Just what are the markets doing?

Current Market Summary

We are very aware that 2018 has been the worst year for markets since the financial crisis in 2008.

This market weakness has accelerated during the final quarter of 2018 as volatility has picked up significantly. We see this as being a symptom of a quarter in which monetary policy was not just tightened, but tightened at an accelerating pace. Investment market growth in recent years has been fuelled by Quantitative Easing (QE) that is now coming to an end. This took place simultaneously around the major economies of the world and has drawn liquidity away from global equity markets, causing stocks to fluctuate further from their fundamental valuations. We have seen a move from QE to Quantitative Tightening (QT).

With interest rates low and inflation at current levels, bond yields still represent poor compensation for risk relative to equities and as such we are mandated to manage investment portfolios in order to meet long term investor aims rather than short term trends. 

Recent falls in energy costs will act as a tax cut to consumers and businesses around the world, as it did during the last bout of volatility in 2016. As then, lower cost inflation should set the stage for a recovery in economic activity and further profit growth.

The growth environment moving into 2019 is mixed, with the US remaining strong but growth outside the US more problematic. Particularly weak are China and Europe, reflecting Europe’s increasing reliance on external demand. In the UK and Japan, conditions are stable if uninspiring and Brexit obviously poses uncertainty to UK growth.

Tightening monetary policy can make other asset classes look more attractive if, say, bonds offer more attractive returns for lower risk than equities. That is not the case now though as recent declines in bond yields mean that they still fail to compensate investors for inflation in any major economy outside the United States. With interest rates and bond yields so low they still make equities look attractive by comparison, however the flood of bonds in the market does draw liquidity away from the equity market which means prices can fluctuate further around the true valuations of shares. That is why we have seen short term monetary policy changes, causing bouts of investment market volatility.

On the fiscal side we are now seeing more expansionary budgets from the UK, Italy and France. There are hopes that the US may provide a further boost to its economy through investment in the currently ailing infrastructure. The former Republican Congress would only approve tax cuts, rather than new spending. President Trump is happy to countenance both.

The most significant boosts have come from the decline in energy prices, caused by a combination of more supply (through the easing of sanctions on Iran and greater US shale production) and some concern over demand/s for the forthcoming year/s. Higher energy prices mean a transfer of income from the world at large to a small handful of producers, largely concentrated in the Middle East, Russia and the US. The prices of stocks have fallen quite sharply against relatively modest downgrades to economic activity.

Another positive outcome for the global economy would be a sustainable long-term trade agreement between the US and China. Recent discussions on this would appear to be more positive than at any time during 2018.

BREXIT, what happens next?

We feel there is now a lower chance of no deal. The Prime Minister surviving the no confidence vote makes it impossible that she might be replaced by a more aggressive Conservative with a greater desire to push for no deal. In addition, the European Court of Justice have also ruled that the UK can unilaterally withdraw Article 50 and therefore continue its membership of the EU. The ruling gives the government far more flexibility and therefore greatly reduces the risk of “no deal” on the UK’s withdrawal.

The flipside of this is that the confidence vote win for May now slightly reduces the chance of a meaningful renegotiation. As the EU will recognise, they do not need to make concessions to appease the Eurosceptic wing of the Conservative Party in order to avoid facing a more Eurosceptic Prime Minister in the future. For similar reasons a Canada-style arrangement now also has less impetus. Therefore, we see no real change to the chances of passing the deal that she has already negotiated – these still look low. The remaining options would include a Norway-for-now option, which can be made to appeal to both Brexiteers and Remainers alike, on the grounds that it is either start of the journey of leaving the EU or the softest way of abiding by the referendum result.

But one curious and very important action was taken by the EU; in December when the UK Government started seriously talking about a no-deal, the EU immediately offered free movement of lorries movement in and out.

The economy outlook over Europe is not positive, is slowing down quickly, and this could be a significant catalyst as to why the EU needs to come to a deal with the UK. France has proposed a budget which breaches EU debt requirements – Italy, given the way they were dealt with, will be looking closely as to how our Gallic friends are dealt with.

As a result of the recent vote, the options in front of May are now crystallising in the way that we expected. What is in front of us is quite market friendly in the medium term – i.e. bullish GBP, bearish gilts, better for domestic companies, worse for multinationals. While the field of possible options is narrowing, however, the period of uncertainty has lengthened and that continues to weigh on the pound.

What will this mean for me?

The decision to quit the EU has caused international investors to avoid UK assets, amidst concerns that a ‘hard Brexit’ will damage the economy’s health. Recently seen new economic assessments of Brexit, including those from the government and the Bank of England, looked at a range of scenarios and in every case the UK economy is expected to fare worse under Brexit than had Britain voted to stay in the EU. UK equities have been the least-favoured equity asset class in the world this year. But because of the fall in Sterling, equity income stocks in the UK markets have provided a good dividend yield. For none income seekers the compounding of dividends over the long term does have a positive impact on performance.

Despite the uncertainty, we firmly believe it is important to stay invested. Some of the biggest one-day upswings in the market occur during these volatile periods and indeed we saw the US Dow Jones Index recover by 5% on the 27th December following a 2.9% fall the previous session.

Research also shows that long term investor returns are substantially reduced when even the 10 best market days are missed:

Crucially, although Brexit has caused international investors to avoid UK assets, the reality remains that the UK stock market at large does not reflect the UK economy. Short-term investors at hedge funds and investment banks like to try and make money by trading the potential outcomes of these kind of events. Long-term, active, investors should simply look for what opportunities arise from any pick up in volatility. The gloomiest current economic forecasts are based on what we know now, but a lot could happen in the next few months that could alter them significantly.

Even if the economy does fare worse under Brexit, that doesn’t mean that there won’t be plenty of attractive investment opportunities for our investment partners to exploit. The better approach is to be ready to react and make the most of the turbulence the ongoing process will undoubtedly create. Being brave and buying at the bottom is a tactic that has worked time and time again during stock market history.

Remaining invested and having investment partners who are alert to new opportunities, remains the best way to proceed and deliver on the portfolio’s long term aims.

As always, if you are feeling uncomfortable with what is going, on please call Suzanne, myself or a member of the Team. We are here to support and work with you! You can contact us on 01246  435 996. 

A shorter version of this article first appeared in the Yorkshire Post.