Investment Comment October 2018

The first half of 2018 saw robust global economic growth, at a rate of 3.75%, but signs of a slowdown are becoming more prominent, suggesting that global expansion may have now peaked. In support of this claim, the OECD interim economic outlook reported business survey results suggesting reduced global investor confidence, subdued manufacturing export orders and slower growth in both advanced and emerging market economies. Amidst the prevailing trade uncertainties, global trade growth declined to 3% in the first half of 2018; down from 5% in 2017. Any further escalation in trade tensions is expected to have adverse effects on global investment activity, employment and living standards. Advanced economies continue to experience job growth, with the OECD-wide unemployment rate of 5.3% currently below the pre-crisis level. Nominal wage growth remains moderate but real wage improvements have been subdued by an uptick in consumer prices. Global GDP growth is expected to stabilise at 3.7% throughout 2018 and 2019, due to downward revisions for most of the G20 economies. This is 0.25% lower than initially projected.

In the third quarter, the US continued to dominate global markets with the MSCI USA up 8.7%. The euro area followed with the MSCI Europe ex UK returning 3.04% over the three-month period. The UK and emerging markets remained flat with the MSCI UK and MSCI EM returning -0.8% and 0.13% respectively. Asian markets improved slightly, despite the ongoing trade tensions with the US, with the MSCI Asia returning 1.92% on the quarter.

On the back of strong economic growth of 4.2% in the second quarter, the US continues to flourish under strong macroeconomic conditions. The US stock market reached twin landmarks in September, reaching an all-time high as well as experiencing the longest bull run in history.

US wage growth has risen at its fastest pace in nine years, as employers continue to increase pay to attract and retain quality employees in an increasingly tight labour market.  Average hourly earnings increased by 2.9% in August and unemployment held steady at 3.9%; almost at an 18-year low.

US manufacturing signalled the weakest rise in private sector business activity since April, with the US PMI output index declining from 55.7 in July to 55 in August. However, the reading is still well above the 50 no-change value and broadly in line with its post-crisis average of 55.2. The core consumer price index rose 2.2% year-on-year in August, below the expected 2.4%. Despite softer inflation data, the bullish outlook on the US economy saw the Federal Reserve increase interest rates to 2.25% in September; above the inflation rate for the first time since 2008.

The normalisation of monetary policy in the US is set to continue but the current fiscal stimulus and increased government expenditure are likely to boost short-term domestic demand. This is expected to further contribute to current market momentum on the back of robust employment creation, strong asset prices and record levels of oil production.  According to OECD data, GDP growth in the US is projected to be close to 3% in 2018 before easing to 2.75% throughout 2019.

In the UK, economic growth in the three months to July increased at its fastest pace in a year.  Second quarter growth increase by 0.6%, largely due to a sharp recovery in retail and construction activity, which increased 2.1% and 3.3% respectively. UK manufacturing activity remains subdued, with the IHS Markit Purchasers Managers Index (PMI) declining from 53.8 to 52.8 in August; the weakest reading in 25 months but still indicative of growth.  Average earnings, excluding bonuses, rose by 2.9% in the second quarter, exceeding expectations of a 2.8% rise and up from 2.7% in the first quarter.  However, UK Inflation increased to 2.7% in August, widely exceeding economists’ expectations of 2.4%, which is expected to subdue real wages and dampen household consumption. UK unemployment remains steady at 4%.

With the existing economic conditions in line with the Bank of England’s expectations, the Monetary Policy Committee voted unanimously to keep rates at 0.75% in September. However, Governor Mark Carney expressed his concerns regarding a no-deal Brexit scenario. The Governor proposed that an agreement based on the initial Chequers Compromise Plan (free trade area in goods and agriculture), will recover 75% of growth lost after the 2016 referendum but warned that a no-deal scenario would significantly weaken Sterling and set in motion a series of events which might result in a recession. Despite the prevailing uncertainty of negotiations and a decline in UK investor confidence in recent months, modest growth of 1.25% is expected for the UK throughout 2018 and 2019.

European output growth has eased since the start of 2018 due to softer external demand. Concerns regarding ongoing Brexit negotiations remain. Sentiment towards Germany has improved but the outlook for Italy remains passive due to concerns about possible consequences resulting from the new government’s expansionary budget policy objectives. The uncertainty of policy choices, higher interest rates and slower employment growth in Italy, is likely to materialise in softer economic expansion. Eurozone business confidence remains flat with the euro PMI declining to 54.2 in September, slightly down from 54.5 in August. However, wage growth in the area is close to its average before the financial crisis and is argued to be growing faster than the US in real terms.

