There is a little over 6 weeks before the Brexit date is reached. Without a deal the UK risks falling out of the European Union without trade deals, or a solution on the border of Ireland. This would no doubt cause a lot of volatility in UK assets up to the departure date and beyond depending on the outcome. Since the vote to leave the EU in June of 2016 we have seen the effects of the decision on the currency, markets, and economic numbers. As an investor with a longer horizon, how should you look at these events as they unfold and uncertainty depresses prices.
Looking at the headlines it seems the Eurozone is the obvious winner if the UK suffers a hard exit. Goods from the UK to mainland Europe are small in comparison and many companies have already started to move staff and jobs out of Britain. Looking at the overall economic growth globally the Eurozone might not fare as well as many expect. Aside from the Brexit uncertainty global growth is slowing down and the Eurozone is no immune. In the event of a slowdown the UK is in a better position to provide stimulus to their economy and the depressed Pound will help with exports.
The Eurozone didn't see the economic decline that the UK did after the vote to leave, but since the slowdown started, the Euro countries were hit hard by their intertwined bonds and banking system and the end of massive QE stimulus. One of the major themes we are following is European Disunity, a slowdown in growth and the lack of political will for more monetary accommodation, many of the countries are starting to undertake fiscal stimulus. This is a good sign that the European governments are aware of the problems, but it raises the concerns about which countries can afford to add a lot of stimulus and which cannot. This could create the two speed Europe we have seen in the past, only this time the ECB could have mixed data on their hands.
While Brexit is not great for the UK and will see volatility in the coming months, take into account the larger economic trends and who would be most likely to manage and come out of an economic slowdown quickly, should one occur. In this scenario the UK looks much more nimble and has the ability for more monetary and fiscal stimulus. Now would be the time to sit back and wait to start buying.
US markets have rallied back pretty well at the start of this year, with the S&P500 up over 10% it seems that there is a nice comeback to the market sell-off we had in December. Earnings were not as stellar as in the past so that can't account for the upswing, and trade tensions, Brexit, and a global slowdown are still on the table. The one factor that seems to be putting the market on an upward trend is the change in Fed policy. Since the start of the year the Fed has been pushing a message of patience and concern over the rate of increases that it was set to make in 2019. Since the start of December the probability of an increase in 2019 virtually disappeared, in fact a rate cut of 25 basis points is starting to creep back on the table.
The concern about this current situation is that there is a great emphasis on the actual news of the Fed taking it slower in its tightening policy but the events that are causing the concern are still being priced in as remote. The global slowdown, trade tensions, and Brexit have yet to materialize into real crisis. If you look at the economic data coming out of the US it is still surprising to the upside. This is giving the impression of a strong economy with the Fed easing. These two issues are not going to remain intact for long. The concerns facing the global economy are going to start affecting the US proving the Fed early to react, of the US will in fact weather all of these global concerns somehow at which time the Fed will most likely reverse their tone rather quickly.
Futures in the US are down today after a long weekend at which time the IMF updated its global outlook lower. This was reinforced by China reporting its weakest annual expansion since 1990. A lot of this news from the US side is going to be priced in this week, but overall the news didn't seem to have too much of an effect on global markets. The reason for this could stem from the sell-off in December, when all of the companies started to issue profit warnings about growth in China. Markets sharply sold off (some argue too much) on the expectations that the bad news will come out in the figures this month.
What does this mean longer term? There is more evidence that economies are slowing and this will affect the markets. It will also dampen the market sentiment we have seen since the start of the year where stocks were coming off the December bottom thinking the sell-off was too severe. A January rally of about 10% and data now confirming that there was a slowdown in key markets should pause the bullish sentiment on the markets until data points towards recovery or more contraction.
Concerns about the debt loads in China and the US should be looked at in terms of timing. The ability to manage these large debt payments will become harder as the economy slows down, exacerbating the problem as companies, individuals, and governments try to deleverage. In the deleveraging process there are 3 main ways to manage the debt: Extend maturity, restrict growth and paydown, and default. Extending maturity, especially in the US, will be difficult in a higher rate environment, also the markets are now demanding more premium in spreads over lower quality loans. This leaves the other two options, where the countries will have to muddle through payments and manage those obligations over growth or in the event that is unmanageable, default. These two options are not great in terms of global growth prospects turning around in a short time frame. With rates higher in the US (and the Fed willing to pause and possibly even cut in the future) and the Chinese government starting to add stimulative measures to their economy, mass defaults should not be common. This leaves economies, and their markets muddling through the soft patch, subject to data and bouts of volatility, a great time for income and buying opportunities.
Futures are pointing towards a lower opening today with news of Eurozone industrial production and Chinese exports adding to the declines. These data points coincide with the start of a very busy week that will help shape investment decisions for the coming year.
