Investment Outlook – Fourth Quarter of 2019

Overview
2019 was a good year for investors. Stock markets in the advanced economies ended the year strongly, with emerging markets following behind.

This was not expected at the beginning of the year. Christmas 2018 was bleak, as a year of volatility and uncertainty ended with a sharp sell off. The fears of slowing global growth and the US-China trade war raised the spectre of recession. However, ultimately these concerns proved unfounded.

In the long run, share prices are driven by expectations of future profits, but in 2019, profits did not increase significantly. The positive performance is therefore explained by an improvement in sentiment and by falling interest rates.

In the US, the Federal Reserve, which at the end of 2018 had indicated that it would continue raising interest rates, performed a U-turn early in 2019 and committed to lowering interest rates to offset shocks caused by the US-China trade war. This resulted in 3 interest rate cuts, reversing almost all the rate rises in 2018.

It was not only a good year for equities, but for most financial assets, including government and corporate bonds, commodities and gold.

 

The fourth quarter
The pre Christmas ‘Santa rally’ for stock markets was in full swing in the fourth quarter, with major central banks around the world providing supportive policies, and the US and China agreeing a mini trade deal. The US cancelled planned new tariffs on Chinese goods and cut some already in place, while China agreed to buy more American goods.

The quarter was dominated by politics around the world:

 

UK
In the UK, the general election resulted in a landslide victory for the Conservative Party. Following the result, sterling rallied and UK domestically focused shares outperformed. Given the size of the majority, Boris Johnson’s European Union withdrawal bill sailed through the House of Commons, setting the scene for the UK to formally leave the EU by the end of January. Johnson has committed to getting a trade deal done by the end of 2020, and this means the next 12 months will be characterised by tough negotiations and brinkmanship which will likely mean further volatility in sterling.

 

US
Following the interest rate cuts of 2019, Federal Reserve Chairman Jerome Powell suggested further cuts would be unlikely, unless economic data deteriorates significantly or there is an escalation in the US-China trade war. The current policy will continue as long as economic data remains broadly consistent with the outlook of “moderate economic growth, a strong labour market, and inflation near our symmetric 2% objective”.

Looking forward in 2020, politics will remain in sharp focus, while President Trump‘s impeachment proceedings continue, and in July, the Democratic party will determine who Trump will face in November. Election years tend to be turbulent for stockmarkets, and the prospect of a Democrat victory will weigh on markets given Trump’s policies have been overtly pro growth, albeit with little concern for the ever-expanding deficit.

 

Europe
In Europe, it was all change at the EU. Ursula von der Leyen, the former German Defence Minister, replaced Jean-Claude Junker as President of the European Commission, and former Belgian Prime Minister, Charles Michel, took over from Donald Tusk as President of the European Council. These are key roles in determining the direction of Europe and the EU’s future relationship with Britain.

In addition, Christine Lagarde, the former head of the International Monetary Fund, replaced Mario Draghi, to lead the European Central Bank (ECB). At the end of his tenure, Mario Draghi had pushed interest rates further into negative territory (from -0.4% to -0.5%) and re-started the bank’s bond buying programme, committing to get inflation back above 2%. Subsequently, Ms Lagarde appealed to eurozone governments to increase spending with a focus on rebalancing the eurozone economy away from exports by boosting domestic demand. In response, Germany’s central bank chief warned that the Bundesbank would oppose any effort by Ms Lagarde to relax the eurozone’s inflation target of 2%.

 

China
China celebrated 70 years of the Communist Party while tensions escalated in Hong Kong (HK). It didn’t help China-US relations when President Trump signed legislation backing pro-democracy protestors. In November, elections in HK seemed to endorse the protestors’ actions, and brought some calm. The extent of the troubles has pushed HK into recession and many local stocks now trade at a significant discount to global peers. However, it should be remembered that the territory is important to Beijing, as highlighted by Alibaba (the online retail giant and China’s largest publicly listed company) which sold over 500 million shares through the Hang Seng stock exchange in the quarter.

 

The Wuhan virus
The virus which started making headlines in December is known as ‘2019-nCoV’, a form of coronavirus, so called because the virus’ resembles a crown under a microscope. 2019-nCoV is the seventh known coronavirus, the other high profile relative being SARS (severe acute respiratory syndrome) which hit the headlines in 2003. SARS infected over 8,000 people and killed around 800, and the economic cost was in the order of $30bn-100bn due to disrupted trade and travel over a 9 month period.

The race is on for scientist to establish how infectious and how lethal the virus is. In many people the new virus causes only mild symptoms, so the 3% fatality rate maybe an overestimate. The world is better prepared to deal with the virus than it was at the time of SARS, and significantly the Chinese authorities have been quicker to acknowledge the virus. In comparison, SARS was kept quiet for months, significantly compounding the problem. Chinese scientists have quickly isolated the pathogen and shared its genomic details with the world.

In Wuhan, where the outbreak started, the authorities locked down transport links. Several other cities are facing similar restrictions, affecting more than 30 million people at a time when many in China would be travelling to visit family for the lunar holiday. The size of the Chinese economy means that an upheaval on this scale is a significant factor influencing the pace of global economic growth.

 

2020
In 2019, sentiment jumped as concerns about a possible recession receded and loose monetary policy (low interest rates and more quantitative easing) fuelled global rally in asset prices. The extent of this positivity is unlikely to be repeated in 2020, although major governments and central banks have committed to supportive economic policies.

Meanwhile, the well documented risks remain, particularly the risk of further tensions in the Middle East and the potential for a resumption in the US-China trade war. However, clearly the main new concern is the Coronavirus, the time it might take to bring it fully under control, and the resulting economic impact. The relative speed and extent of the global response is likely to bring the epidemic under control faster than SARS was in 2003.

Our portfolios remain well diversified across asset classes and geographies, and are designed to reduce any volatility which these concerns may generate in global markets.

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