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Monthly Update | Happy Christmas for markets?

Stock markets sparkle, the economy lights up and central banks show good will. But could the ghosts of political risk, past, present and future still pay markets a visit?

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Recent developments suggest it really could be a case of happy holidays for investors.

There are signs that global economic growth, which has been slowing for over a year, is picking up. At Coutts we believe the business cycle may be bottoming out, with recent data showing a modest rise in growth. In light of this, we recently took a slightly more pro-growth stance in our client portfolios and funds by buying more European stocks.

Meanwhile, central banks have shown strong support for their economies and there have been tentative steps forward in the US-China trade talks and Brexit progress.

This has all buoyed stock markets. In the US alone, the S&P 500, Nasdaq Composite and Dow Jones Industrial Average indices all rallied to record highs in November. The MSCI All Country World Index returned 2.9% in local currency terms in November – 22.9% year-to-date – and most major stock markets ended the month in positive territory. As investors took on more risk, government bond yields rose (prices fell).

But without wanting to spoil the Christmas party, Monique Wong, Executive Director, Portfolio Management, says Coutts remains conscious of the political risks still lurking in the background.

“Markets have performed very well so far in 2019, despite talk of a potential recession which now looks less likely than it did earlier in the year,” she says. “This is obviously good news for investors, but we need to keep an eye on potential pitfalls.

“Geopolitical risk remains the Grinch that could steal Christmas. The trade talks rumble on and have made progress but a positive outcome is still not guaranteed, while election-related uncertainty hangs over markets in the UK.”

 

Global economy perks up

Signs that the global economy may not be slowing as quickly as previously thought include the UK avoiding recession. After falling by 0.2% in the second quarter of 2019, the economy grew by 0.3% in the third quarter, avoiding the dictionary definition of a recession – two quarterly contractions in a row.

Meanwhile, GDP in Germany and Japan also avoided economic falls, growing by 0.1% over the same period compared with the previous three months.

The US economy remains the real bright spot, with official figures showing that it grew at an annualised rate of 2.1% in the three months to the end of September, higher than expected.

The world’s largest economy is practically bursting with Christmas cheer. Unemployment remains at a record low, inflation appears contained and consumer and government spending are still buoyant.

“Markets have performed very well so far in 2019, despite talk of a potential recession which now looks less likely than it did earlier in the year.”
Monique Wong, Executive Director, Portfolio Management at Coutts

Our Positioning

At Coutts we continue to have a small preference for equities and other risk assets over more defensive investments within our portfolios and funds. As a result, throughout this year we have tilted our investments towards areas that look more attractive in a slower-growth environment, like the US.

Increasing our exposure to European equities was the first step away from that approach for some time. We did it because we think the improving macroeconomic backdrop could lead to Europe’s exports benefitting from rising demand in China.

Supportive policies from the European Central Bank (ECB), including the prospect of fiscal stimulus, are also potentially positive for European equities. A change at the top hasn’t signalled a change of direction. The new ECB president Christine Lagarde used her first official speech this month to confirm her commitment to the direction set by her predecessor, Mario Draghi.

 

Political upheaval affects emerging markets

Politics has hurt emerging market bonds and equities in recent months. Examples include the Hong Kong protests and political disruption in Latin American countries such as Chile, Colombia and Peru.

We have a low exposure to emerging market equities, with some selective positions in China and Russia where we see particular opportunities. While the improving macroeconomic environment could be beneficial for the region, and a degree of political risk is part and parcel of investing in emerging markets, we remain cautious for the time being.

We are also keeping a close eye on the US dollar as the currency has huge influence over the fortunes of emerging market assets.

When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

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    Market Performance

    Important: This graph shows a very isolated period of past performance. For further context of historic performance over the last five years, please see below. As always, past performance should not be taken as a guide to future performance.

