Steve Wilson, Managing Partner discusses 2hWealthcare’s thoughts on the key issues that will influence markets and investment decisions over the next few years.
Central Banks remain the key driver for markets
2019 finished with a rally in stockmarkets and from a UK perspective, some certainty with the direction of political travel in respect of Brexit, good or bad depending upon your views. Thoughts as to what a new decade may bring for investors has to start with some reflection on the past ten years and from a markets perspective it has to be one that has been dominated by the actions of Central Banks.
The decade following the Great Financial Crisis introduced Quantitative Easing (Central Banks buying Government Bonds with ‘printed’ money) and ‘Zero Interest Rate Policy’ that saw the yields on $15 trillion of Government Bonds in Europe and Japan turn negative; which meant getting back less money than the amount invested without taking any inflation into account.
As global economies improved and markets soared, attempts by the US Federal Reserve to restore ‘normality’ with higher interest rates were met by sharp market falls and accusations that the Fed would be responsible for de-railing the economy. These market jitters led Federal Reserve Chairman Jay Powell to take a dramatic U-turn on policy and cut rates three times in 2019, in addition to re-commencing Quantitative Easing with nearly $100bn per month of Government Bond buying from October. He has also very clearly spelt out that rates won’t be going up this year even if inflation starts to rise away from the 2% target.
This had a dramatic impact in the US, where the market was up 28% by the end of the year, demonstrating that the prosperity of Wall Street remains dependent upon the words and actions of its Central Bank.
Going forward, the question is whether the market momentum will be sustained and more importantly, supported by global economic growth. Or, is it no more than a short-lived reaction to another injection of cash which will soon fade when the economic realities become obvious?
The economic fundamentals are holding up
Being the World’s largest economy, the USA continues to be the bellwether for the state of the global economy. Despite concerns of a slowdown, US growth was 1.9% in Quarter 3 and expected to show a similar figure for the final quarter of 2019. Retail sales remain in reasonable shape and there is no firm indication that manufacturing is bottoming (Purchasing Managers Index – October and November). Jobless claims, despite some recent increases, are exceptionally low year on year.
Furthermore, there has been a sharp steepening in the Treasury spread between 2 and 10-year maturities. As we highlighted in our August 2019 Bulletin, an ‘inverted’ yield curve is often a pre-curser to recession. The fact that the curve has steepened could be taken as a bullish signal that the US economy is moving further away from an inverted yield curve and therefore a possible recession.
In his last post for 2019, Ed Harrison of Credit Writedowns summarised his view:
“None of the data are consistent with a recession or an imminent recession, but the data still point to middling growth at best”.
Can Donald Trump cut a deal?
By far the current single biggest concern for global growth is the China/USA trade tensions. When China entered the World Trade Organisation some years ago it wanted preferential terms but put barriers to imports in place to protect their domestic economy. Now that China is the world’s second largest economy with unfair trade advantages it could be strongly argued that President Donald Trump has a very good case for a fairer two-way deal.
It is thought that China is stalling over a trade deal in order to negotiate with a new US President after October 2020. But Donald Trump’s tough approach to trade talks and tariffs on Chinese imports is hurting the Chinese economy and also winning him support at home; he stands a strong chance of re-election. Donald Trump is renowned for his ability to get a deal; a good trade deal and an end to the tensions would give a huge boost to the global economy.
In Europe, the Chinese slowdown is hurting manufacturing; Germany only just managed to avoid a technical recession in Quarter 3. Productivity remains poor in the Euro Area, particularly in Italy. Concerns that the EU is following Japan in long-term stagnation with price deflation, slow growth and increasing Government debt are fuelling calls for greater fiscal stimulus by way of more ‘investment’ in infrastructure and job creation.
Following the UK election and sweeping Conservative majority, an ‘end to austerity’ is also expected – lower taxes and increased Government spending will dominate the Tory agenda. It’s also in everyone’s interest that the EU and the UK come to a sensible deal on trade terms as soon as possible. Pragmatism and a ‘soft’ Brexit beckons.
If there is one thing that markets like, it is liquidity. A combination of continued low interest rates, more QE and higher Government debt to fund new spending will boost the economy, the labour market and incomes. It is also likely that with a more relaxed approach to inflation targeting, prices will rise faster than they have for the previous decade.
The UK looks to be very attractively valued
The one market that stands out at the moment is the UK. UK equities have lagged the global markets for the past 3 years due to political uncertainties, consequently they are now considered to be very good value; price/earnings ratios for the UK are at their lowest for decades. Furthermore, UK companies are paying extremely good dividends – the difference between the average UK company dividend and the 10-year UK gilt yield has not been as wide since the 1930’s. This all points to considerable potential for a revaluation of stocks over the next 12 months.
Looking at the current position, there is every reason to be reasonably optimistic for the short-to medium term outlook for the economy and for stockmarkets, particularly the UK.
Looking at the longer term, all cycles come to an end, usually as a result of credit becoming harder to obtain. Central Banks will not be able to keep rates at such low levels indefinitely; Japan’s exception has been its isolation and public willingness to hold Government Bonds. We therefore remain extremely wary of owning long-dated Government debt and prefer real assets that have an inflation hedge. Good quality companies that provide goods and services that are needed, real estate, land, forestry and gold remain qualified wealth preservers over the long-term.
Please don’t hesitate to contact us if you would like to discuss any of the above.