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28th October 2019
Market Commentary October 2019

Newsletter Oct 2019 MKG Comms

Financial commentators can usually find interesting topics to write about, but we really are spoilt for choice at the moment. Reams of paper could be devoted to the ongoing Sino-American trade war, the efficacy of global monetary policy or the slowing of the global economy. However, I’ll try and distil these complex issues into the salient points and focus on what this has meant and what this might mean for investments.

The trade war between China and America has been rumbling on for nearly two years now, with no prospect of a resolution in sight. What started out as minor tariffs on solar panels and washing machines has evolved to encompass thousands of products affecting nearly $750bn worth of trade between the two countries. Neither country seems willing to de-escalate the situation and the tariffs, which average over 20%, are starting to negatively impact consumers and companies. Whilst exporters do feel some pain from tariffs, it’s important to remember that it is importers that pay the tariffs, and these are often passed on to consumers in the form of higher prices. Whilst the stock market has tended to overreact in the short-term to the escalation of tariffs, the American economy has been more resilient. However, with global growth starting to slow, the tariffs are exerting extra pressure on the already beleaguered economy. In the absence of any reversal of the tariffs, we would expect US stocks to remain volatile due to deteriorating economic fundamentals. This has already led to interest rate cuts by the Federal Reserve, but we would anticipate that interest rates will keep falling to try and stave off an economic downturn. Whether lowering rates will be enough is the trillion-dollar question.

Questions over the efficacy of monetary policy in the future have been asked by many in the market for some time; and in essence the conundrum is, ‘How can central banks fight recessions if interest rates can’t move much/any lower?’ It’s a very valid question. In prior economic downturns, central banks would lower interest rates in an effort to ease financial conditions and kick-start the economy. If rates are -0.1% in Japan or -0.5% in the Eurozone, then the scope to reduce interest rates is very limited. Quantitative Easing could be utilised to a greater extent but there is little evidence that this actually stimulates growth in the underlying economy, but instead just props up asset prices. The only other available tool is the more aggressive utilisation of looser fiscal policy. However, governments are already heavily indebted and the scope for lower taxes and higher public spending seems restricted.

Whilst we’re not at the point where monetary and fiscal policy tools have been exhausted, it would not surprise us if we get to that point over the next few years. Central banks and governments will have to be imaginative as to how they can combat the next recession, as the future efficacy of conventional monetary policy is limited. Whilst interest rates remain low, or move lower, it is easy to see a relative valuation argument for equities over bonds; but it does depend on the stability of the economic outlook.

The global economic outlook has certainly deteriorated over the past year with many metrics such as industrial production, gross domestic product or business confidence sharply declining across many economies. The deterioration of economic fundamentals in the past has been greeted by rising stock markets since lower interest rates increase the valuations placed on companies and improve corporate profitability. However, the market has taken little solace from the recent pieces of poor data, as they have been far worse than in previous years. The market is also starting to question how much further interest rates can fall from the current level and how effective these future rate cuts may be. In light of these factors, we would expect companies with earnings that are less exposed to the economic cycle to perform better than companies that are more cyclical in nature.

Whilst the outlook may appear gloomier than it has done in the recent past, it is important to remember that there have been many times over the last ten years where uncertainty has been high: the Eurozone debt crisis (chapters one, two and three), the ‘Taper Tantrum’ of 2013, the vote on Scottish independence, US debt ceiling negotiations, the collapse in commodity prices of 2016, the aftermath of the Brexit referendum and the election of Donald Trump, to name but a few. Uncertainty is always prevalent, and it is likely that we are in for a period of heightened volatility. However, it is important to take a long-term view on investments and take advantage of market volatility as and when it arises.