MARKET COMMENTARY – DECEMBER 2018

Stock market volatility continued through November and the start of December. Whilst there was no single catalyst, higher US interest rates, trade policy issues and geo-political risk dominated market movements.  Economic fundamentals do however remain relatively supportive, with global unemployment falling and stable inflation being positives for consumers.  The third-quarter earnings season in the US has been reasonably positive, although given concerns that profits may have reached a high point, the market has been sensitive to changes in consensus over future earnings prospects as a result of the potential pressures upon profit margins associated with higher costs.

The S&P 500 (US) has been the strongest major developed market during 2018 and remains in modestly positive territory for sterling investors.  The US economy continues on a reasonably solid footing, inflation remaining broadly stable and the labour market healthy. In the mid-term elections the Democrats took control of the House of Representatives and the Republicans strengthened their position in the Senate. As a result it seems less likely that there will be any extension of fiscal stimulus by the Republicans in a bid for further support in the run up to the 2020 presidential elections. The Federal Reserve left interest rates unchanged following the November meeting and against this broadly supportive backdrop US equities continued to deliver comparatively attractive returns, particularly for sterling investors due to the strength of the US dollar.

UK equities meanwhile have continued to be impacted by uncertainty over ongoing Brexit negotiations and weakness from influential sectors including banks, tobacco and mining. A withdrawal agreement was reached between the UK and the EU however the crucial parliamentary vote has been postponed as the Prime Minster accepted her plans face defeat.  Mrs May is now attempting to negotiate concessions of the backstop which comes into force if there is no agreement on a trade deal by the end of the transition period in 2020.  A new vote is planned before 21 January but with the EU indicating that there will be no re-negotiation, the outcome remains highly unpredictable and this is likely to reflect in volatility in sterling and UK domestically focused stocks.

Emerging market equities have been weighed down by fears of a slowdown in the pace of Chinese economic and credit growth, the vulnerability of some economies to tighter US monetary policy and concerns about the potential impact of global trade tensions also impacted. Developing economies reliant on external funding are finding the tightening in US monetary policy challenging.  As the US Federal Reserve continues to raise rates and reverse the quantitative easing policies used to support the economy in the aftermath of the financial crisis, countries with higher levels of dollar-denominated debts and significant or widening current account or fiscal deficits will remain under pressure.  The tightening of interest rates that Turkey, Argentina and now Mexico have undertaken are examples of the steps needed to defend their currencies and control inflation in the scenario, which will prove a drag on growth.

Confidence remains disappointing in the eurozone, the composite Purchasing Manager’s Index (PMI) falling more than anticipated with both manufacturing and service confidence declining. Some of the weakness can be attributed to Germany where industrial production fell as companies are faced with new emissions standards. Italy also struggled to make headway, with third quarter

GDP down 0.10% from the previous quarter, the continuity of political uncertainty and tightening of financial conditions continues to weigh on corporate activity, where slowing production and corporate activity may contribute to the persistence of stubbornly low inflation. The European Central Bank (ECB) is still on course to finish its programme of quantitative easing by the end of 2019 although the market is placing a lower probability on the bank being able to lift rates in the second half of 2019.

The backdrop to the global economy has not changed significantly in terms of growth prospects, the US, where the economic cycle is the most advanced continues to provide comparatively attractive returns against a backdrop of weaker global markets.  Trade tensions and political risk continue to be concerns, the latter particularly in Europe with continued Brexit uncertainty and the conflict between Italy and the EU over the former’s budget. With geopolitical considerations unusually prominent, including the growing rivalry between the US and China and the ongoing Brexit uncertainties, heightened volatility may continue. Taking into account the late stage of the economic cycle, a diversified approach certainly remains appropriate for most investors.

Performance to 11 December 2018

* October 2018