Monthly Update | Markets rise and shine

Europe caught in trade war crossfire

Europe has been hit by difficult circumstances in China, but that’s not the only thing weighing on the economy and we remain cautious for now. We believe weaker global growth will prove challenging for the region and, having reduced our exposure in 2018, we’re sticking to a more-or-less neutral allocation.

European equities continued to bounce back in February, in line with global markets, but results were subdued relative to other developed markets. Growth across Europe remains sluggish as trade tensions continue and China’s economy slows.

Trade concerns have affected demand for European exports, and potential US tariffs on European cars could have an even greater, negative impact across the region.

As the region’s largest economy, Germany’s relationship with China is particularly important. In 2018, the 30 companies included in the DAX stock index made a record 15% of their revenue, or €200 billion, from China. In addition, 5,200 German companies with a total of one million employees are active in China, according to the Federation of German Industries.

Brexit uncertainty creates mid-cap opportunities

While UK stocks have weakened, we see good value among domestically-oriented companies – typically in the mid-cap space – which should be boosted by a Brexit resolution.

Brexit continued to dominate the news in February. There seemed to be a new development almost daily, but at the end of the month the Prime Minister had promised MPs a vote on a no-deal Brexit and delaying the departure date if her withdrawal agreement was rejected again.

We bought UK mid-cap stocks after prices hit a three-year low in the December sell-off. When Brexit uncertainty clears, we expect these companies – which tend to focus on the domestic market – to get a boost from a surer economy and stronger sterling. They also have a healthy dividend yield – 3.1%, compared to 4.4% in the FTSE 100, and 2% for America’s S&P 500, as at the end of February.

Emerging markets weaken on dollar strength

Emerging markets are vulnerable to a strengthening dollar but emerging market debt still provides attractive income.

After a strong surge in January due to dollar weakness, the MSCI Emerging Markets index was more-or-less flat in February. Total return was just 1.1% in local currency terms – compared to 3.3% for developed equity – and negative for sterling investors due to the stronger pound.

We reduced our exposure in 2018 from a positive to a neutral position, as slowing global growth and a stronger dollar saw the outlook dim somewhat.

We still like the look of emerging market debt, but recently shifted exposure away from local currencies which are vulnerable to a rising dollar. This move has reduced currency risk while allowing us to maintain exposure to attractive yields.

Market returns

In the US, the S&P 500 returned 3.2% while the MSCI Europe and Japan indices also provided a solid gain for investors. Despite ongoing concerns over Brexit, a weaker pound boosted the MSCI UK Index – returning 2.3% over the month in sterling terms. Gilts returned -1% and yields rose slightly, reflecting the renewed investor confidence in UK equities.

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.