2019 Outlook

If you had to sum up why world, ex-US, financial markets typically underperformed during 2018 then economic growth, currency movements, and trade talk uncertainties would be the three most influential headwinds. Simply put, U.S. economic growth surprised on the upside whilst other major economies did not, the dollar appreciated against most other currencies, and concerns about essential future trading relations impacted the more export-focused European and emerging markets last year. In order for international markets to gain momentum over the U.S. in 2019, these concerns need to be quelled.

Decisions, decisions

I thought I would use Billy Connolly’s witticism about his homeland to highlight the essential debate in financial markets at the moment. During the last month, the UK’s most-quoted stock market index – helped by a rising oil price boosting energy sector shares – reached an all-time high.

Everything in its right place

There is an old market expression that says ‘As goes January, so goes the year’. The historic data rationale for holding this view is decidedly mixed but global equity market investing adherents will be entering February feeling very excited. Simply put, January was a decidedly positive month for global equity investors, and it is easier to say which markets went down rather than quote the long list who had their best start to the year for a number of years.

Investment Strategy Quarterly

Outside of a few select emerging markets, inflation worries have been notable by their absence for financial market participants in recent years. Of the major global central banks, only the Bank of England is currently mildly embarrassed due to the specific influence of lapping the post Brexit referendum vote weak Pound period, which had a mechanical impact of raising import prices.

The UK is dancing all by itself

I pointed out in the most recent Investment Services Quarterly that over the past fifteen or twenty years October had a slightly rude reputation as a bad month for equity market investors. October 2017 will go down in the history books as not only being a positive month for almost all global investors, but additionally one which saw many well-regarded volatility measures continuing to bump along the bottom.

Investment Strategy Quarterly

What were you doing on the 5 July 2007? I cannot remember either, but the history books tell us that this was the last date when the Bank of England raised interest rates (by a quarter of a percentage to 5.75%). Since this point, interest rates have only fallen, including the most recent August 2016 decrease to the current rate of just 0.25%.

Screen-Shot-2016-03-17-at-23.33

Is the BOE on the Cusp of Tightening Policy?

What were you doing on the 5 July 2007? I cannot remember either, but the history books tell us that this was the last date when the Bank of England raised interest rates (by a quarter of a percentage to 5.75%). Since this point, interest rates have only fallen, including the most recent August 2016 decrease to the current rate of just 0.25%.

But is this about to change? Traditionally, independent Central Banks with relatively narrow inflation control mandates, like the Bank of England, typically raise interest rates when the level of price increases threatens to pierce their target inflation level. For the Bank of England this moment was, a number of months ago, influenced by the impact on imported prices, like energy, by the sharp fall of the Pound in the second half of last year.

Given the uncertainties around Brexit and recent economic growth data, which has been typically weaker than other developed market peers, this has caused a conundrum for the Bank of England. Reflecting this, the Bank’s own Monetary Policy Committee (MPC) observed a few weeks ago, after a meeting which concluded that interest rates should be currently held, that:

“The MPC’s remit specifies that, in such exceptional circumstances, the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.”

‘Exceptional circumstances’ covers a variety of sins but maybe something has changed in the water at Threadneedle Street because Mark Carney, the Governor of the Bank of England, in an even more recent national radio interview said that ‘we can see that in the coming months if the economy continues on this track it may be appropriate to raise interest rates’.

Well that is a surprise – and certainly induced an immediate response from both the bond markets as well as mortgage lenders. So what is the reality and can we expect, for the first time in over a decade, an increase in interest rates?

The economic case for an interest rate increase is currently not wholly proven. Brexit negotiations are an uncertainty and the average consumer remains under pressure with limited wage increases and high personal debts. However, monetary policy remains exceptionally loose with a negligible 0.25% base interest rate, the Pound on a trade weighted basis near multi-decade lows and a quantitative easing stimulus programme, which was further augmented at the time of the last interest rate reduction in August 2016 when the big fear was an imminent shift of the UK economy into recession.

In short, a very mild tightening of policy – maybe reversing some of the extraordinary additional stimuli measures implemented fourteen months ago – is quite plausible and would reflect an acknowledgement that, whilst the backdrop is still uncertain on an absolute basis, relatively speaking there is slightly more clarity. However, the bigger insight is that anyone expecting a return to the interest rate or broader monetary policy norms of the generation before the global financial crisis a decade ago is going to be incorrect.

