Over the week, markets struggled for direction as mixed headlines continued to exacerbate intra-day market movements. As we move further into Q1 and the economic data continues to worsen, when we look at the recent movements of global indices, it is clear that investor optimism has created a metaphorical house of cards, as we await a catalyst for the artificial rally to be brought back down to reality.
Why are markets rallying?
In recent weeks, in the absence of positive economic data, markets have rallied on the back of optimism and sentiment over unknown outcomes such as Brexit, US China trade wars, and changes in monetary policy stance as recently indicated by the Fed and the ECB.
European markets moved higher this week after the ECB’s chief economist Peter Praet indicated that the ECB could change the direction on interest rates given the current extent of the economic slowdown in the Eurozone. Praet also hinted that the ECB would be discussing new loans to European banks through a new round of TLTROs (Targeted longer-term refinancing operations), illustrating significant concerns within the central bank over the current weakness in the European economy. In reaction to the news, markets rallied on the back of renewed optimism for a looser monetary policy, however the policy shift highlights valid concerns over the stability of the European economy over the year. The Eurozone has struggled in recent months due to reduced global demand owing to weaker global growth, Brexit uncertainty and US China trade tensions. Despite markets moving higher on sentiment, the area remains a key concern as we move further into the year, with a number of economists now forecasting recession in the bloc.
The Fed minutes from the January meeting gave further insight into the Fed’s dovish capitulation last month, with the minutes showing uncertainty within the committee over whether another hike in 2019 would be necessary, and a preference to end the reduction of the balance sheet this year following the observation of considerable weakness in the US economy. US markets moved higher on the speculation of no further rate hikes over the course of 2019, however the committee did highlight that if inflation accelerates, a rate hike is still possible, with some members still supportive of a rate hike if the economy performs in line with expectations. Overall, the minutes confirmed our view that downside risks now outnumber the upside risks in the US economy.
In the UK, Brexit uncertainty continues to weigh on markets, with markets rallying earlier this week due to weaker sterling following the news that 11 MP’s have now defected from their respective parties in favour of an independent seat. Conversely, today markets are lower on the back of stronger sterling resulting from news that Theresa May is having ‘constructive talks’ with EC President Juncker in her bid to achieve legally binding changes to the withdrawal agreement. Over the week, the FTSE 100 gained ground, however uncertainty continues to feed through into the economic data, with key economists reducing 2019 UK growth expectations.
As US-China trade talks continue, with the 90-day trade truce coming to an end on 1st March, the two parties remain far apart on key issues, and an extension of the truce is now expected. Although markets have rallied in recent weeks on the back of optimism over an agreement, reports that the US wants China’s negotiators to promise to keep the yuan stable as part of any agreement could derail progress. In addition, a new spat between Australia and China could dent sentiment in global markets while progress on a US-China trade deal is yet to be seen.
Market movements are being exaggerated
As highlighted by Dave Haviland of Beaumont Capital Management in a recent interview with Bloomberg, the current rally appears to have been exaggerated by an element of FOMO (fear of missing out), therefore on the surface, markets are doing great, however upon closer inspection of the economic fundamentals, we realise the significant weakness in the global economy.
Currently, the S&P 500 index stands at 2,784, just below its higher resistance level of 2,800, however volumes remain low, indicating a lack of conviction in global markets. Further trade optimism could cause markets to breach this level, however it is key to highlight that given the weakness in the US economy, this is an artificially inflated market, reflected by the dovish Fed movements, therefore although we continue to monitor market movements, we remain confident in our positioning.
The wind is picking up
A potential catalyst for the pull back in markets could be the central bank meetings in March, which will highlight the risks facing the US and EU economies based on new economic forecasts, and set the scene for monetary policy over 2019. The ECB is expected to announce significantly weaker forecasts and more information about the possibility of more TLTRO’s.
The Fed’s meeting in March is expected to give greater clarity on whether rates will be hiked again this year, and the potential ending of the balance sheet run off this year. Considering the strong labour market data and upward pressures on inflation given a potential recovery in oil prices, all eyes will be on the March meeting. The rally from the December lows has been built mostly upon the dovish Fed approach. If some of the members of the FOMC remain hawkish and inflation picks up, the market may get nervous and start to consider the weaknesses emerging in the global economy.
Previous performance during challenging market conditions
As highlighted in previous market commentaries, a bounce is normal as we enter a bear market, and while we resent missing out on gains, we remain confident in our analysis and the expectation that markets will decline within this half of the year. When we look at current market conditions, we are reminded of 2008 and 2015, where markets rallied prior to a significant pull back. Charts 1 and 2 illustrate how our OBI portfolios performed relative to global indices over the periods, demonstrating consistent returns at a lower level of volatility in each case. While we know the interim period is hard, the data continues to reinforce the importance of a defensive portfolio allocation as we weather current market conditions.
Chart 1: Performance Aug 2008- Aug 2009
Chart 2: Performance Feb 2015- Dec 2015
Keep calm and carry on
In true British fashion, on the back of the high levels of uncertainty in markets, we encourage clients to remain calm and content in the knowledge that as the economic backdrop worsens and markets overheat, our portfolios are defensively positioned, with high cash levels enabling a high level of agility when the time comes to redeploy into new opportunities. In the meantime, as we await a capitulation in markets we continue to watch movements closely.
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Following the defensive repositioning of portfolios in December, our OBI portfolios have a low equity allocation, with exposure predominantly coming from the FTSE 100 and S&P 500 shorts as well as the Odey Long/Short European fund. For this reason, the equity exposure within portfolios is inversely correlated to markets ahead of the expected decline this half. Markets rallied over the week on optimism over a US-China trade agreement, optimism over a reduction of central bank tightening and favourable currency movements. Following a positive week last week, the OBI portfolios declined this week as a result of the inverse equity market correlation, reinforcing the stark differences in intra week market movements.
The economic data continues to support our expectation for a drop back in markets in H1, therefore we remain defensively positioned going forward. It takes time for the data to feed through structurally, therefore as we wait for the data to feed through into markets, we are expecting volatile market conditions to continue, however it is key to bear in mind that the scenario will take time to play out. We must view intra week market fluctuations in the context of longer-term market trends and stay content in the knowledge that portfolios are protected from the excessive risks in markets.
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
Have a great week,
Gina & Jason