For financial professionals only
A few weeks into 2020 and investors could be forgiven for thinking things were looking up. China and the US signed a Phase One agreement – a détente in the long running trade wars. The UK (finally) departed the EU, three and a half years after voting to do so. Then along came a deadly strain of Coronavirus; a timely reminder that markets can fall on sentiment, as well as rise.
US v China
With the death toll rising daily, Chinese fatalities of the Coronavirus have now outstripped those of the 2003 SARS outbreak leaving markets understandably nervous. China’s slowing economy has long been on the radar, but even GDP at around 6% per annum considerably boosted global growth forecasts. The costs of treating and containing the spread of this illness – including the remarkably rapid construction of a custom-built hospital from ground zero – will weigh heavily and be compounded by loss of revenue as a result of worldwide travel restrictions imposed.
In the wake of this epidemic, trade wars may seem a distant memory, but it is important to remember the current position is a ceasefire, not an armistice. The next stages will play out against a backdrop of further political upheaval with US Presidential elections in November, with Trump riding high following his acquittal in the Senate.
The power will likely shift in the tensions between the US and China as the impact of tariffs hits the pocket of the US consumer – this is not a situation that will serve Trump in the latter stages of a re-election campaign. The US Federal Reserve are unlikely to soften this blow any further than they have done during the last 12 months. The Chinese have the option to hold out and see whether a more sympathetic candidate makes it to the White House by the end of the year. But Trump has all to play for, so a resolution (in name at least) is more likely going forward. That said, the protectionist rhetoric has hit a deep chord, particularly around technology, so expect to see the friction between these two superpowers continue long into the future in some form of Intellectual Property War.
A very British Exit
Meanwhile, as pledged so persuasively in his election campaign, Boris “got Brexit done”, but this represents the beginning – not the end – of the divorce process. Trade agreements need to be negotiated, and quickly. The Conservatives will also want to capitalise on the historic victory of December. That means delivering on election promises, particularly in former Labour heartlands, without alienating traditional Tory voters. Add to this the fixed 31st December deadline to our current “transition period”, and the risk of hard Brexit is almost inexplicably back on the table.
UK businesses have been stockpiling and deferring investment since the outcome of the 2016 referendum. This may well have distorted data, so we will look for normalisation in the year ahead to give a truer picture of the state of the economy. UK businesses may decide now is the time to press the button on investing – there is only so long you can paper over cracks before you need to fix the roof. Equally, they could elect to kick the can down the road until that final December 2020 deadline has passed.
Reality check
The recent drop in markets may be disappointing for short term performance, but in the long run may not be such a bad sign. It seemed markets were willing to price in positive returns irrespective of potentially negative outcomes, after a decade of accommodative monetary policy whenever there were shocks to the economy. This can’t be realistic, or sustainable.
Though a tragic way to find out, it is almost a relief to find that global markets, while wrapped in a comfort blanket of debt and quantitative easing, still respond negatively to bad news. The truth is that the shadows cast in a miserable fourth quarter of 2018 will fall across much of 2020. Investors would do well to exercise caution in this late cycle stage. The next recessionary phase is a “when”, not an “if”, and while it is natural to want to participate in any rallies still to come, the key is to be selective about how we do so.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.