Welcome to Market Musings – a lighthearted commentary issued from time to time. In this issue we bring to you a summary from our recent Home Stretch events held in London, Bristol, Exeter and Manchester over the last two weeks. Co-CIO Gregory Perdon shares insights from across the globe and Investment Manager Edward Johnstone discusses the impact to our investment strategy.
Gregory, with just over a year to go until the next presidential election, what’s on President Trump’s radar currently?
Americans are especially sensitive to the value of their houses, 401k pension plans and the cost of petrol. President Trump is aware of these three sensitivities. With the goal of re-election he is pressuring the US Federal Reserve into cutting interest rates, as well as managing his foreign policy around ensuring reasonable oil prices. Lower interest rates will help prop up the stock market, as well as provide homeowners the ability to re-mortgage onto cheaper rates. As it relates to oil, on the heels of the Saudi attacks, the President immediately announced the release of strategic reserves in an attempt to reverse the spike in oil prices. This is all designed to keep more disposable income in the pockets of his voter base. Our view is that President Trump does not need to win the trade war; he just needs to have the appearance of a win because ‘his electoral base doesn’t read the fine print’.
Putting Brexit to one side, what’s the key story coming out of Europe?
Europe is the economic block that everyone loves to hate. A few years ago the three main economic challenges were the spectre of deflation, high and persistent youth unemployment and a broken banking system. Fast-forward to today and all have improved significantly: we see positive (albeit modest) inflation, youth unemployment continuing to grind lower and banks with significantly stronger balance sheets.
We are now facing a manufacturing led recession in Germany, one which no one forecasted. In spite of slowing German growth, there are reasons to remain positive. We believe the trade wars will simmer down as we approach the US elections in November 2020, the European Central Bank will continue with an era of cheap money, and finally there will be stronger and stronger calls for fiscal stimulus.
Who will be key in the latter two? Enter Christine Lagarde. We believe she will be spending more of her time in Berlin as opposed to Frankfurt leveraging her expertise in lobbying – as Mario Draghi always said ‘Monetary only works in conjunction with fiscal’. How would that work? Germany can spend their way out of recession in one of two ways. They can declare a state of emergency, or change the constitution. We believe over the short term changing the constitution will prove difficult. However, the Germans could find innovative ways to address very specific areas of weakness (such as a cash for clunkers scheme).
Speaking of innovation, how has Japan responded to its challenge to increase inflation?
As a nation, the Japanese are great innovators. So much so, they have decided to create artificial inflation! They have introduced a VAT hike attempting to deliver on their objective to increase inflation, while simultaneously introducing measures to lower taxes on food, offer incentives to purchase cars as well as provide free childcare and reduce university fees. Very innovative indeed, a tax hike disguised as fiscal stimulus!
Japan is an attractive equity region that is under-owned benefiting from cheap valuations and continued monetary support.
And what of China?
Is China building more bridges to nowhere, or slowly displacing the US as the global hegemon? President Trump would like us to believe that China is on the ropes but the reality is very different. The country is still growing at circa 6%, benefiting from tax cuts, increased infrastructure spend and easing monetary policy.
Edward Johnstone looks back over the past 12 months at key market movements and our investment strategy response:
In the last quarter of 2018, markets focused on the escalations between the US and China. Disappointing earnings from some of the big tech companies, and the possibility that the US Federal Reserve would continue to increase interest rates in 2019.
From a position of fear, moving into October 2018 we increased our allocation to Gilts and US Treasuries. We also bought domestic Chinese A shares; they had been very beaten up and in our view were too cheap to be missed.
In the first three months of 2019, we saw a very different landscape. Optimism ensued over the US-China trade talks, and the US Federal Reserve highlighted that it would put further interest rate increases on hold. This resulted in one of the strongest equity rallies since 2010, primarily driven by US equities. We decided to remove the Gilts and Treasuries added in 2018, rotating into Emerging Market debt, as well Asian equities.
Q2 was a tale of two halves. Initially, we saw stronger than expected US economic growth, again spurring on investors to continue allocating to equities. Mid quarter, Donald Trump put a spanner in investor exuberance through trade tariffs. Ending the quarter with the US Fed moving from a pause in interest rates, to language much closer cuts. We took this opportunity to take profits in our US equities, bringing our UK equity underweight back to neutral.
The most recent quarter has been more muted. The US Fed cut interest rates both in July and September. This was the first rate cut in ten years, although, clearly signposted and so no surprise. We maintained our current positioning throughout Q3 reflecting our view that risks are well balanced to the upside and downside.
Presently we are slightly overweight bonds, with a higher allocation to corporate and Emerging Market bonds over Gilts and Treasuries which we see as expensive. We are broadly in line in equities. We hold less in the US and Europe, and have an overweight to Emerging Markets; primarily through Chinese equities. We continue to allocate to global as opposed to UK property.
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Co-Chief Investment Officer
Arbuthnot Latham & Co., Limited
Co-Chief Investment Officer
Arbuthnot Latham & Co., Limited