The Brexit vote is on Tuesday, where UK parliament is going to have a vote on May's proposal for leaving the union. Should they reject the deal, there is little chance that another round could take place before the March deadline, increasing the chances of delaying or having a second vote to avoid a hard Brexit. Companies are adjusting to this new reality as seen in the numbers today. Capital goods such as machinery and white good like stoves and refrigerators were all down in the Ind. production numbers. Retail goods also saw a decline, emphasizing that everyone is holding back investments and purchases as the deadline approaches with no deal in place.
The decline in Chinese exports, specifically with the US, is also a reading of a larger picture concern. The trade wars between the US and China are still ongoing, with tariff increases on Chinese goods pushed to March. There is time for negotiations to take place now, but this extended time frame lowers the urgency. Earnings season in the US is kicking off this week which will show how much the trade wars affected companies last year and give some insight into what impact executives think it will affect overall 2019 earnings.
Overall this week will be important for the sentiments that develop out of the news. Data points are already showing a slowdown as a result of the political uncertainty of these events, so earnings warnings or a vote down of May's Brexit deal will be seen as continued weakness from uncertainty.
Oil prices have rallied at the start of the year picking up note from media and market analysts. This rally looks great coinciding with the start of the year, but at these levels the fundamentals will be responsible for significant moves in any direction. Starting the year from an extreme sell-off helped pull the commodity up from the pre Christmas low, back to levels seen at the start of December. This level is an good example of dislocations in the markets temporarily creating opportunities to purchase assets at a fair price. We can look at this historical example to spot future opportunities.
The end of 2018 saw a lot of volatility enter markets and, looking back, created opportunities for entering into some positions. Spotting these trends and executing on them requires prior planning and building a case. Oil was in a decline from the start of October as too much supply started to pressure prices and fears about the global economy came to the forefront. As the markets came to the end of the year we saw an extended sell-off in risk assets and commodities when trade tensions between China and the US started to increase. But there were trends that weren't all bad that came from these extremes.
In the beginning of December, OPEC and Russia agreed to curb production as the US was hitting record production numbers. This news came after the majority of the swings in the price of oil and temporarily put a stop on fall in oil. Then, among light trading and trade fears the price started to drop dramatically despite fundamental news not coming out every day.
Making the assumption that you were looking to get into oil or oil commodities and determined that the news from OPEC and sanctions on Iran were good catalysts for an entry point (with some security knowing that the lack of high yield bond issuance was a good sign there wasn't aggressive expansion in the Fracking sector) you would now be watching this space. The relentless drop in the oil price would prompt you to look for data supporting that movement, inventories? flat to down in the US. Production? cuts from OPEC were to take effect in 2019. Downside risks include trade wars heating up and an economic slowdown.
Forecasts for a slowdown are present but not extreme, and the Fed came out more dovish on rate increases, providing some security that they will be willing to hold rates if conditions worsened. The US and China gave a 90 day extension to trade tariffs at the G20 in the start of December, providing some opportunity to reconcile before that time. This left oil in a good position to be bought in the violent downswing at the end of December. This doesn't mean it is a bottom, or that there is significant upside in the near term. Rather it was a good entry point with a margin of safety compared to the fundamentals at this time.
So how can you use this hindsight to look ahead? Looking at what opportunities may lie ahead and building a story is the first part. Is volatility coming back into the markets and now is a good time to buy protection in the form of puts because of low volatility? Are retails stocks looking cheap after Macy's caused an industry-wide selloff yesterday? Now is the time to start looking into these answers and waiting for a shorter term dislocation in the market to start building a longer term position.
It has been a good start to the year in equity market terms. Stocks were rallying off their lows in December and the Vix has come back down to around 20. There is a lot of talk around what happens in January spells out the year. In reality the longer term prospects will determine how 2019 will end. This week we have seen growth prospects for countries downgraded in the EU, where even Germany is not spared. The World Bank has came out downgrading global growth, with the decline led by the advanced economies. The causes of these lower estimates are not new (slowing trade, less commodity demand, removal of central bank stimulus) but they were something the market seemed to ignore, at least in the US last year. The declines we have seen in the markets have caused participants to take these changes into account in finding the right balance of long term economic prospects and market levels.
Over the past 2 months there are many people who no doubt questioned being in the markets during such a violent downturn, and are not questioning why they are not more invested into the markets now. Small gains do make for longer term returns but trying to time the markets in such an extreme fashion is difficult. Creating a longer term outlook and using that as a guiding principal of when to add or take away from exposures in the market is where the individual gains an advantage. Looking at the data it is a good time to build a story around different asset classes, sectors, and regions to invest in. Find the conditions that make sense to buy into (or sell out of) a position in the longer term, and execute.
