetary Policy Committee (MPC) also voted to keep rates on hold at 0.75% in June, warning that UK economic growth could fall to zero in the second quarter. Should Brexit pass smoothly, the MPC said rate rises would be required at a gradual pace and to a limited extent to maintain its inflation target of 2%. On that very matter, the race for Prime Minister has come down to just two, Boris Johnson and Jeremy Hunt, and with Johnson the bookies’ favourite, odds of a hard Brexit have increased. As we said last month, it remains hard to see how anyone can get a deal through at this stage or re-negotiate with the EU, so we remain in the same bind.

With all this in mind as we come to the end of another quarter, we look again at what could bring an end to the longest bull market in history. It is said bull markets never die of old age and there is always some other cause: usually an excess of some kind building up – of debt, concentration, valuations or corporate exuberance. What is the excess this time? Tech valuations look stretched in parts – and we feel the sector could come under renewed fire during the election cycle – and the US has outperformed other regions to a huge degree. The key excess globally is, of course, ultra-low interest rates and quantitative easing and when the US made noises about ending this regime towards the end of 2018, equities quickly lurched into bear market mode.

Among fund managers, at least, sentiment appears to be nearing a tipping point, with respondents to Bank of America Merrill Lynch's monthly survey of investors at their most bearish since the Global Financial Crisis. Global managers have slashed exposure to equities to a net 21% underweight, the lowest allocation since March 2009, and increased allocations to both cash and bonds.

For me, such surveys tend to be a contra indicator and I am never sure how accurately they reflect positioning. I see the low equity weighting as a positive, with potentially more buyers than sellers as fund managers see the opportunity to take a contrarian view.

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Wednesday, July 10, 2019, 9:28 AM