The Bank of England is not the only central bank coming to these conclusions. The Federal Reserve in the United States was the first major western central bank to slash interest rates and introduce a quantitative easing stimulus programme in the aftermath of the events in 2007 and 2008. As is often the case with economic policy, the ‘first in, first out’ rule is very apparent. Famously, the Federal Reserve raised interest rates after seven years of pause in December 2015, and since then there has been a further three small tweaks up. Perhaps more insightfully is that the pause on the creation of new central bank stimulus pre-dated any of these interest rate movements and occurred in October 2014 (and actual balance sheet size reduction is only starting this month).

The essential conclusion from all of this is that the speed of policy tightening is, by historical standards, desperately slow reflecting the ongoing challenges for most global economies. This broad profile is highly likely to be replicated by the Bank of England: potentially a minor tweak up in interest rates and a progressive end to new expansion of the quantitative easing balance sheet. If the Bank of England does decide to move in upcoming months, the magnitude of the shift will be extremely minor: there are too many fears out there to do anything else.

And this is why knowing what you are investing in and why is absolutely critical for the next few years, whether you are a bond or equity investor.

Chris Bailey, European Strategist, Raymond James Euro Equities

Currencies and Hope

Chris Bailey, European Strategist, Raymond James Euro Equities*

July is often a month of contradictions with, for example, the lure of holidays for the world’s investors coinciding with heavy corporate reporting. Typically, July is a positive month for global stock markets, and if you are sitting in America having invested in some pan- European opportunities, you would be congratulating yourself in the wisdom of your decision. A bit closer to home though, July 2017 proved to be an unusual month, with a near-rampant Euro providing some strong currency translation boosts for British or Swiss investors, whilst underlying broader Euro denominated indices edged down, despite Eurozone economic confidence levels reaching its highest level for a decade.

Currencies have lots of different influences on stock markets. The rise of the Euro in July – and to a lesser extent the Pound – against the US dollar, changed the types of shares investors wanted to hold. In investment markets we typically call this rotation. Unsurprisingly, exporters are often the first sector to be sold as a higher local currency hinders their competitiveness at the margin (even though there are many factors in exporting success of which price per se is just one). More domestically focused stocks can often be the beneficiary of such moves, and there are some tentative signs of this, with the much-criticised financial sector continuing to perform well versus other areas of the stock market.

Meanwhile, the fall in the US dollar over recent months may have made transatlantic trip costs slightly more tolerable, but the bigger impact has been a well-received reduction in the threat from current global financial imbalances, including the large Eurozone trade surplus, building dollar-denominated debt burdens in the emerging markets and sensitivity in the United States to trade. Add in hopes for political reform in Europe and increased use of the ‘transitional arrangements’ concept in Brexit and you have many of the component sources of the global stock market rally of 2017 – and the greatest influence on financial markets today.

Hope is typically good for equities and less good for the more defensive fixed income sectors – and the two often come together in another important sector rotation, centred on the impact of higher bond yields. Typically, higher yielding sectors of the market – ‘bond proxies’ like consumer staples, healthcare and utilities – struggle in times of hope, compared to the more cyclical commodity, financial or technological sectors. A quick look at July’s pan-European sector performance data shows that whilst staples and healthcare lagged, materials, energy and the aforementioned financial sectors led the way. Whilst there are plenty of individual stock stories that helped contribute to these trends, the underlying theme of hope feels to be all-important.

Currencies and hope have been positively aligned for all of 2017; believers in Eurozone structural reforms and a compromise-heavy and delayed Brexit will see plenty more scope for the Euro and the Pound to recover back to levels many would have regarded as normal a few years back. This occurrence however, would come with another sector rotation surprise: a fuller revival of those more domestically focused areas of the market, including the currently generally maligned retail and construction sectors, as well as the already well performing (in aggregate) financial sector.

A further sector rotation could well be the theme within the markets after you return from the beach, if the currencies and hope cycle continues apace. Something to ponder in the upcoming, quieter August weeks.

“Flattery is a kind of bad money, to which our vanity gives us currency” Francois de La Rochefoucauld

Important notice: This “Marketing Communication” is not an official research report or a product of the Raymond James Research Department. Unless indicated, all views expressed in this document are the views of the author(s). Authors’ views may differ from and/or conflict with those of the Raymond James Research Department. The author is not a registered research analyst. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realised. Past performance may not be indicative of future results.