Investment Comment January 2019

Investor perceptions of downside risk to the global economy, along with global trade war uncertainties, aggravated the decline in investor confidence in the fourth quarter, which saw the second correction of 2018. Global equity markets contracted, with the MSCI World (ex UK) index declining -10.7%. The UK market mirrored the global market decline, with the MSCI UK down -10.5%. Global bonds proved defensive, returning 3.7% over the three months but both UK property and Emerging Market equities contracted.

The US economy faces several headwinds, including the lagged effects of interest rate hikes, uncertainty from protectionism and fading benefits from ‘one-off’ tax cuts.  Growth is forecast to slow to between 2% and 2.5% in 2019 with a further expected contraction towards 1.8% by mid-2020. However, US fundamentals remain strong and indicative of growth. The labour market is tight with unemployment at 3.7%, the lowest level in almost fifty years.  In December, the Federal Reserve increased interest rates for the fourth time in 2018 to 2.5%. US markets saw the sharpest reaction to an interest rate rise since 1994 with the S&P 500 falling by as much as -2.3%. Investors had expected a more soothing tone from Fed chairman Jay Powell, but markets were shaken after the chairman said he did not see the central bank changing its “autopilot” policy of reducing the size of the Fed’s balance sheet. Forecasts by Fed officials no longer show three increases in short-term rates in 2019 and have been adjusted down to just two quarter-point increases.

In the UK, the Office for Budget Responsibility (OBR) raised its economic growth forecast for 2019 to 1.6%, an increase of 0.3% from the Spring Statement prediction, despite the year-on-year contraction experienced in the third quarter. UK wage growth is at its highest level since the global financial crisis, with average weekly earnings in the third quarter increasing 3.1% year-on-year, exceeding the consensus forecast of 2.9%. However, uncertainty surrounding Brexit negotiations continues to rattle markets with business confidence falling to its lowest level since the global financial crisis.

With UK inflation currently at 2.4%, the Monetary Policy Committee voted unanimously to keep rates at 0.75% but reiterated their plan to gradually increase interest rates to 1.5% by mid-2021. The Bank released results from their Brexit stress test analysis, highlighting possible difficulties of a no-deal outcome. However, Mark Carney announced that the UK banking system is strong enough to support households and businesses during a disorderly Brexit scenario with all UK lenders passing the annual stress test. MPs will vote on the UK’s Brexit deal in the week beginning 14 January.

Eurozone economic growth continued to slow in November with the IHS Markit Purchasing Managers Index (PMI) declining to 52.7, down from 53.1 in October. However, business confidence remains fairly robust and the labour market is strengthening. Italy has brought its two-month stand-off with the EU to an end, after a compromise was reached over its 2019 budget. The agreement reduces Italy’s 2019 budget deficit to 2.04%, down from its original plan of 2.4%. This has allowed Italy to avoid potential EU sanctions and has calmed tensions between EU leaders and Italy’s populist government. Italian 10-year bond yields fell to 2.79%. Two months ago, during the height of the tensions, the yield had risen to 3.8%. The bulk of the spending cuts are reported to come from delaying the universal basic income scheme and the proposal to cut the retirement age. A safeguard clause to increase VAT was also included, which would be implemented should Italy’s budget numbers be worse than expected.

A negative outcome on trade between the US and China is expected to have significant growth consequences for the wider Asian market. The World Bank, in their East Asia and Pacific economic update, estimates that a 1 percentage point drop in China’s GDP growth would subdue expansion in developing Asia-Pacific countries by 0.5% after two years. However, China continues to grow in line with expectations, expanding by 6.5% year-on-year in the third quarter of 2018. The People’s Bank of China also injected $109bn into the economy and reduced the reserve requirements ratios to mitigate trade war pressures on growth. Relations between the US and China have improved since the G20 summit in Buenos Aires at which both countries agreed to halt new trade tariffs for 90 days to allow for further negotiations. China had agreed to reduce tariffs on the imports of US cars and would commit to the purchase of a substantial amount of farm, energy and industrial goods in order to reduce the current trade deficit. The November PMI in China of 50.0 indicates that manufacturing confidence declined to neutral levels for the first time since July 2016. However, favourable future trade negotiations would provide support for improved market confidence.

Restoration efforts in Japan, following natural disasters in September, supported national sales growth and saw the Japanese PMI increase towards the end of the third quarter. However, the index declined slightly from 52.9 to 52.2 in November, with growth prospects subdued due to a significant increase in imports relative to exports and hints of monetary tightening by the Bank of Japan.

Oil prices shot to four-year highs at the beginning of October, peaking at just over $85 a barrel on the back of tight supply and concerns regarding US sanctions on Iranian oil exports. However, fears of a global economic slowdown, coupled with the continued expansion of US crude supply, has created bearish sentiment across oil markets. Brent Crude reached year lows of $50 in December, a c.40% decline from its peak. OPEC agreed to new supply cuts of 1.2 million barrels per day from January. This failed to allay market concerns of an emerging supply glut as the initial $3 jump in price was soon reversed.

With global equity markets contracting in the fourth quarter, we continue to advise our clients to take a long-term view on their investment portfolios. Whilst political tensions may induce market volatility, we do not see a compelling reason to meaningfully alter our recommended asset allocation strategy. The global economy is still expanding, and we continue to communicate to our clients the importance of holding a well-diversified portfolio to alleviate any potential market volatility.

Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.