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Monthly Update | Trade truce brings autumn windfall for markets

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Summary

Geopolitical tensions cooled in October along with autumn temperatures, as the US and China reached a tentative trade truce and the chance of a no-deal Brexit receded.

6 min read

October provided an autumn boost to equity markets as geopolitical risks – namely the US-China trade war and Brexit – receded. The MSCI AC World Index of global equities was up by 2.0% in local currency terms.

A stronger sterling, however, saw this translate to a -2.2% loss in sterling terms. Combined with a weak performance in UK equities – a consequence of the stronger pound and political noise – this made for a difficult October for sterling-based investors, despite strong equity performance elsewhere.

Overall, financial markets continue to be supported by central bank policies and a relatively healthy trading environment. Coutts Head of Investment Strategy Sven Balzer says, “While some reduced macroeconomic risk is helping markets, a more decisive improvement in underlying economic fundamentals is still the missing variable for many investors. But the stability of financial markets in recent months remains a positive development, which confirms our stance of prudent optimism and well-balanced portfolios.”

 

Markets bloom as trade truce blossoms

Investors grew more confident as the US agreed to suspend its next tariff hike on China. President Donald Trump said negotiators had reached a “phase one deal” with China, which included the commitment to increase agricultural purchases, and reassurances on the need to address financial services and technology theft. The deal is expected to be signed in November.

The reduced chance of a no-deal Brexit also improved investor sentiment. Given the improving macroeconomic risk, bond yields increased (and prices fell), while major stock market indices continued to rise. Since the start of the year, markets remain positive across the board, with the S&P 500 and MSCI Europe now both showing returns above 20%.

At the end of the month, the US Federal Reserve cut interest rates for the third time this year, by 25 basis points to a range of 1.5% to 1.75%. It said this was justified due to uncertainty over the economic outlook. While the cuts were expected, they show that financial conditions will remain very loose for the foreseeable future, a net positive for markets. The US economy is sending mixed signals – manufacturing activity is slowing but the housing market has picked up, and both the labour market and consumer spending seem to be holding strong.

This has been particularly beneficial for US equity, with the S&P 500 going on to record highs. Having increased our position in US equities earlier in the year, this was positive for Coutts funds and portfolios.

“While some reduced macroeconomic risk is helping markets, a more decisive improvement in underlying economic fundamentals is still the missing variable for many investors.”
Sven Balzer, Head of investment strategy, Coutts

Outlook remains positive for Europe

Eurozone manufacturing data stabilised in October after the low readings of the previous month. We remain positive on the region and believe the economic cycle is showing signs of life. Leading indicators in China, Europe’s biggest export market, suggest rising demand that should support European companies over the coming months.

Supportive policies from the European Central Bank remain a positive for the region, even if markets were largely unmoved by Mario Draghi’s final meeting as president of the bank. He reiterated his calls for more fiscal stimulus, which we believe will be a core theme in the coming decade. As new bank president Christine Lagarde takes over, we don’t expect the policy direction to change.

We increased our allocation to European equities in October. Sven says, “Europe looks attractive based on fundamental data and has been abandoned by international investors since last year. Additionally any positive development towards a soft Brexit will help EU stocks.”

 

Brexit deadlock continues

October saw increased momentum in Brexit negotiations. Sterling grew in strength against the US dollar as Prime Minister Boris Johnson secured a fresh withdrawal agreement with the European Union, reducing the chance of a no-deal Brexit substantially. UK large-cap stocks tend to decline as sterling becomes stronger, illustrated by a fall of -2.1% in the MSCI UK in October. Additionally, non-sterling assets also become less valuable on a relative basis. This combined effect has been a drag on returns for sterling-based investors.

The UK now faces a general election on 12 December. With a highly volatile political situation, the impact on investors is difficult to divine.

As Sven explains, “At Coutts, we don’t position our portfolios for binary events. What we do is identify opportunities where these events cause stress or dislocation. The Brexit journey has provided us with a couple. One, sterling valuations are cheap on a long-term view and our UK portfolios are carrying around a 10% higher sterling weight than at the time of the referendum. We also have exposure to mid-cap and domestic stocks, which have enjoyed a rising earnings growth profile, especially mid-cap stocks.”

The weeks leading up to the election are likely to see some market volatility. We’ll continue to hold our positions in UK assets for now, but will keep a close eye on any developments over the coming months.

