Quarterly update: Central bank support soothes political pain
In our Q3 investment outlook, we consider the forces that will be driving investment returns over the coming months.
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Despite a series of political shocks – in August in particular – markets turned in a broadly positive performance in the third quarter, with the MSCI AC World Index of global equities returning 1.1% in local currency terms. The travails of sterling, however, meant that this was 3.3% for sterling investors as the pound was blown off course by the political contortions of Brexit. Over the year to date, market performance remains very strong, with global equities returning 17.2% in local currency terms.
CENTRAL BANKS TAKE ACTION IN FACE OF SLOWING GROWTH
While political news flow can lead to increased volatility, the global economy has a more powerful impact on long-term investment performance. With economic growth slowing, central banks have acted this quarter to reduce the impact.
The Federal Reserve cut interest rates twice, by 25 basis points in July and again in September, while the European Central Bank also unveiled new stimulus measures to bolster the eurozone economy. The Bank of England kept interest rates on hold at 0.75%, and policymakers indicated that prolonged Brexit uncertainty would keep rates lower for longer.
Coutts investment strategist Lilian Chovin said, “We see slowing but reasonably resilient growth, supported by central banks, continuing for the time being. Coutts client funds and portfolios are more defensively positioned than this time last year, but are broadly neutral. Equity exposure is focused more on developed markets – principally the US – and we have increased our allocation to US Treasuries at the expense of gilts while we wait for Brexit uncertainty to resolve.”
Trade wars and turmoil exacerbate summer slump
While it’s not unusual to see market weakness as trading volumes decline slightly in the dog days of summer, August’s poor performance was further driven by investor concerns around political unrest in Hong Kong, an increasingly fractious debate around Brexit in the UK, and rising temperatures in the US and China trade dispute.
On trade, Beijing and Washington both threatened escalation in August, then backed down and agreed to resume trade talks. Meanwhile, the Hong Kong government withdrew its controversial extradition bill, reducing tensions, although protests have continued.
While these both represent an ongoing political risk, we think the trade war dispute should settle down, at least temporarily, as President Trump’s re-election campaign gathers pace. Celebrations to mark the 70th anniversary of the People’s Republic of China (PRC) are also under way, which may also serve as a motivation for the Chinese government to reduce pressure on Hong Kong and take a more emollient approach to trade. Both issues remain in play, but we expect a reasonably settled few months ahead.
TROUBLE FOR TRUMP
Just as markets were digesting the ups and downs of US-Sino trade relationships, reports surfaced alleging that President Trump asked the Ukrainian leader to find incriminating evidence against Joe Biden, front-runner for the Democrat presidential nomination. Democrats saw this as their chance to impeach the President and are seeking further evidence.
As a result, investors sought safety. Having recovered most of the drawdown from August, markets went into retreat.
We believe the market reaction looks over-done. Impeachment has come up before with President Trump – a vote was taken by congress in March in the wake of the Mueller Report but quashed by Nancy Pelosi. It could cause some administrative delays in the US and push the President’s legislative programme off course, but we don’t believe it is likely to result in his removal from office.
But Lilian highlights how the potential impact on Joe Biden could cause problems for investors. “He is currently favourite to stand against President Trump in 2020,” he says. “Elizabeth Warren, currently second place for the Democratic nomination, is seen as negative for markets. An election where a wounded Trump stands against Warren could lead to trouble for US stocks.”
Oil prices spike
Markets were further shaken by drone attacks against Saudi Aramco oil processing facilities in Abqaiq and Khurais. Oil prices rose by almost 20% after two attacks on Saudi Arabian facilities cut off more than half the country’s production. Brent crude, the international benchmark used by oil traders, jumped to $70 a barrel at one point after the incident. Saudi Arabia reacted quickly to supply concerns, stating that its oil output would return to normal by the end of September.
Tensions in the Middle East rose as the US and Saudi Arabia blamed Iran for the attacks. But the US has since dialled back on its initial, bellicose reaction, suggesting a conflict is unlikely, which should calm markets. The spike in prices could have an effect on inflation, but we don’t anticipate prolonged support for higher oil prices.
Brexit Turmoil continues
In the UK, meanwhile, there were some remarkable scenes in Westminster as the Prime Minister tried to assert his Brexit agenda. Sterling fell substantially on his appointment as investors priced in the increased possibility of a no-deal Brexit. While it recovered some composure as Parliament moved to limit the potential of a no-deal, it remains at historically depressed levels.
However, as Lilian points out, sterling’s big drop isn’t necessarily all bad for investors.
“Earnings for the globally focused companies in the FTSE 100 get a boost when the pound falls, which is usually good for share prices,” he says. “Also, as international investors based in the UK, we at Coutts use sterling to invest in companies all over the world on our clients’ behalf – and a lower pound makes these investments more valuable.”
We have reduced our exposure to sterling-based assets in recent months, limiting the effect on portfolios. Given sterling’s attractive valuation, we recognise the potential for gains if the political climate improves. We are watching the situation closely for opportunities to buy sterling-based assets that are attractively valued.
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.