Market Review and Outlook
Review of June 2018
The MSCI World index of developed stock markets rose 0.7% in sterling terms in June, and 0.3% in local currency terms. This does not, however, convey the increased sense of apprehension that was -and continues to be- felt by many investors, from an assortment of issues.
Foremost is the growing risk of a U.S-led global trade war, not least its impact on the U.S economy from higher import prices (tariffs act as an import tax). Meanwhile the rise of political populism in Europe, with Italy now in the vanguard, is leading once again to fears that nationalist politicians may yet break up the euro if not the E.U as well.
We saw a further flattening of the U.S Treasury yield curve in June, as the Fed raised rates once again while long dated yields fell. This unconventional response by the bond market to higher central bank interest rates is often seen ahead of recessions. However, it may simply reflect strong demand for long-dated assets by investors.
Meanwhile fears mount that China’s credit-driven growth in recent years is about to come unstuck, as the central bank comes down hard on the shadow banking sector. At the same time as exporters brace themselves against a wave of U.S import tariffs.
These fears were encapsulated in the rise of the VIX index (the so-called ‘fear gauge’) from 15 to 17 by the month end, which is high by historic levels.
The U.K stock market fell 0.2%, while MSCI U.K small cap index was flat over the month. Investors are waiting for more clarity from the U.K government on its Brexit goals, while industry leaders became more vociferous in their warnings over a hard Brexit.
The MSCI Emerging Index fell 3.4% in sterling terms, and was down 2.5% in local currencies. The underperformance of emerging stocks relative to their developed peers reflects their greater vulnerability to a global trade war, with China and other emerging Asian stock markets particularly weak.
Higher dollar borrowing costs, as the Fed continues to raise its key interest rate and the dollar rallies as a result, has also affected emerging stocks since many companies – as well as governments- borrowed heavily in cheap dollars earlier in the decade.
U.K house price inflation continues to ease, with Nationwide’s monthly survey in June reporting the lowest national average price rise in five years, at 2.0% year-on-year. London was the weakest region, down 1.9%, while the East and West Midlands, and Wales, all saw gains of over 3%.
The flattening of the Treasury yield curve in the U.S has echoes in the U.K mortgage market. The gap between two and five year fixed mortgages continues to narrow, as growing expectations of a Bank of England rate hike by the year-end has lifted two-year rates. Meanwhile, intense competition by mortgage providers for longer term loans depresses five-year fixed rates.
A desire for a second term in office will (hopefully) eventually undermine President Trump’s willingness to engage in trade wars, given that history shows trade wars leading to lower living standards on all sides. Becoming self-sufficient is an expensive business.
If so, current U.S GDP growth of around 2.8% this year can probably be maintained given the recent round of tax cuts, easily outpacing that of other major developed economies.
Unemployment is at a multi-decade low of 3.8%, wage growth is finally picking up and American corporations are enjoying very strong earnings growth. Indeed, S&P 500 corporate earnings rose an average of 27% in the first quarter of this year, over the same period last year, and analysts’ consensus expectations for the second quarter are at 19%.
These are extraordinary numbers, and help explain why global portfolio fund managers currently favour the U.S stock market over any other developed region or country (the U.K is bottom of the list, on Brexit fears).
Yet market nervousness over geopolitics, not least Trump’s talk on trade, has led to U.S stock prices being broadly flat since January – with a lot of volatility in between times.
It may be difficult to ignore the noise coming from the White House, but investors who do so, and who focus on improving stock valuations in the world’s largest stock market, may well be glad that they did.
Investors should, as ever, discuss with their adviser the potential benefits of maintaining a diverse portfolio of equity investments by both sector and geographic region, as the best defence against market uncertainty. Fixed income plays a vital role in a truly balanced portfolio, often helping to minimise overall portfolio falls during periods of market stress. This is because of the historically low (if not negative) correlation between equities and bonds.
The content of this publication is for information purposes and should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. It does not provide personal advice based on an assessment of your own circumstances. Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness. Any expressions of opinion are subject to change without notice.