Mario Draghi, president of the European Central Bank, confirmed that it would slow the expansion of their quantitative easing programme, as the euro area is strong enough to produce stable inflation and solid growth. However, interest rates are expected to remain low towards the summer of 2019. The OECD proposes that accommodative monetary policy and mild expansionary fiscal policy, combined with strong employment growth and favourable financing conditions will support domestic demand in the euro area. GDP growth is estimated to remain close to 2% throughout 2018 and 2019.

A stronger greenback combined with rising interest rates in the US, contributed to sizeable currency depreciation in various emerging market economies, resulting in tighter financial conditions for economies with large foreign denominated debt. Turkey and Argentina have been particularly affected. Turkey, arguably one of the most vulnerable emerging markets due to its reliance on foreign debt, aims to cut public spending by £10bn. Interest rates were also lifted to 24%, up from 17.75%, with the objective to stem the currency crisis. This significantly weakened growth expectations for the country. Growth prospects for Argentina also weakened considerably due to an accelerated pace of fiscal consolidation and strong monetary policy tightening. Strong currency depreciation will support exports, but economic growth is projected to decline by 2% in 2018 and stabilise towards 2019.

The pace of economic recovery in Brazil has eased due to strike-related disruptions and uncertainties pertaining to future government policy. Prospects for growth in South Africa remains subdued after the country slipped into a recession in the first half of 2018. Investor confidence remains low, reflecting the uncertainty associated with future economic reforms. However, President Ramaphosa has recently approved a new charter to lift legal restrictions on the South African mining industry, with the aim to attract foreign investment.

The outlook for India and China does not resemble their emerging market counterparts. India is set to remain the fastest growing large economy in the world with GDP growth projected to be 7.5% throughout 2018 and 2019. The Indian Current Situation Index, which measures consumer confidence, is currently at 97; well above its historic low of 88 and up from 95.1 in the first quarter. Indian valuations are also currently at a 37% premium to the median Price to Earnings ratio relative to emerging markets as a whole. However, household debt has increased, and the country faces competitive challenges, as non-oil exports only experienced a marginal increase. This points to a potential slowdown in momentum.

In China, headwinds resulting from the current trade dispute with the US have been modest. A depreciating currency would help offset the impact of higher tariffs on exports. Economic growth is projected to ease in 2019 to levels below its current rate of 6.5%. In relation to this, the People’s Bank of China injected $22bn into the banking system through loans in August to boost medium-term liquidity.

Core Inflation in Japan, the closely watched inflation gauge by the Bank of Japan, which excludes volatile food and energy prices, increased 0.4% in August. Price appreciation far from the central bank’s target rate of 2%, coupled with passive national wage growth, have forced the Bank to maintain interest rates at current levels until 2020.

The price of oil reached a 4-year high in September at $81 and is expected to exceed $100 per barrel in 2019 following the materialisation of US sanctions on Iran in November this year. Volatility is expected to increase depending on the severity and duration of the imposed sanctions. A recent data release on global oil demand, suggests that oil prices will soar over the next five years due to a dramatic expansion in airline demand. Airlines are projected to be the fastest growing oil consumer at 2.2% on average per year by 2040, which will offset the reductions brought forward by the electric car. OPEC expects oil demand to reach 112 million barrels per day by 2040 (up from a current 93 million barrels per day per International Energy Agency).

As articulated in Cantab’s Autumn 2018 Outlook, global trade negotiations represent a significant current uncertainty, but we believe a degree of compromise between the US and China is likely. Furthermore, Brexit negotiations in global investment terms continue to remain insignificant. The UK economy remains strong and is likely to be able to withstand a significant shock in a way it was unable to do in the 1970s. Whilst it is important to continue monitoring this, it is also important to consider our investment horizon and the global nature of client investment portfolios.

With strong global growth expectations towards 2019, we continue to see attractive opportunities across global markets. However, prospects across countries are diverging, especially with emerging markets, which are experiencing significant headwinds in current financial market conditions. During this time, we continue to advise our clients about the importance of holding a well-diversified portfolio and taking a long-term view on their investment returns.

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.