Quarterly update: Is the global economy turning a corner?

What a difference a year makes

Cast your mind back 12 months and we faced a very different picture – markets had fallen substantially, with much of the damage coming in the last quarter of 2018.

Alan explains that, at the end of 2018, markets were expecting the US Federal Reserve (Fed) to turn down the heat on monetary policy in the face of a slower global economy.

“When that didn’t happen, markets took a dive, and Fed Chair Jerome Powell had to spend the next few weeks fiercely backpedalling to reassure markets that the central bank was actually on their side,” he says.

2019 subsequently saw three rate cuts, the last in October. At the last Fed announcement in December, Powell indicated that there aren’t likely to be further cuts in the near future, and any escalation in interest rates is likely to be gradual.

US interest rates remain of vital importance to global markets. As the world’s largest economy, and with the dollar still the currency of choice for many international markets, the Fed’s actions have an outsize effect on investors.

The Fed has moved to support the economy in 2019, and US economic data remains strong. Markets are currently pricing-in a single base rate rise at some point in 2020, and we believe this should continue to provide a good environment for investors.
 

New broom at European Central Bank but no sweeping changes

In Europe, meanwhile, Christine Lagarde replaced Mario Draghi as European Central Bank (ECB) president in November. In her first speech at the helm, she indicated her commitment to her predecessor’s supportive monetary policies, while also adding weight to Draghi’s view that national governments should consider introducing some fiscal stimulus measures to boost their own economies.

Alan highlights the investment case for Europe. “We believe the European economy is showing signs of life. Leading indicators in China, the region’s biggest export market, suggest rising demand that should support European companies over the coming months. As a result, we raised our allocation to European equities in October.”
 

Conservatives claim victory

The biggest news in the UK for the quarter was the decisive victory of the Conservative party in the general election in December. There are three ways this result could affect the investment environment.

1)      Sterling – The value of the pound surged, reaching $1.35 before falling back to what looks like its current default level of around $1.30.  Normally this would be a short-term headwind for sterling-based investors, reducing returns from assets denominated in foreign currencies and putting pressure on profits for large, export-driven companies in the FTSE 100. However, we view UK assets as under-owned after several years of major outflows.

2)      UK equities – As above over the medium term, UK equities should benefit from the return of global investors after a period of under-investment. UK equities offer good value both on internal equity valuation characteristics and as sterling remains undervalued relative to longer-term measures. While Boris Johnson’s large majority in the House of Commons has increased the possibility of a harder Brexit, our central scenario remains a deal in 2020.

3)      Gilts – Government bond yields have risen (and prices fallen) as investors regained their appetite for UK risk assets and global bonds sold off. With inflation still well below the Bank of England’s 2% target, interest rates are likely to stay low, which could put a ceiling on yields (and therefore a floor on bond prices) for the time being.

In the days after the election, we used cash reserves to add to our holdings in UK equities.  Alan highlights the positive outlook, “Based on our analysis, UK equities are very attractive, particularly on valuation measures. Greater clarity on Brexit, albeit with some uncertainty potentially further down the line in 2020, could act as a trigger for gains.”

This move has also increased our overall equity exposure, in line with our view on the positive global outlook.
 

A done deal?

While the election grabbed headlines in the UK, the ‘phase one’ trade agreement between the US and China announced in October is a far more significant development for investors. Global stock markets jumped as the deal approached its final stages in December, with the S&P 500 rising to another record high for the year.

We expect further positive news in 2020 on trade. With the first stage of the agreement seemingly near completion, the two countries now appear more likely to be able to reach a ‘phase two’ deal. President Trump may also be keen to take a more trade-friendly approach in a presidential election year.

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.