Markets rebound yet global growth slows

Andrew Milligan

Politics and economics are important for financial markets. With Brexit negotiations making limited progress, a shutdown in parts of the US government, Germany only narrowly avoiding recession last year, and the International Monetary Fund (IMF) downgrading its views on the global economy, there has been a stream of bad news. However, Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, explains how financial markets are forward looking – a positive policy response and upbeat corporate earnings reports have encouraged a sharp snap back in investor sentiment in January from December’s woes.


Brexit means…

Starting with Brexit, the possibility of a disorderly exit continues to concern investors who understandably ask such questions as ‘what’s the likelihood of a ‘no deal’ Brexit, and what could it mean for the UK economy, currency and stock market’.

With so much political uncertainty, a simple but useful way of assessing the market’s views about Brexit is to look at sterling versus the US Dollar or the Euro. When the pound was approaching 1.25 against the dollar in December, it was clear that global investors were worrying about buying UK assets. However, in recent weeks, sterling has risen to 1.30 – 1.31 against the dollar as the series of debates and votes in Westminster suggest a disorderly exit in March is less likely.

If the likelihood of a ‘no deal’ does increase due to policy errors in Westminster and Brussels, then, at Aberdeen Standard Investments, we’d expect the pound to fall rapidly towards 1.20 against the dollar. Similarly, we’d expect the Euro to sell-off versus other major currencies, due to uncertainty about the impact of such an adverse outcome on already weak European economies.
For the time being, a ‘no deal’ Brexit is seen as unlikely but clearly not impossible as negotiations enter an even more complicated phase.

The US government shut down

Another source of worry was the lengthy shutdown of the US government, at 35 days the longest on record. However, it should be remembered that this only affected a small part of the government’s operations. All federal employees will eventually be paid now that President Trump has climbed down and agreed to funding – for three weeks at least.
There’s an impact on the US economy, of course, particularly for many companies which normally supply goods and services to the various government departments.

Further ahead, the dispute casts a dim light on the ability of the President and the new Congress to work together over coming months on bi-partisan legislation. The question investors will be asking is – does this mean the President will focus more on foreign and trade policy in coming months? Recent signs of trade talks between the US and China have been positive but we continue to warn about the strategic rivalry between these two giants of the world economy.

Germany avoids recession

News that German industrial production and retail sales slumped into year end, with the country just avoiding a technical recession, has raised concerns about Europe’s largest economy. Manufacturing was hurt by rising barriers to global trade, the slowdown in China and in particular weakness in global car sales. But it’s important to note that consumer demand in Germany has actually held up quite well. Unemployment is low in Germany and we’re starting to see wages growth.

As we move into the spring, we expect to see modestly positive growth especially if the car sector starts to splutter back to life. However, the European Central Bank (ECB) seems unwilling or unable to do much about the economic slowdown across Europe.

For now, we await overseas developments, especially in China and the US, to trigger a renewed demand for European products. At Aberdeen Standard Investments, we hold a neutral position on European equities at present. Valuations may be attractive but profits growth remains subdued and the political backdrop doesn’t look too helpful in the run up to the European parliamentary elections in May. However, we still like European real estate and high yield bonds even in this slow growth environment – for those investors who need income Europe has possibilities.

Global growth to slow in 2019

These downgrades were across the board – but remember that 3.5% economic growth for the world economy is perfectly decent.

Growth above 4% is seen when the world economy is synchronised, as happened in 2017, but monetary tightening has brought that to an end. On the other hand, global growth below 3% would be a worry as that would suggest more countries are entering some sort of recession.

Bond markets are supported by these sorts of forecasts as they suggest that inflation pressures should be contained and central banks don’t need to be aggressive. Equity investors have also been worried for six months about the downgrades to economic forecasts and profits expectations from a wide range of analysts, including our economists. So in many respects the IMF is only catching up with the consensus.

Looking forward, if global growth stabilises into the spring and then recovers into the second half of the year, as we expect based on a broad range of stimulus measures seen in China and Europe, then equities can make headway.

Market volatility retreats

December saw a large sell-off in many equity markets due to concerns about US monetary policy, the pace of economic growth in China, and worsening trade tensions between the US and China.

Conversely, in January investors have been reassured by increasingly dovish signals from the US central bank, more policy-easing in China and promising signals about trade negotiations. In fact, January 2019 has been one of the best Januarys for the S&P500 Index since 1989. Plus the recent gain of 7.2% for the FTSE® All World Index puts December’s 7.1% drop into perspective.

This view is strongly supported by the latest important announcement from the US central bank. It’s taking more account of weak activity and stressed financial conditions around the world, and pushing back any possible interest rate increases to later in 2019.

Emerging or developed?

There are strong links between developed and emerging markets through supply chains. So if growth slows in developed markets, we don’t expect 2019 to be a stellar year for business activity in many emerging economies.

However, there are still some attractive opportunities in emerging market bonds and equities which our fund managers can take advantage of. Different countries can perform in different ways; for example, although Chinese equities have fallen about 24% in the past 12 months, Brazilian equities are up about 20% over that period. Security selection can really matter in these markets!

Different levels of debt, different exposures to global trade, different sensitivity to the US dollar or oil prices can all make for a different combination of drivers.  On balance we think valuations are worth looking at as long as the US dollar is stable or even edges lower against emerging market currencies. This would provide a helpful backdrop for investor capital to flow from more expensive to cheaper assets, which have more exposure to a recovery in global activity.

Company profits matter

Now we’re in earnings season, our focus moves to company performance and investors want to know where they can find opportunities. This is difficult to answer at a sector level, with no clear leaders, so individual stock picking is still the order of the day. For example, stress tests of the banks in the US and UK suggest that most of them are relatively well protected. However the same cannot be said for some European and Japanese banks where profits growth is simply very low in a slow growing environment.

We’re already seeing very different reports coming from the fourth quarter US earnings season. Many technology companies have reported weak demand for data centres or mobile phones, but the share prices of Apple and Facebook rose sharply on their profits announcements. In general, US firms are beating analyst expectations by about 2%, providing a helpful backdrop and inviting global investors back into equity markets.

However, it’s clear that analysts have an eagle eye on forward looking statements and many stocks have been severely punished when they’ve disappointed. Our equity positions are currently overweight emerging markets and Japan, and neutral at present on the US and Europe.

More details can be found in the February edition of Global Outlook.


The information in this article should not be regarded as financial advice. Please remember that the value of your investment can go down as well as up and may be worth less than you paid in. Information is based on our understanding in February 2019.

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