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Monthly Update | parliament packs up and trade war takes toll

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Summary

The US-China trade war and UK parliament shutdown have had very different effects on markets

4 min read

Journalists call the summer the ‘silly season’ – a quiet period when there isn’t much to report so there’s more coverage of lighter, perhaps more frivolous stories.

But this summer has been anything but quiet for investors.

While Westminster reels from a surprise parliament shutdown, Washington and Beijing up the stakes in their trade war. Meanwhile, anti-government protests in Hong Kong continue to escalate.

This has all added to the general sense of uncertainty chipping away at investor confidence, and markets have had a tough time as a result. Although most equity prices recovered by the end of the month, America’s S&P 500 and Dow Jones Industrial indices recorded their worst trading days of the year in August, and the UK’s FTSE 100 hit a six-month low. 

 

Consumers still confident but manufacturing in slowdown

Consumers remain the ray of sunshine in the UK and US economies. Consumer confidence is still at high levels and employment is strong. 

Manufacturing sectors are being impacted by a global slowdown, but that’s why central banks stand ready to provide support. Overall, the world economy still grows, even if at a slowing pace.

The current market swings are in part seasonal. We usually see a traditional summer slowdown in market activity as investors swap trading for travelling, and this makes those markets more susceptible to sudden shifts.

 

Parliament shutdown fails to move markets

It’s worth remembering the clear distinction between politics and economics at such times. While the US-China trade war is undoubtedly hitting countries’ exports and therefore denting market performance, the UK parliament shutdown decision actually had little impact.

Coutts head of investment strategy Sven Balzer explains, “Sterling slipped a little on the news but that was about it. Investors are in ‘wait and see’ mode given the many potential scenarios that could now play out – including the possible reversal of prorogation. 

“With sterling weak against the US dollar, markets are pricing-in a somewhat harder Brexit outcome, but it is difficult for investors to have much conviction in any one conclusion at the moment.”

Sven adds that the best investor response is to stay calm. 

“We will continue to see alarmist news headlines about Brexit and politicians being provocative to ram home their points,” he says. “But in our view the best thing to do is to step back from all the rhetoric and speculation, remain disciplined in your investment approach and stay focused on the fundamentals.”

 

Coutts plays it safe but looks for opportunities

We have kept our client portfolios and funds well diversified and positioned them more defensively to reflect the current political landscape and slowing economic growth. 

Sven says, “A couple of months ago we reduced our investment in equities, taking some good profits, and added to government bonds. 

“Even within our exposure to equities, we tilted our portfolios towards developed markets and focused on regions that are generally more appealing when growth slows. This includes buying more US stocks which, albeit expensive, give exposure to high quality companies and continue to deliver strong returns.”

“Struggling markets can present opportunities just as much as strong ones can. And through our robust analysis of market data and trends we are constantly looking out for any such chances to make a gain.”
Sven Balzer, Head of investment strategy, Coutts

He adds, “Struggling markets can present opportunities just as much as strong ones can. And through our robust analysis of market data and trends we are constantly looking out for any such chances to make a gain.”

 

Recession? Really?

The uncertainty permeating markets has even led to one of the signals of a recession rearing its head – the inverted yield curve. Allow us to explain…

Investors can now make more money – or achieve a higher yield – on short-dated bonds in the US than on long-dated ones. Normally it’s the other way around. Long-term bonds are generally seen as riskier because the longer they last, the greater the uncertainty. They usually come with a higher yield than short-dated bonds to compensate for this.

The current situation suggests investors believe the longer-term outlook for economic growth and inflation is more uncertain than the immediate future – one of the reasons why it’s seen as a potential sign of recession.

But will it happen?

Sven says, “While the yield curve does suggest a possible recession, other important factors, such as consumer and corporate credit market data, remain quite strong. Our own analysis at Coutts puts the chance of a recession in the US at one in three at the moment.” 

 

Trade war: can we talk?

Trade frictions increased in August as the Chinese government and President Trump announced additional tariffs on various goods. Stock markets fell and the yuan slumped to an 11-year low, but then recovered after both sides tried to downplay any further escalations. 

Our view is as it has always been. In the run-up to next year’s US election, both sides will come to some sort of agreement. Longer term, however, the strategic rivalry will persist.

Find out more about our investment outlook for the rest of the year and read our recent Q&A article about the UK parliament shutdown.

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 click on the “Equity Markets Performance” heading above. As always, past performance should not be taken as a guide to future performance.

    Equity Markets

    Performance (%tr*, local)

    12 month performance to end June

    As of:  31-Aug-19

    Current

    -1M

    -3M

    YTD

    2019

    2018

    2017

    2016

    2015

    Developed Equity (MSCI)

    1,644.9

    -1.9

    5.2

    29.0

    7.3

    11.5

    19.5

    -2.1

    9.0

    MSCI UK

    2,070

    -4.1

    1.7

    12.8

    1.7

    8.3

    16.7

    3.4

    -0.2

    MSCI UK Large Cap

    1,018

    -4.4

    1.1

    13.2

    2.9

    8.2

    16.8

    5.4

    -2.4

    S&P 500

    2,926

    -1.6

    6.9

    37.9

    10.4

    14.4

    17.9

    4.0

    7.4

    Nasdaq Composite

    7,963

    -2.5

    7.1

    52.3

    7.8

    23.6

    28.3

    -1.7

    14.4

    DJ EuroStoxx

    370.9

    -1.3

    4.1

    16.0

    3.1

    4.3

    25.6

    -10.8

    12.1

    Nikkei 225

    20,704

    -3.7

    0.8

    14.0

    -2.6

    13.5

    31.1

    -21.6

    35.7

    Hang Seng

    25,725

    -7.1

    -3.1

    29.4

    2.5

    16.3

    27.8

    -17.5

    17.6

     

