Market review for fourth quarter 2019 and the outlook
Posted by Liz Rees in Market commentaries category on 24 Jan 20
Europe ex UK
|4th Quarter 2019
|Full year 2019
Source: FE Analytics, performance on a total return basis in local currency, 31/12/2019
Quarter 4 performance: optimism returns
Markets began the quarter on the front foot as the US and China called a temporary truce to their trade wars. Donald Trump declared that it would produce a much-needed lift to the flagging world economy, investor sentiment warmed and stock markets across the globe rose, rounding off a year of impressive gains.
Over the quarter, China was the best performing major market. Investors were encouraged by action from its Central Bank to stimulate economic growth whilst the inclusion of more Chinese mainland shares in leading stock market indices has generated increased interest from overseas investors.
Meanwhile, trade disruption held back other parts of Asia. Civil protests in Hong Kong led to it registering the lowest returns among developed markets in spite of a successful listing of Alibaba shares.
UK shares enjoyed a late rally following a significant Conservative majority in the General Election that raised expectations of more business friendly policies and progress on Brexit.
Over the year, the US once again took the top slot. Healthy consumer spending led to company earnings growth that just about justified the premium ratings in popular high growth sectors. Interest rate cuts have underpinned confidence in the corporate outlook.
Key events of the quarter
In mid-October the US announced it would postpone $250bn of tariffs due to take effect, in return for the Chinese agreeing to buy US agricultural goods. China also agreed to concessions on intellectual property and financial services but did not give ground on industrial subsidies.
By December the two nations concluded a Phase One trade deal. There will be no new tariffs on Chinese goods and some previous ones will be reduced. The US will halve existing tariffs on $110bn of goods but will retain them on $250bn of goods for the time being.
China will buy significant quotas of American energy and agricultural products along with some other manufactured goods. However, if this does not materialise, the US reserves the right to reinstate its tariffs.
The agreement was well received, particularly by other export dependent countries, such as Japan which had been caught up in the fall-out, prompting upgrades to the outlook for global trade and business investment.
Boris Johnson didn’t manage to get Brexit done by 31st October, despite presenting a revised deal to address the Irish border issue, because the Democratic Unionist Party refused to support his proposals.
Consequently, Britain headed to the polls on December 12th and the Conservative Party secured a landslide victory, securing 359 seats including many long-held Labour seats in the Midlands and the North. The pound strengthened and the UK stock market saw investors return from the side-lines. Soon after, MPs voted by 358 to 234 to leave the EU on 31 January.
Elsewhere in Europe, the Spanish elections produced no clear majority. The governing socialist party of Pedro Sanchez remained the largest party but with fewer seats forcing it to enter a coalition with the far-left, anti-austerity Unidas Podemos alliance.
Donald Trump become the 3rd
US president to be impeached, charged with using his office for personal gain. The trial will be in the Senate in January but Republican control of the house means he is unlikely to be removed from office.
The oil price weakened over the quarter despite OPEC* agreeing further small supply reductions. However, a renewed outbreak of conflict in the Middle East at the start of the New Year caused a sharp, albeit short-lived, spike in the oil price.
Economic trends and outlook around the globe
In its latest World Economic Outlook, published on January 20, the International Monetary Fund (IMF) expects global GDP 2
growth of 2.9% for 2019, 3.3% in 2020 and 3.4% in 2021. This represents a minor downgrade to its October forecasts, reflecting negative adjustments to economic activity in a few emerging market economies.
On the positive side, sentiment has been boosted by tentative signs that manufacturing activity and global trade have reached a floor, as well as accommodative monetary policy and favourable news on US-China trade negotiations.
Overall, risks to global activity are now less tilted to the downside although geopolitical tensions, notably between the United States and Iran, persist.
UK growth is expected to stabilize at 1.4% in 2020 and edge up to 1.5% in 2021, which is unchanged from the October outlook. The forecast assumes an orderly exit from the European Union at the end of January followed by a gradual transition to new economic relationships.