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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 of:  31-Oct-19 Current -1M -3M YTD 2019 2018 2017 2016 2015
    Developed Equity (MSCI) 1,710.4 1.9 2.4 34.6 3.5 12.9 18.6 11.2 -0.2
    MSCI UK 2,076 -2.1 -3.4 13.7 2.8 5.9 11.1 18.5 -5.9
    MSCI UK Large Cap 1,016 -2.5 -4.1 13.6 3.3 6.5 11.2 21.1 -9.1
    S&P 500 3,038 2.2 2.4 43.5 4.3 17.9 18.6 15.4 -0.6
    Nasdaq Composite 8,292 3.7 1.7 58.8 0.5 25.2 23.7 16.4 4.0
    DJ EuroStoxx 388.7 1.3 3.7 21.8 5.1 0.3 23.3 3.6 3.9
    Nikkei 225 22,927 5.4 7.4 27.1 -7.8 20.8 26.0 -3.6 9.4
    Hang Seng 26,907 3.3 -2.2 36.2 -2.7 4.4 23.0 16.1 -5.9
    Emerging Equity (MSCI) 57,978 3.0 1.9 31.7 0.2 3.0 22.2 13.4 -6.8
    BRIC (MSCI) 691.4 4.1 2.6 46.3 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:  31-Oct-19 -1M -3M YTD 2019 2018 2017 2016 2015
    US Treasury index 1.69 -0.2 1.9 4.5 8.0 -3.7 -3.9 1.7 1.2
    UK gilts index 0.63 -2.3 1.8 4.2 11.7 -2.0 -7.2 10.5 5.9
    Eurozone govt bond index -0.40 0.5 2.0 0.9 8.1 -9.7 -2.7 6.1 -2.0
    US investment grade index 2.84 0.3 2.0 5.0 8.7 -5.3 -2.3 4.1 -3.4
    US high yield index 5.70 -0.3 -0.1 -0.3 1.0 -3.0 2.4 7.5 -9.1
    Emerging market index 59.31 -8.7 -51.1 -61.0 -52.4 -15.4 3.8 26.6 -0.3
    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:  31-oct-19 Current -1M -3M YTD 2019 2018 2017 2016 2015
    Commodity index (TR) 168.1 2.0 0.8 -5.0 -6.6 2.6 -0.3 -2.6 -26.0
    Brent oil price (spot) 59.3 -2.8 -7.4 7.4 -26.3 45.1 18.4 2.0 -50.2
    Gold bullion (spot, per ounce) 1510 2.5 5.8 30.5 23.7 -7.2 -2.9 18.6 -8.1
    Industrial metals (TR) 248.5 1.8 2.8 13.7 -2.1 -2.4 24.0 3.7 -25.3
    Source: Datastream
    Inflation & Interest Rates Current   Interest Rate Forecasts (%) Rate Announcement
      Inflation (%)   Current February March Next Date
    United States 1.70 1.710 1.75 1.75 1.75 11-Dec
    United Kingdom 1.70 1.7 0.75 0.50 0.50 19-Dec
    Eurozone 0.70 0.700 0.00 -0.10 -0.20 12-Dec
    Japan 0.20 0.200 -0.10 -0.20 -0.20 11-Nov
    Source: Coutts & Co.
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    Coutts House View

    Equities

    Equities continue to be supported by the “phase one” trade deal between the US and China and a new Brexit deal, which have reduced the two main headline risks of the year. As we expected, the American 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 to provide 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 receding slightly, having risen over previous months.

    The data still shows an ongoing slowdown in global economic growth, although we are starting to see some stabilisation in our short-term indicators that measure the strength of the global business cycle.

    Over the year we have tilted our allocation towards developed markets, gradually changing focus to regions that look more attractive in a slower-growth environment. Increasing exposure to Europe adds a more pro-growth exposure to portfolios for the first time this year.

    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. A strengthening US dollar has been a headwind for emerging markets this year, but this may be about to change. Given the large liquidity injections by the US central bank, more US dollars are now available. A weaker US dollar would be positive for emerging market equities.  

     

    Positioning

    US =
    UK -
    Europe +
    Japan -
    Emerging Markets -

    Bonds

    We have increased our investment in US and UK bonds throughout 2018 and 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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