    Emerging Equity (MSCI)

    55,659

    -2.5

    -1.1

    26.0

    2.2

    10.9

    22.2

    -7.3

    6.6

    BRIC (MSCI)

    660.6

    -2.4

    1.9

    39.2

    3.2

    20.2

    24.7

    -14.1

    14.1

    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 June 
    As of:  31-Aug-19 -1M -3M YTD 2019 2018 2017 2016 2015
    US Treasury index 1.51 3.2 3.6 5.8 5.0 -2.8 -4.6 3.7 -0.2
    UK gilts index 0.40 3.5 5.9 5.9 2.7 -1.1 -4.1 10.9 6.3
    Eurozone govt bond index -0.71 0.6 5.6 -0.6 4.7 -8.8 -2.8 7.3 -6.1
    US investment grade index 2.81 2.8 5.3 5.8 6.7 -5.1 -2.4 3.6 -4.4
    US high yield index 5.72 0.1 2.0 -0.2 1.5 -3.5 6.3 -3.0 -6.9
    Emerging market index 60.87 -55.9 -52.3 -64.8 -17.1 -4.0 0.0 23.9 -5.8
    Source: Barclays indices; Datastream; *current yield on benchmark 10-year Treasury, gilt and bund respectively.
    Commodity Markets   Performance (%, dollar) 12 month performance to end June 
    As of:  31-Aug-19 Current -1M -3M YTD 2019 2018 2017 2016 2015
    Commodity index (TR) 162.8 -2.3 -0.4 -8.0 -6.8 7.3 -6.5 -13.3 -23.7
    Brent oil price (spot) 61.1 -4.6 -8.5 10.7 -12.8 64.5 -2.3 -20.5 -45.3
    Gold bullion (spot, per ounce) 1529 7.1 17.6 32.1 12.9 0.6 -5.9 13.0 -11.2
    Industrial metals (TR) 242.9 0.5 4.0 11.1 -11.0 15.2 17.5 -11.5 -19.4
    Source: Datastream
    Inflation & Interest Rates Current Inflation (%) Interest Rate Forecasts (%) Rate Announcement
    Current November January Next Date
    United States 1.81 2.25 1.75 1.25 18-Sep
    United Kingdom 2.10 0.75 0.50 0.50 19-Sep
    Eurozone 1.00 0.00 -0.10 -0.20 12-Sep
    Japan 0.50 -0.10 -0.20 -0.20 19-Sep
    Source: Coutts & Co.
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    Coutts House View

    Equities

    Equity markets came under pressure in August as the trade war, Brexit uncertainty and Hong Kong protests stopped July’s summer rally. As these topics play out over the coming months they keep the risk of more ‘episodic’ volatility alive.

    In September we expect the American and European central banks to lower interest rates and talk up support for their slowing economies. Our in-house indicators see the probability of a US recession as one-in-three, which means central banks will need to be more accommodative.

    The data still shows an ongoing slowdown in global economic growth, although we continue to monitor our indicators for any signs of potential stabilisation or reversal.

    Our current, overall equity position in a typical balanced portfolio is marginally below neutral after taking profit on some strong-performing holdings in July. We remain flexible, however, and follow market and economic data carefully to inform future decisions.

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

    The Brexit process is back in full swing. Daily headlines are guaranteed as government and parliament debate how to proceed until 31 October. Most of our UK investments remain for the moment in large, international companies which are more insulated from Brexit developments and more diversified in an economic slowdown.

    We continue to hold a small exposure to emerging market equities. While we monitor developments in trade negotiations between the US and China, we see the strengthening US dollar as a headwind for emerging market assets – for now. If the dollar continues to rise, we suspect the US administration would become increasingly uncomfortable with such a strong currency. And any action it takes to weaken the dollar would potentially be positive for emerging market assets.

     

    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 volatile markets and amid slowing economic growth with low inflation. When investors priced-in several interest rate cuts by the US Federal Reserve and other central banks earlier this year, it supported bond prices.

    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 have reduced our investment in UK commercial property recently as the potential for returns looks less attractive.

    After a difficult 2018, absolute return strategies continue to deliver muted returns and our conviction in their value as diversifiers in current markets has diminished. We continue to hold some alternative investments though, mostly linked to specific investment themes instead of broader funds.

     

    Positioning

    Absolute Return +
    Property +

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.

Key Takeaways

Markets had a challenging August as the US-China trade war and Brexit uncertainty continued to cause uncertainty – although most equity prices had recovered by the end of the month.

There are still positives. Consumer confidence remains high in the UK and US, and employment is strong. Overall, the world economy continues to grow, but at a slower pace.

At Coutts our client portfolios and funds are well diversified and we have positioned them more defensively to reflect the current political and economic backdrop.

About Coutts investments

With unstinting focus on client objectives and capital preservation, Coutts Investments provide high-touch investment expertise that centres on diversified solutions and a service-led approach to portfolio management.

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