Economic growth slowed to an annualised rate of 1.1% in the third quarter. This was the lowest growth for a decade and a contraction of 0.3% in November indicates minimal growth in the final quarter.
The economy was more or less flat in the 3 months to November; manufacturing and services expanded modestly but construction saw a big decline. Activity slowed sharply ahead of the General Election as businesses weighed up the prospect of a radical Labour government.
November surveys of manufacturing and services fell to 3 year lows as uncertainty affected confidence, hurting both domestic demand and exports. The flash IHS Markit manufacturing PMI*, fell to 48.3 from 49.7 in October. The PMI* for services, which represent 80% of the economy, slipped into contraction territory at 48.6 versus 50 in October.
UK retail sales, which have supported economic growth for some time, rose 0.6% year on year in October, but stalled in November with volumes down by 0.6% according to the Office for National Statistics (ONS), well short of expectations. Early discounts ahead of Christmas failed to attract shoppers, leaving sales for the year down 0.6% versus consensus estimates of 0.5% growth.
On a positive note, a survey from Barclaycard found that while consumers were pessimistic on the economy they remained confident about the outlook for their personal finances due to the strong labour market.
Record employment levels and strong real earnings growth, along with the promise of a rise in the national insurance threshold, should be supportive going forward. The ONS reported that average earnings rose 3.2% in the 3 months to October. Moreover, UK unemployment fell to 3.8%, the lowest since 1975.
The UK Consumer Prices Index (CPI) fell to 1.3% in December after energy regulator OFGEN lowered price caps on utility services. It remains well below the official target of 2%, making it easier for the Bank of England to reduce interest rates.
Chancellor of the Exchequer, Sajid Javid, will deliver his first Budget in March which should reveal more detail on the government’s spending plans. UK productivity growth of 0.2% in the last decade has been well below the long-term average.
The United States
The IMF expects growth of 2.0% in 2020, declining to 1.7% in 2020. The moderation reflects a return to a neutral fiscal stance and anticipated diminishing support from further loosening of financial conditions.
Economic growth slowed in third quarter to 1.9% annualised as business investment stalled. Unsurprisingly, the Federal Reserve cut interest rates for the third time in October, giving a target range for the Fed funds rate of 1.2-1.75%.
The current expansion is the longest in history thanks to supportive monetary policy. However, further easing would require a material reassessment of the economic outlook and in December the policy rate was left unchanged. Meanwhile, the Fed’s reduced its estimate of long-term unemployment.
US manufacturing contracted marginally faster in November despite expectations of a strong rebound. The ISM manufacturing index was 48.1 versus 48.3 in October. However, industrial production did recover, rising a higher than forecast 1.1% month on month, helped by the return of automotive workers following a strike.
Personal consumer expenditure increased by 2.9% in the third quarter versus 4.6% in the second quarter. More recently, MasterCard reported healthy retail sales over the Christmas period, tempered by surveys that show customers feel less positive about the outlook than a year ago, in spite of low unemployment and rising wages.
In October the important non-farm payrolls figures showed job creations increased by 128,000. A further 266,000 jobs were added in November, well ahead of analysts’ estimates, although in December the 145,000 jobs created was short of forecasts. Nevertheless, unemployment held steady at 3.5%.
Company profits have held up relatively well although has been some weakness in certain sectors including energy, materials and technology. Consumer spending continued to support the discretionary, staples and services sectors.
The IMF forecasts growth in the euro area to pick up from 1.2% in 2019 to 1.3% in 2020 and 1.4% in 2021. Projected improvements in external demand support the anticipated firming of growth. Projections for France and Italy remain unchanged but have been reduced for 2020 in Germany, where manufacturing activity remained weak in late 2019, and for Spain due to deceleration in domestic demand and exports.
The Eurozone has felt the effects of trade wars, Brexit and a sharp decline in auto industry output. Nevertheless, the region recorded a modest 0.2% rate of growth in the third quarter, in line with the previous quarter. Whilst Germany managed just 0.1%, Spain and France were the strongest contributors to growth.