Sometimes the market seems to be dislocated from the theory that you laid out. This is a great way to know where you need more research and testing. Perhaps change the amount allocated. This could help avoid mistakes in the long run, or find great opportunities where the market is thinking too short term.
Yesterday we saw global markets shocked by the news of a slowdown in Apple sales in China. This potentially caused the flash crash in Yen currency pairs, markets to sell off globally, yields to drop, and Fed expectations to start pricing in a rate cut in 2019. This is a culmination of all the bad news of last year coming to a head. Bad times are still ahead for us.
Today, job numbers came out in the US way above the estimates that the markets expected. The Fed said that they would be more patient with monetary policy as they assess data. Market soared back today as the good data seems to negate the moves we have seen yesterday, along with the fears that a global slowdown is increasingly likely.
What needs to be looked at through this chop is where the longer term trends are and how 'sticky' each data point is. The news by Apple (and other companies) about lower than estimated earnings in 2019 will not be a transitory event. Companies do not put out bad news of this sort if they feel the markets will turn around quickly and result in better earnings. As far as the Fed coming out to reassure markets they will be patient with the data, while it is taken as good news in the market (the Fed put trades are being reinforced) the Fed would only act towards easing as the data comes out confirming what companies like Apple are warning, a material slowdown in growth. The Fed put is great for longer term buys, knowing there is some support as the economy slows, but still would come on a backdrop of lower US growth. The high jobs numbers are great for the economy and point to the US continuing to buck the trend of the rest of the world, however the stickiness of these numbers are not as reliable over longer term horizons. Companies hire cautiously and close positions hastily as the economy sours.
For your portfolio these times still present opportunities as a decisive direction is still unclear. Knowing there is a backstop of the Fed softening its stance on rate increases, the dollar should not see as intense of a rally this year as we did in 2018. This helps in the Emerging market space as well as commodities (trade wars will still determine the majority of movement near term). The severe sell-off in the developed markets are providing attractive yields for longer term value plays and aligning valuations where we have seen stocks get expensive.
The start of the new year has many analysts discussing what the year ahead might bring and how to positions portfolios for them. I can fully appreciate the start of the year as a new beginning to the investment process but the last quarter of the year has provided most of the insight we need to assess how the markets will fare this year.
Markets started lower from bad manufacturing data coming out of China, this is a continuation of the concerns that the engine of global growth is slowing down. There will be no easing of these concerns without the Chinese government taking action to stimulate the economy. Concerns over the debt loads of companies are also a concern and will be looked at closely.
UK Manufacturing PMI came in better than expected but was attributed to large inventory build ups in preparation to Brexit disruptions that could come about in March from a disorderly withdraw from the EU. This will be a very important, and news dominating, event that will dictate currency and market movements for the first quarter. European parliamentary elections will have a large effect on the unity of Europe and further integration (or dis-integration) but will not get the same market attention as Brexit I fear.
In the US the markets open 2019 with the government shutdown still in effect. As the newly elected leaders are sworn in, you can expect more headlines (hopefully for the better) coming out this week to dictate market sentiment. The points of contention are the same as we have seen last year, deficit spending, campaign promises and partisan politics generating uncertainty in the markets.
None of these problems started in 2019 but will definitely shape the outcome of the new year. As the predictions for 2019 market performance come in, their accuracy is dependent on a lot more political outcomes than cyclical and economic trends. The only accurate prediction at this stage is that 2019 will bring uncertainty and opportunity.
The IMF forecasts that the changes in the global economy will not spare the US market in 2019 as it did this year. While growth in the global economy has been showing signs of slowing down, the US has been immune to much of the malaise.
Despite slowing growth in Europe and Asia and the US raising rates 75 basis points this year (and still expecting another increase to round out to a full 1% increase for 2018), the markets have performed relatively well, until October. With the headwinds of the tax cuts dying down and markets are starting to look at 2019 projections and the likelihood that the US can go against the global trends another year.
The cancellation of the Brexit vote today shows ow sensitive the markets are to data at this juncture. On edge markets are keeping volatility high, probably into the next year. The Fed meeting coming up on the 19th of this month will be exceptionally important. Markets will be hanging onto the language that comes out of the meeting to see how the FOMC will respond to this mix of data, and adjust their 2019 outlooks accordingly.
October jobs numbers were higher than expected coming in at 250k vs an estimates of under 200k. This will keep the data dependent side of the US equation going strong into next week. Data had a larger influence in October as yields and trade wars rocked markets. As we have seen in just the past week, lackluster PMI numbers and the fear of bad jobs numbers took the dollar rally in reverse. Now with better than expected numbers coming out today it will be interesting to see if the decline continues. If all remains constant we should see a stabilization in the Dollar and the equity markets to a degree. An increase of volatility will have to come from another source in the near term (earnings for stocks and perhaps geopolitics for the Dollar) to see volatility tick back up.