    Equity Markets Performance (%tr*, local) 12 month performance to end September 
    As at 30 November 2019 Current -1M -3M YTD 2019 2018 2017 2016 2015
    Developed Equity (MSCI)    1,761.59 3.2 7.7 25.2 3.5 12.9 18.6 11.2 -0.2
    MSCI UK        2,102.83 1.8 2.6 13.4 2.8 5.9 11.1 18.5 -5.9
    MSCI UK Large Cap        1,023.79 1.3 1.6 11.8 3.3 6.5 11.2 21.1 -9.1
    S&P 500        3,140.98 3.6 7.9 27.6 4.3 17.9 18.6 15.4 -0.6
    Nasdaq Composite        8,665.47 4.6 9.1 31.9 0.5 25.2 23.7 16.4 4.0
    DJ EuroStoxx           399.34 2.8 7.9 25.6 5.1 0.3 23.3 3.6 3.9
    Nikkei 225       23,293.91 1.6 13.3 18.7 -7.8 20.8 26.0 -3.6 9.4
    Hang Seng      26,346.49 -2.0 3.1 5.6 -2.7 4.4 23.0 16.1 -5.9
    Emerging Equity (MSCI)   58,288.49 0.6 5.2 12.0 0.2 3.0 22.2 13.4 -6.8
    BRIC (MSCI)           699.13 1.2 6.3 15.5 3.3 3.6 26.6 14.5 -6.0
    Source: Datastream, all returns in local currency; *tr=total return, including reinvested dividends.
    Bond Markets 10-year yield* Performance (%, local) 12 month performance to end September
    As of:  30-Nov-19 -1M -3M YTD 2019 2018 2017 2016 2015
    US Treasury index 1.76 -0.5 -1.8 5.1 8.0 -3.7 -3.9 1.7 1.2
    UK gilts index 0.86 -1.2 -2.8 6.7 11.7 -2.0 -7.2 10.5 5.9
    Eurozone govt bond index 4.40 0.3 1.7 9.3 8.1 -9.7 -2.7 6.1 -2.0
    US investment grade index 2.87 -0.1 -0.9 10.3 8.7 -5.3 -2.3 4.1 -3.4
    US high yield index 5.59 0.1 -0.1 7.6 1.0 -3.0 2.4 7.5 -9.1
    Source: Barclays indices; Datastream; *current yield on benchmark 10-year Treasury, gilt and bund respectively.
    Commodity Markets   Performance (%, dollar) 12 month performance to end SepteMBER
    As of:  30-Nov-19 Current -1M -3M YTD 2019 2018 2017 2016 2015
    Dow Jones-AIG Commodity Index (TR)           163.75 -2.6 0.6 2.5 -6.6 2.6 -0.3 -2.6 -26.0
    Brent oil price (spot, US$ per barrel)            64.50 8.8 5.5 27.6 -26.3 45.1 18.4 2.0 -50.2
    Gold bullion (spot, US$ per ounce)        1,461.54 -3.2 -4.4 14.1 23.7 -7.2 -2.9 18.6 -8.1
    Dow Jones Industrial Metals (TR)           236.35 -4.9 -2.7 3.8 -2.1 -2.4 24.0 3.7 -25.3
    Source: Datastream
    Inflation & Interest Rates Current Interest Rate Forecasts (%) Rate Announcement
      Inflation (%) Current Feb (est) April (est) Next Date
    United States 1.80 1.75 1.75 1.75 11-Dec-19
    United Kingdom 1.50 0.75 0.75 0.75 19-Dec-19
    Eurozone 1.00 0.00 0.00 0.00 12-Dec-19
    Japan 0.29 -0.10 -0.10 -0.10 19-Dec-19
    Source: Coutts & Co.
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    Coutts House View

    Equities

    Equities continue to be supported by improving economic momentum and diminishing geopolitical risk. The ‘phase one’ trade deal between the US and China and a new Brexit deal reduced the two main risks of the year, and UK markets remained calm when the election was announced.

    As we expected, the US and European central banks continued with their policy of lower interest rates and continue to talk up support for their slowing economies.

    Simultaneously, the US Federal Reserve also started providing large amounts of US dollar liquidity to markets in response to large demand for the ‘greenback’. Central bank actions remain the defining factor of this year’s positive equity performance despite a slowing global economy.

    On the fundamental side, our in-house indicators see the probability of a US recession as very low in the short term, having risen slightly over previous months. We have been seeing a slow-down in global economic growth for over a year now, but we believe the business cycle may have bottomed out. In fact, economic data recently released indicates a modest pick-up.

    Over 2019 we have generally tilted our allocation towards regions that look more attractive in a slower-growth environment. However, increasing exposure to Europe in October added a more pro-growth exposure to portfolios for the first time this year, reflecting our belief that economic activity will pick up in the coming quarters.

    Our two largest holdings remain US equities – the country is seeing the best economic growth – and UK stocks, because of attractive dividend yields and substantial under-investment from overseas due to Brexit uncertainty.

    We continue to hold a small exposure to emerging market equities but have a close eye on the US dollar. While the improving global economy will benefit emerging market assets, the state of the US currency is just as important to their performance in our view. A strengthening US dollar has been a headwind for such assets so far this year but this may change. Given the recent, large liquidity injections from the US central bank, more US dollars are now available, potentially weakening the currency. And a weaker US dollar would be positive for emerging market stocks.

     

    Positioning

    US =
    UK -
    Europe +
    Japan -
    Emerging Markets -

    Bonds

    We increased our investment in US and UK bonds throughout 2018 and in the first half of this year. Government bonds provide valuable diversification benefits, particularly in times of volatile markets and slowing economic growth such as we saw over the summer. As fears about macro risks and a potential recession were scaled back in October, bond prices fell. We expect them to continue to drop unless trade fears re-surface.

    Outside of developed market government bonds, we continue to invest in specialised credit themes, such as subordinated financial credit and emerging market debt, based on attractive valuations and income and positive prospects over the medium term. In emerging market debt, we hold local currency government bonds and short-dated US dollar-denominated corporate bonds.

     

    Positioning

    Government -
    Investment Grade -
    Financial Credit +
    Emerging Market Debt +

    Other Assets

    We continue to hold some exposure to UK commercial property and absolute strategies linked to specific investment themes instead of broader funds.

     

    Positioning

    Absolute Return +
    Property +

When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up and you may not recover the amount of your original investment.

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