One of the best macro-economic and stock market commentaries I listen to is the JP Morgan’s quarterly “Guide to the Markets,” presented by the excellent Karen Ward, a Chief Market Strategist at the investment firm. In a recent webinar she naturally highlighted the 180 degree turnaround in market sentiment since the end of the year. The key factors have been the volte face in the US Federal Reserve’s monetary and interest rate policy, which has gone from hawkish to dovish, China shifting its foot from the brake to the accelerator with economic stimulus and a more favourable outlook for US/China trade deals. Equities and bonds have both rallied in the last few months.
Ward then considered the impact of the policy changes arising from the world’s two biggest economies. Firstly US monetary policy matters, both domestically and globally. On the former a pause on interest rate rises and quantitative tightening* makes corporate re-financing more affordable and it boosts consumer confidence in the US with lower mortgage rates. On the global stage a weaker dollar is a tail wind for commodities and it is positive for emerging markets with dollar denominated debt. In terms of trade whilst US exports accounts for just 13% of its GDP the US is the world’s third biggest exporter (Source: Trading Economics). Moreover the US runs a trade deficit i.e. imports more than she exports which is one reason that if the US sneezes the world catches a cold.
Interestingly Ward thought China’s stimulus is more significant for the global economic growth. She argued that China is still an emerging market with relatively low rates of urbanisation and real GDP per capita** and its expansion still has a long way to run. China of course has more influence on global trade than the US. The US economy is very consumer oriented whereas China’s is more export and infrastructure led which are both key planks of global trade. Infrastructure although domestic in nature requires raw materials and hence imports and trade. As an example of the importance of China and global trade Ward explained the poor European economy in 2018 was in significant part due to the Chinese slowdown. We also know that intra-Asian trade is strongly influenced by China. Moreover the US economy is expected to slow later this year as the sugar rush from Trump’s fiscal stimulus (corporation tax cuts and spending) reduces.
Whilst sentiment has much improved since the end of the year we are approaching a record for the length of the current global economic expansion. Everyone seems to agree we are late in the cycle. According to Ward equities are no longer screamingly cheap and for ongoing upward momentum in prices to continue we will need to see good corporate earnings growth coming through. The problem with being late in the cycle is that low levels of unemployment creates wage growth pressures which impacts on companies’ margins. Arguably recent US and Chinese policies will extend the cycle but for how long? Interestingly Ward says a late cycle favours investment in larger companies, quality and value.*** I’ll need to give that some thought. As you know I am a supporter of smaller companies.
My conclusion is that although equities have rallied in 2019 and markets are calm there are reasons to be cautious. Whilst there are known knowns such as the current economic stimuli, there are the known unknowns for example when will the cycle end and there are unknowns unknowns. The latter are potentially the most dangerous – unexpected geo-political events or unseen systemic economic threats could through a spanner in the works.
*Quantitative tightening (QT) is the reversal of quantitative easing (QE) in which a central bank offloads from its balance sheet the bonds it has acquired from money printing. QT reduces liquidity and causes bond prices to fall and yields to rise. Ward says that QT will come to an end earlier than predicted in the autumn . With interest rate rises on hold or set to fall (Ward says there is a 60% chance of this before the end of 2019) the bond market reacted very favourably.
**Real GDP per capita is the average contribution to the economy per head of population taking into account inflation. GDP is gross domestic product, a measure of the size of an economy.
***Value is an investment style that favours undervalued companies based on fundamentals. Since the global financial crisis investors have favoured a growth investment style with more visible earnings and superior growth.
The content of this blog are my own thoughts and assessments based on my understanding of the JP Morgan presentation. Nothing in this article should be construed as personal investment advice, for example to invest in larger companies or value investments.. These may not be suitable for you. You should seek individual advice based on your own financial circumstances before making investment decisions.