The Multi-Asset Process

May 2019 Market Review

As regular readers of our monthly updates will be aware, Brexit and trade wars have been the dominant geopolitical concerns for the best part of two years – and after an enjoyably quieter April, both were back to market-shaking form in May.

This was most evident on the S&P 500, which was down close to 5% over the month, denting the best start to a year for equities since 1987. Dimming memories of the chaotic final quarter of 2018, the US index had climbed close to 18% over the first four months of 2019 but renewed uncertainty surrounding trade put a firm brake on this.

President Trump decided to raise an existing 10% tax on many Chinese imports to 25% after talks broke down and China responded by increasing taxes on many American imports. In the usual tit-for-tat escalation, Trump further spooked markets by talking about taxing an even wider range of China’s products – in what many see as a clear shot at his potential democrat rivals in 2020.

Expanding his ire as the month progressed, Trump jumped on to Twitter and threatened to impose a 5% tariff on all Mexican imports from 10 June unless the country takes measures over emigrants at the US-Mexico border. This comes in the wake of a recent trade agreement between the US, Mexico and Canada, which could now be in jeopardy.

On the back of this unwelcome return of hostilities, the Organisation for Economic Co-operation and Development (OECD) has warned that further escalation of the US-China trade war would cause significant damage to the American economy, as well as the rest of the world. According to the influential group, an intensification of the dispute would likely knock as much as 0.7% off global GDP by 2021-22. Under such a scenario, the hit to the world economy from higher tariffs could be quantified at almost $600bn (£472bn).

Rounding out the list of countries threatened by Trump in May, tensions continued to rise with Iran, which suspended its commitments under the 2015 international nuclear deal. As the US re-imposed sanctions, Tehran allegedly placed missiles on boats in the Gulf and US investigators reportedly believe the country damaged four tankers off the coast of the United Arab Emirates. Trump upped the ante by threatening to wipe a country that has endured for more than 2000 years off the map and this is another concern for our ‘market noise’ folder, particularly given how it might affect the oil price.

As we wrote last month, US equities have only ever outperformed the rest of the world by the current margin in one other period during my career, the tech boom of the late 1990s, and we are expecting some reversion to the mean over the months ahead. Early signs suggest we may be on the right track here: data from IHS Markit reveal a strongly negative signal for US corporate earnings and the S&P500 earnings per share indicator has fallen to its lowest since February 2009.

Once again highlighting the case for diversification (and not zero weighting asset classes even if you are broadly bearish on their prospects), bonds rallied hard over the month, bringing 10-year yields in the US close to 2% for the first time since late 2016. This has led to the spread between two and 10-year yields, a common recession indicator, move to levels last seen in 2007, and several market watchers believe the deepening inversion of the yield curve is clearly signaling an economic downturn.

Against this backdrop, many are predicting another downward shift in the "dot plot" forecasts for trajectory of the Fed Funds Rate when the bank meets in June. At the start of 2019, two hikes were expected this year, but markets are now pricing in three cuts by the end of 2020 and Fed chair Jerome Powell has a thorny path to tread, especially with an election looming in 2020 and the inevitable chaos that will entail.

Across the Atlantic, Brexit was back on the agenda as Theresa May made a final attempt to patch together a parliamentary majority for an EU exit. Predictably, this was quickly howled down by MPs on both sides of the divide, with several that backed the previous deal rejecting this new iteration, suggesting a defeat could have been even heavier.

With cruel timing, this proved the end of May, who announced she will stand down on 7 June and pass the Brexit shambles to a successor. So far, the number of Tory candidates up for the post could fill a football team and while some are clearly just looking to raise their profile, this demonstrates the lack of consensus and divisions in the party that May had to face.

Elton John is a rare source of quotes for investment commentaries but to celebrate the release of Rocketman in UK cinemas, I would echo his thoughts on Brexit, comparing it to "walking through Hampton Court maze blindfolded, being turned around 16 times and trying to find your way out".

With Boris Johnson the bookies’ favourite of becoming the next Prime Minister, odds of a hard Brexit have increased. But Boris will have to contend with his behaviour during the initial campaign, particularly the claims around the NHS, which may haunt him as well as Michael Gove. 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. Amid all this, the Conservatives received a bloody nose in European elections no one thought we would be involved in, with the new Brexit party winning out.

This increases fears about further lurches to the right politically and it was interesting to see European fragmentation lead BlackRock’s latest Geopolitical Risk Indicator, outranking trade tensions and rising conflicts in the Gulf as the number one concern. According to the group, Italy’s government continues to clash with the EU over its policies, while Brexit and rising populism elsewhere further undermine what looks an increasingly fragile European project.

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


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Wednesday, June 5, 2019, 9:04 AM