Market Commentary 4th July 2018
Happy 4th July to all our American brethren, you are still so important to us….
How different my scenes are since last year? I was diving with Turtles, Sting Rays, and funny looking fish this time last year in St Lucia at the Pitons and was watching our American friends drinking gallons of beer and continuously singing star-spangled banner with an arm across their chest. Today I am sat in my office looking at the calm world and thinking of England Winning the world cup, with scorched grass wondering where reality lies, between the two reflections! (fingers crossed on the football)
My days are though being focused on looking at the global economic data and deciding whether we should stay invested and ride the volatility or get out and go for safety. That decision today is stay invested but with caution and balance on both sides, because although data is good we are seeing it slowing and if it slows as anticipated and the rate hikes come through as anticipated then this would then indicate a global slowdown. BY focussing on trying to spot this we are trying to get ahead of the curve with regards to investment positioning. Economists still expect the US to continue up the trajectory of growth. The US economy is in great shape which is leading global growth and there is a lot to like about low unemployment, except inflation. The economy appears to be firing on all cylinders in the second quarter with GDP growth likely to approach 4.5% annualised, and the unemployment rate near twenty-year lows at 3.8%. that said, it is apparent that we can see initial signs of growth fatigue.
In this year, the US economy may well record its strongest performance in thirteen years, breaching 3% annual average growth for the first time since 2005. As much as Trump likes to show off that this is his attribute, it is the optimism in the markets that has driven markets to where they currently are, backed up by strong economic data. Key drivers also attributed to this growth story are the strong labour market fundamentals, elevated confidence, and reduced tax burdens in an environment of still-low interest rates and moderate inflation. The economy has benefitted from an acceleration in export growth, although it is anticipated by economists that this couldn’t last very long if Trump spoils the relations with the rest of the world. The acceleration reflected in the Dollar’s decline and synchronised strength in global demand now seems to be fading away. The growth in the US is ‘roaring away’ and the factor currently contributing to this is the current fiscal stimulus. Although interest rates are still relatively low in terms of their absolute levels, the next two rate hikes we are expecting this year could come to reflect the robust growth in the markets. The strong economic growth and rising core inflation should prompt this move by the Federal Reserve and it is expected that they may hike rates four times over the next 12 months if the core fundamentals remain unchanged. It is then, we should start to worry about a slowdown.
What are the key risks in the US, and therefore in the rest of the world?
When we talk about the markets to economists, the simple format of the current juncture of the cycle is that if they aren’t any political risks, the global economy would be shooting away. Despite the ‘roaring growth’ in the US, there are still a couple of key risks that shouldn’t be overlooked.
- Rising trade tensions which are an immediate concern for the global economy, especially in the context of a softening global backdrop;
- Consumers have been dipping into their savings to finance outlays over the last two years. This is particularly troubling for low/middle income families who are increasingly exposed to confidence and energy price shocks
- A more hawkish Federal Reserve will put upward pressure on borrowing cost and lead to tighter financial conditions.
- To use a rather timely World Cup analogy: we are conscious that the economy could start cramping up in extra time as inflation firms and monetary & fiscal policy tighten.
So, what is currently driving the growth? the simple answer is a combination of strong labour market fundamentals, elevated confidence, and reduced tax burdens amongst an environment of still-low interest rates and moderate inflation. There would clearly be a significant risk of a recession occurring in 2020, particularly if current trade tensions spiral out of control. The protectionist measures put in place so far will not have a significant impact on either GDP growth or domestic US inflation. Tariffs on all US-China trade, the departure of NAFTA and/or the imposition of motor vehicle tariffs would all have a more marked impact. It is anticipated that in 2019, the boost from tax cuts and higher spending will fade, just as the cumulative tightening in monetary conditions begins to weigh more heavily on rate-sensitive spending. Yes, prior to Trump’s midterm elections, the tax cuts are anticipated to provide a boost to post-tax incomes and profits of up to 0.8% of GDP this year. However, while the US economy is currently very strong, some cracks are appearing in the pillars of growth, and some are starting to question the economy’s resilience. From a political phase, Trump’s mid-term elections
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track continue to be volatile. We have seen sharp gains, followed by sharp declines and then sharp rises again, which is very typical for this late cycle stage in the global economic cycle. The markets have on average remained flat with some up slightly and some down slightly even though the data has been strong, all due to the political risks. The model portfolios therefore have a fine balance between equity and non-equity assets, which enables the portfolios to be well diversified during this high-risk environment as we can capture the upside of the equity markets and hedge the portfolios with the non-equity assets.
Whilst we have been updating the model portfolio factsheet for the new month, once thing has become apparent that the multi asset funds that we hold in the portfolios are skewing more of their investments into the UK to take out some of the currency risk. This has been brought by from very positive manufacturing, construction and services data and could further add to our conviction that the UK economy is very resilient, despite the Brexit pressures. We will continue to watch the assets the fund managers bring into the portfolios and will adjust based on the macro.
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
I think its only correct to highlight the US Independence Day for this day in history because its only by chance we write the commentary on a Wednesday and the US Independence Day falls on a Wednesday. So, having said that, on this day on 1776, the 13 American colonies throw off British rule as Philadelphia’s Continental Congress announces a new nation made up of United States. The anniversary of this Declaration of Independence, ratified one year into the Revolutionary War, will continue to be celebrated in the US as Independence Day.
As always have a wonderful week and stay safe.