Investment Outlook – Second Quarter of 2019

Overview
Stock markets in the advanced economies gained in the last quarter, although there was a pullback in May due to concerns over the US-China trade tensions. Toward the end of the period, renewed hope for an easing in the trade war combined with the promise of supportive policies from central banks, to cause markets to rally.

A brief review of the major regions and asset classes follows:

United States
US equity markets performed well, with the S&P500 index reaching a new record high. Although the Federal Reserve (Fed) did not cut interest rates in June, there were strong indications that cuts would be forthcoming.

Although the quarter was positive in the end, strains in US trade relations caused markets to fall in May. By June, progress in talks with China, and Trump suspending the threat of Mexican tariffs, provided relief. Markets were also buoyed by supportive rhetoric from the Fed.

Economic data was mixed over the period. On the positive side, the US economy grew at an annualised rate of 3.1% in the first quarter, the unemployment rate remained at a 49 year low of 3.6%, and average hourly earnings climbed 3.1% from the previous year. However, consumer and business confidence weakened, and business activity slowed. The Fed’s indication of increased support is likely to have a positive impact on sentiment and activity in the coming months.

Europe
Shares in the eurozone also advanced with European Central Bank (ECB) President Mario Draghi hinting at further policy easing if required.

Certain sectors the market, such as car manufacturers, wobbled over the quarter due to tensions concerning trade, but recovered in June as tensions eased.

Economic growth for the eurozone was confirmed at 0.4% on the previous quarter, and the inflation figure remained stable at 1.2% in June. Draghi suggested that further monetary policy easing, such as new bond purchases, would be implemented if the inflation outlook failed to improve.

Italy was back in the spotlight as the European Commission cut its forecast for Italian economic growth to 0.1%, which means their budget deficit will now exceed the previously agreed level.

UK
UK equity markets performed well, undeterred by ongoing Brexit related uncertainty and the resignation of Prime Minister Theresa May.

Companies promising resilient earnings growth continued to outperform. Large consumer goods companies and tech companies enjoyed another quarter of strong relative performance. The more domestically focused sectors tended to underperform due to political and Brexit uncertainty.

The impact on the UK manufacturing sector of the 31st March Brexit deadline became clear. The economy grew by 0.5% in the first quarter but then contracted by 0.4% in April mainly due to a sharp fall in car production. The manufacturing sector weakened as the rush for orders ahead of the UK’s original Brexit date faded in April.

The Conservative Party began the process of selecting its new leader after Theresa May’s resignation. This upheaval and the extension of the Article 50 deadline to 31st October means that there is not yet an end in sight to the fog of uncertainty.

Asia & Emerging Markets
Asian markets posted mixed results in the second quarter, driven by trade tensions and other economic concerns.

China
Chinese markets finished in negative territory, impacted by global trade uncertainty. The US increased tariffs on $200bn of Chinese imports from 10% to 25%, threatened tariffs on the remaining $300bn, and blacklisted telecoms company Huawei. China reacted by raising tariffs on $60bn of US imports from the existing 5-10% range to a maximum of 25%. However, tariff hikes were put on hold following the G20 summit in June, and the US has eased export controls against Huawei.

Elsewhere, emerging market shares recorded a slight gain in the quarter. Indian markets progressed marginally as Prime Minister Modi was re-elected and the central bank cut interest rates. Russia also performed positively, partly due to a rally in Gazprom shares, but also as the central bank cut interest rates in June and signalled further easing this year.

Japan
Japanese shares fell in the quarter. Several factors are causing a headwind for the Japanese market. Corporate earnings growth has been slowing. The US campaign against Huawei is already impacting Japanese component companies, and the US-China trade war threatens to impact global supply chains. Furthermore, trade talks between the US and Japan were delayed.

Economic data was mixed with weakness in the domestic economy, but Japan’s growth rate for the first quarter of 2019 surprised the market at an annualised rate of 2.1%, meaning Japan is likely to avoid recession in the near term. The Bank of Japan left interest rates unchanged in the quarter.

Global Bonds
Government bond prices rose, and corporate bond markets performed even better. In the quarter, expectations that central banks would keep monetary policy loose supported the bond market. Both the Fed and ECB confirmed more supportive policies, promising further policy measures if needed.

Commodities
The oil price (Brent crude) declined 4.5%, despite a rise in geopolitical tensions in the Persian Gulf. By contrast, gold rose 9.1% and other precious metals followed.

Summary
As discussed in our last report, economic activity is now slowing, but the significant change in the quarter is that the US and European central banks have both now set out their stalls to provide support and boost economic activity.

The risk of recession in the major economies remains low. The US-China trade war has eased again, and although the risk of a resurgence in tension remains, global markets are likely to draw stronger support from the major central banks and we continue to expect benign scenario for the remainder of 2019.

For the rest of the year, equity markets are likely to continue to be driven by sentiment regarding global growth and the economic cycle, central bank updates regarding interest rates and monetary policy, ongoing US-China trade considerations, and European politics… which still includes Brexit.

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