Henry James International Management December Market Commentary

Market Overview

Whoever first articulated ‘no pain, no gain’ was probably talking about weightlifting or long distance running, but little did this word-smith know that this maxim would perfectly capture what investors experienced in 2019: soaring equity prices in spite of persistent economic threat, raging volatility and nagging market anxiety. 2019 was generally very good for investors; indeed, on December 31 the S&P 500 was up 724 points (28.88%) from where it was 12 months earlier. Such gaudy, portfolio pleasing figures, however, entirely fail to account for the true story of 2019: it was a year in which there was always at least one major (often multiple) geopolitical or economic issue seemingly poised to bring markets to their knees. For example, the MSCI EAFE index’s returns of 3.27% in December, 8.21% in the 4th Quarter and 22.66% in 2019 entirely obscure the pessimism with which 2019 began, not to mention the realities of the government shutdown and the feud between President Donald Trump and the Federal Reserve over monetary policy. Indeed, by looking at the MSCI Emerging Markets index’s return of 7.53% in December, 11.93% in the 4th Quarter and 18.9% in 2019, one cannot see the very real economic scars left by the US – China trade war, nor can one recall the way in which it constantly threatened to boil over. Looking at the returns of the MSCI World ex USA Small Cap index of 4.65% in December, 11.45% in the 4th Quarter and 25.94% in 2019, there is neither evidence of the uncertainty caused by Brexit and the disastrous prospect of Britain leaving the European Union (EU) without a deal, nor any indication of how Germany’s manufacturing recession further stifled Eurozone’s anemic growth. And yet, markets muscled through these very genuine headwinds and delivered impressive gains on the back of what clearly was a fundamentally strong US and global economy and Jerome Powell’s willingness to be flexible with the Fed’s monetary policy by lowering interest rates by 75 basis points. And yet, so persistent were 2019 economic threats that the slightest hint of positive news on a topic like the US – China trade war or Brexit generally resulted in a market bounce, something that highlights the discrepancy between the terms ‘markets’ and ‘economies’ and how positive returns for the former does not necessarily indicate robustness in the latter. 

We believe in 2020 the US and global economies are likely to continue to boast the fortitude that saw them safely navigate the stormy waters of 2019, which we believe could set them up for another year on a steady upward trajectory. Despite cause for optimism it would be na?ve to believe that the problems that dogged us last year have simply faded away. Indeed, a matter of hours into 2020 we saw as much when a US drone killed Iranian General Qasem Soleimani (the Islamic Republic’s de facto number two), which prompted somewhat hysterical fears of an impending World War 3, not to mention the price of Brent Crude spiking above $70 a barrel. Some may argue the virtues of pursuing a particular foreign policy agenda, but one thing is clear: markets dread the instability and chaos caused by even the suggestion of war. While tensions have apparently deescalated, and the price of oil has returned to a more reasonable price, a US-Iran conflict could flair up at any moment, which would knock the wind of out of the current optimism for the new year. To make matters even more precarious, though the US and China are inching towards a détente, it is pretty much a given that this trade war will plague markets in 2020 just as it did in 2019. While markets can take comfort in the knowledge that the United Kingdom (UK) will Brexit in a smooth and orderly fashion on January 31, 2020, time is short to work out an actual trade deal with the EU, the deadline for which is the end of 2020, which puts the possibility of a  ‘No Deal’ Brexit back on the menu. Moreover, while Germany appears to be bouncing back, failure for the global manufacturing bellwether to recover and begin growing again will be an albatross for the EU and global economies. 

Investment Outlook

According to James O’Leary, CFA, Chief Investment Officer and Senior Portfolio Manager at Henry James International Management, ‘We are looking at stable global GDP growth above 3%, with 2% in the US and a modest 1% in the EU.’ He is anticipating a slight increase in growth in the UK through a so-called ‘Brexit Bump’ and the resulting economic stability markets have been craving. O’Leary also sees an increase in Japan’s growth with greater exports, but believes that we will see China’s growth drop below 6% for the first time in a long time. ‘We are anticipating a return to long-term market trend returns for developed markets and possibly above market trend returns for emerging market economies,’ says O’Leary.