Germany’s important manufacturing sector has been shrinking for some time. Industrial output was down steeply in October. However, a pick-up in exports has reduced the risk of full-blown recession and November industrial production actually rose 1.1% versus October.
The partial trade deal between the US and China is good news for the export-driven economies of the Eurozone. With many countries experiencing favourable domestic conditions, a rebound in trade could lead to a more positive outcome for the region in 2020.
The new European Central Bank (ECB) President, Christine Lagarde, appears likely to continue the policies of her predecessor, Mario Draghi. Although Eurozone inflation edged up to 1.3% in December, it is not a concern and leaves scope for another interest rate cut. Lagarde has also hinted at “fiscal stimulus”, including tax cuts and infrastructure spending, to boost growth.
The IMF raised its GDP estimates for Japan although still expects growth to slow from 1% in 2019 to 0.7% in 2020 and 0.5% in 2021. A stronger than expected 2019 reflects robust consumption and capital expenditure. An uplift to the 2020 projection reflects an anticipated boost from late 2019 stimulus measures. Growth is expected to soften to 0.5% in 2021, as the impact of fiscal stimulus fades.
GDP** expanded at an annualized pace of 1.8% in the third quarter. This was revised upwards due to stronger capital investment, which rose 7.3%, and robust domestic demand ahead of the 1st
Oct consumption tax increase (from 8 to 10%).
Manufacturing activity subsequently fell to a 3-year low in October, with the HIS (Jibun Bank) PMI standing at 48.4, following the tax rise and a typhoon. Industrial output fell by 0.9% in November due to softer global exports. A new US-Japan trade deal, limiting US tariffs on Japanese cars, should be helpful.
The Tankan index, which measures confidence among large manufacturers, has been weak, reflecting pressure on exports. On the positive side, workers have become more productive. An ageing population has encouraged investment in innovation, leading to greater efficiency.
Activity in the services sector declined for the first time in 3 years in October with the Jibun PMI for services standing at 49.7. However, it swiftly recovered to 50.3 in November and the service sector confidence indicator improved to +20 suggesting domestic demand remains robust.
As expected, consumer spending weakened after the tax hike. Nonetheless, retail sales held up relatively well compared to previous tax hikes, falling by only 2.1% in November after a 7% decline year on year in October. Seasonally adjusted unemployment of just 2.2% in November was supportive.
November’s core inflation figure was in line with expectations, at just 0.5%, suggesting aggressive monetary policy is likely to persist to prevent deflation. Furthermore, the government has approved a record budget to stimulate growth.
Ongoing concerns of the trade war impact, and a possible slowdown after the Olympics, led to Prime Minister Abe announcing a $121bn fiscal stimulus to keep the economy on course. Although there is a possibility of negative GDP in the fourth quarter, a rebound is expected in the first quarter of next year.
The IMF expects growth in the emerging market and developing economies group to increase to 4.4% in 2020 and 4.6% in 2021 (0.2% lower for both years than in the October outlook) from an estimated 3.7% in 2019. The projection reflects a combination of recovery from downturns for underperforming economies and an ongoing structural slowdown in China.
China is expected to expand by 6.0% in 2020 and 5.8% in 2021 and India by 5.8% and 6.5% respectively. India is expected to have slowed to 4.8% in 2019 due to problems in the non-bank financial sector. In Latin America growth was revised down to 1.6% in 2020 and 2.3% in 2021, due to weak prospects for Mexico and Chile, only partially offset by an upgrade for Brazil.
China’s GDP** growth slowed to 6% in the third quarter as manufacturing and investment sentiment deteriorated. Exports suffered as trade wars intensified and the Central Bank warned of a build-up in household debt to unsustainable levels.
Nevertheless, there are signs the worst may be over. Data for November showed retail sales up 8% year on year, industrial production up 6.2% and fixed asset investment +5.2%. The improvement continued in December with industrial production up 6.9%.
The Caixin China General Manufacturing PMI* was 51.8 in November versus 51.7in October. New orders increased, helped by the US exempting 400 products from tariffs. However, business confidence remains weak and factories are still cutting jobs.
In 2010, the government pledged to double the size of the economy by 2020. To meet this target the authorities will need to ensure growth stays close to the 6% level. Further policy easing is possible but may be limited by above target inflation due to higher pork prices pushing up the cost of food.
India also faces challenges, particularly within its banking sector. However, improvement is underway as a result of government action. Russia’s leaders remain focused on economic stability and steady, but low growth.
The largest economies in Latin America, Brazil and Mexico, are making progress. Sentiment towards Brazil has been helped by Congress finally approving the government’s pension reform plans which should boost economic activity.
Mexico’s new leader, Andrés Manuel López Obrador (AMLO), has acknowledged that it is conducive for the government to work with the private sector. Meanwhile, Argentina’s President Macri conceded defeat to the Peronist candidate Alberto Fernandez, though by a smaller margin than expected.
Prospects for investors
Renewed conflict between the US and Iran at the start of the New Year served as a reminder of how geopolitical factors can affect sentiment. Nevertheless, for long-term investors, such events can often present an opportunity to buy on the dips.
Economists have cut the odds of a global recession in 2020, with many considering it a mid-cycle pullback instead. It is hoped that ongoing stimulus from Central Banks will revive the global economy. Obviously, with interest rates so low there has to be a limit to their firepower yet, with below-target inflation in many countries, there is little pressure to raise rates either.
Fiscal spending programmes are gaining traction and should boost consumer confidence, as well as corporate earnings, thus sustaining growth. Capital spending may eventually lead to higher inflation which, in moderation, can benefit banks and utilities.
Japan was the first nation to announce fiscal measures and Britain is set to reveal its plans in the March budget. A significant share of the £100bn UK Infrastructure Fund is expected to be allocated to the Midlands and the North. China has turned to a lending support programme whilst the rest of Asia has the capacity to use both monetary and fiscal easing to overcome short-term setbacks.
There are conflicting signals as to where we stand in the economic cycle. Unemployment rates, often a good guide, are close to record lows in most of the developed world, which suggests the economy is very late cycle.
However, there are few other indications of overheating. Consumer spending does not look over-extended- in fact the opposite may be true. It is impossible to predict the next economic downturn but currently the outlook seems to be for slower growth rather than recession.
The US market remains the home of technological innovation and this is reflected in high valuations. The U.K. and Japan may currently present a more compelling opportunity on value grounds, particularly if there is any pick-up in growth. If the autos and industrials led-slowdown in Europe proves to have bottomed out, rising employment and household income could support recovery here.
Elevated Mergers & Acquisitions (M&A) activity amongst UK-listed companies has highlighted latent value, particularly for overseas buyers. Further strengthening of sterling could see earnings momentum switch from international earners to domestically focused businesses. UK smaller companies may be of interest to investors prepared to accept their higher volatility and lower liquidity.
Emerging markets account for a significant proportion of global growth with several countries forecast to grow in excess of 5% this year. The trade settlement will assist China, India, Brazil and Russia. Expanding middle classes in Asia, along with urbanisation, are significant themes driving domestic growth in this region.
Other enduring themes include technology and environmental issues, in particular climate change. Companies which fail to adapt to change might be at risk of losing out to new entrants. We expect the focus on sustainability to continue to grow, with regulation and policy responses having wide-ranging investment implications.
A repeat of 2019’s exceptional returns in bond and equity markets is unlikely but opportunities do exist. Companies in the UK, Europe and Asia offer attractive yields, often superior to bonds, and dividends can be an important component of total return.
Government bonds retain their diversification role, as do alternatives including infrastructure, property and gold. Bonds do, of course, offer fixed rates of interest which although lower than shares may help to preserve capital if held to maturity.
In summary, time in the market is what matters the most so your returns can compound over time. The key is to ensure you have a well-diversified portfolio by asset class, country, style and size.
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Gross Domestic Product 3
Purchasing Managers Index
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