3 Month Market Review – as at March 31, 2019

Q1 2019

Just when you think that the dance may be over, the band strikes up another refrain. Global markets remain in the tight embrace of the world’s major central banks. What started during the onset of the financial crisis in March 2009 continues to help nurture strength in equity market returns all these years later.

The S&P 500 Index surged 13 percent in the first three months of this year, with the Euro Stoxx 50 Index fast on its heels with a return of 12 percent. Signals sent by the respective central banks are extremely supportive in this regard, and have helped alleviate angst generated from turbulent geopolitical issues and economic downgrades.

Reversal at the Fed

US Federal Reserve (the Fed) Chairman Powell surprised markets by indicating a pause in their interest rate tightening cycle due to the deteriorating global economic outlook. This was well-received by folk in the markets and also no doubt by folk in the White House, who have recently attacked Fed policy as being overly hawkish. This stance has evolved into two presidential nominations to the board of the Fed which could do great harm to the perception of the central bank’s independence, since both Mr Moore and Mr Cain are regarded as partisan to the President.

The recent decision to announce that rates will be kept on hold seems to be genuinely in response to data, but clearly central bankers will not want to create any impression that they’re being steered by politicians. Comments from President Trump that make it harder for the Fed to do what he wants them to do has resulted in a kind of ironic chaos. It’s one thing to appoint yes-men to various regulatory boards, but quite another to risk violating the integrity of the central bank of the world’s reserve currency.

Stock markets have a keen interest in the Fed’s next decision; that is, having raised rates four times last year, should the next move be down rather than up?

Change Afoot at the ECB

In a similar reversal of tone, the European Central Bank (the ECB) announced new stimulus measures for European banks only three months after ending its quantitative easing program, and signalled that rates would stay at record lows for longer. This decision not to exit crisis-era policies was clearly in response to data, driven by a fall in German and Italian output; but also due to factors such as geopolitical conflicts over trade, and the uncertainties of Italian politics, all of which they see as weighing on business investment in the single market. The recent cheap loans granted by the ECB are aimed at easing funding pressure on Italian and Spanish banks, but this doesn’t address the real issue; namely, that Italian companies don’t want to borrow.

IMF Downgrades

Indeed, weak domestic demand and the high premium that the Italian government has to pay to borrow money were cited by the International Monetary Fund (the IMF) as reasons for downgrading growth data in Italy. The IMF cut its estimate for the wider euro area growth for this year by 0.3 percent, to 1.3 percent, feeling that recent widespread street protests in France will weigh on growth, and that the export-driven powerhouse of Germany is suffering from weak global demand and tougher car-emission standards.

The IMF forecast for US growth has been cut to 2.3 percent for this year, reflecting the impact of the partial government shutdown and lower-than-expected public spending. They expect the world economy to grow by 3.3 percent in 2019, down from an estimate of 3.5 percent in January; its third downgrade in six months. IMF Managing Director Lagarde warns that the global economy now faces “a delicate moment”, citing the dangers of policy missteps that could harm economic activity.

China Inflows

Trade talks between the US and China would certainly fit into the “delicate” category. Signs indicate a tentative thaw in the frosty relations between the two superpowers. Sentiment is certainly on the side of China at the moment however, with Chinese equities recording their best quarterly performance in more than four years, on the back of record inflows of foreign investment and buoyant sentiment from domestic retail investors. China’s CSI 300 Index topped the world rankings with a gain of 29 percent over the first three months of 2019.

Further Delicate Moments

Fraught negotiations between Westminster and Brussels will decide whether the UK exits the EU in a disorderly manner. This too certainly fits within any reasonable definition of the word “delicate”. Neither the UK nor the EU is prepared for the UK to exit the single market without striking a deal. The Financial Times recently cited fears highlighted, by experts in the supply of medical equipment, that critical supply shortages may occur in that sector. And it seems that both the UK and the EU rely on imported medical kit from each other.

Governor of the Bank of England (the BoE) Carney concurs that UK and EU ports, and customs operations, would have difficulty coping in the event of a no-deal scenario, and he assesses the chance of an unplanned exit as being “alarmingly high”. Currently, there is pressure on the BoE to raise interest rates, since UK data suggests that the economy is no longer able to grow as fast as it used to without generating inflation. The Office for National Statistics (the ONS) reported that wages grew faster than labor productivity last year, producing an increase in unit labor costs of 3.1 percent; the highest rate of annual growth seen since 2013. UK growth has been anaemic since the financial crisis in 2008, and during this time it has experienced its lowest labor productivity growth for a century. A remark from the most recent ONS report is telling: “It has taken the UK a decade to deliver 2 percent growth, which historically was achieved in a single year”. In this respect, policymakers have concern over both growth and inflation.

UK interest rates have been on hold since August of last year since the central bank is reluctant to alter policy until the Brexit uncertainty is resolved. This seems likely to hold for the duration of the Brexit extension (till the end of October).

Central Banks Still Dominant

So, for the moment at least, the BoE is on hold for very different reasons than both the ECB and the Fed. The ECB has both Brexit and sluggish growth data to contend with. And the Fed has to contend with President Trump and a slowdown in US growth. Indeed, the recent rally in 10-year Treasury bonds predicts a continuation of the slowdown. US economic data over the next 18 months will have major implications for President Trump’s prospects for re-election. If his two nominations to the Fed board were to succeed in a Senate vote then pressure would likely escalate to cut rates ahead of next year’s election. Though beneficial to stock markets over the short-term, there would likely be some longer-term reputational fallout. Interference from President Trump can only hinder. After all, central banks have demonstrated for the last eleven years that they are well-and-truly on the side of the markets. For the long-term investor, the music hasn’t stopped yet.