In O’Leary’s view, the x-factor for the US economy in 2020 will be the forthcoming elections. ‘If the Democrats win the White House, take control of the Senate and maintain the keys to the House of Representatives, we would expect a raise in both corporate and personal income taxes.’ This, he believes, would result in a reduction in corporate earnings, which would negatively impact markets. However, if Trump is re-elected, says O’Leary, the US economy should be in an excellent position to thrive. In the build up to said election, however, O’Leary does not expect to see any large movements in US interest rates in 2020. ‘We expect the current 1.75% rate will remain steady with the possibility of a 25bps cut.  This is because if the Fed Funds rate were cut by too much it would look partisan during a Presidential election.’ Moreover, significant interest rate reductions would cut even closer to zero percent, which would leave the US and global economies with minimal defence in a recession scenario. 

O’Leary welcomes a thawing of the US-China trade war and believes this is a big step in the right direction; however, he does not believe that anything substantive is in the so-called Phase 1 of the deal. ‘It does not address intellectual property theft, corporate governance or a method for penalizing China for violations. Instead it appears to be a deal that freezes tariffs and compels China to buy a lot of US pork.’ The existing tariffs, says O’Leary, will continue as a ‘tax’ on US consumers that will hurt the lower end of the consuming public. It will also hurt China, he continued, and pull down its 2020 GDP to below 6% for the first time since 1990. Moreover, the trade war has inflicted serious damage on China’s economy and will continue to do so until it is fully resolved. But one country’s loss is a gain for others. ‘The trade war is moving US supply chains from China to other Asian countries and, notably, to Mexico, too,’ O’Leary said.

O’Leary is hopeful that Germany will begin to recover in 2020. ‘We are looking for Germany to stabilize and move to positive growth in its manufacturing sector, which on a relative basis is two times larger than that of the US and therefore really important for their economy.’ He continued: ‘With global growth intact Germany and the Eurozone should benefit; and with the exception of France, Italy and Spain, the Eurozone has a relatively low unemployment rate, increasing inflation of 1% to a more targeted rate and positive GDP growth. Moreover, with Brexit uncertainty as a thing of the past there are fewer unanswered questions and therefore more certainty, which should result in better markets.’ 

With Brexit virtually guaranteed to happen at the end of January, O’Leary is forecasting continued low UK unemployment, stable GDP growth (with an increase in 2021) and an easing in fiscal policy; he also expects PM Johnson to fulfil his planned stimulus promises. O’Leary said: ‘The great Brexit versus Remain battle is over as the UK will leave the EU. It is in both Europe’s and the UK’s best interest to make a bad situation work for both. If both parties act reasonably, Brexit should work for both and their respective economies should benefit as a result.’

O’Leary is delighted that the US and Iran have managed to deescalate tensions and though the price of oil skyrocketed it has come down again as fears over oil supply disruption have abated. The question remains, how sustainable is this relative calm and does Trump see conflict with Iran as something that will help or hurt his re-election campaign. O’Leary said, ‘If it hurts him, the episode will subside and if he thinks it will help, we may see renewed tension.’ O’Leary’s clear preference is peace and tranquillity so markets can continue to thrive.

While geopolitical risk and headwinds are ever-present for the year ahead, they are perhaps less threatening than they were in 2019. What is more, the US and global economies appear to be in a better place, too. This combines to create positive mood music for markets in 2020, and yet, much like how it was last year, the question will be the extent to which markets will be able to resume their resilience and trample over present and future threats desperate to derail them and diminish investor profits.

Disclosures

This material is prepared by Henry James International Management and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are obtained from proprietary and nonproprietary sources believed by Henry James International Management, to be reliable, are not necessarily comprehensive and are not guaranteed as to accuracy. No warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions is accepted by Henry James International Management, its officers, employees or agents. This material is based on information as of the specified date and may be stale thereafter. We have no obligation to tell you when information herein may change. Reliance upon information in this material is at the sole discretion of the reader. Certain information contained herein may constitute forward-looking statements. Estimates of future performance are based on assumptions that may not be realized. 

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Any indices chosen by Henry James International Management to measure performance are representative of broad asset classes. Henry James International Management retains the right to change representative indices at any time.

Henry James International Management and its representatives do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation.