Market Musings: What's been going on?

When investing it is important  to not only be aware of what is happening in your own local market but also the myriad of markets around the world that interact and influence it. One must understand the trends and implications both locally and globally.

It would be understandable if, as an investor, you were left scratching your head as to the performance of the markets in recent months. It seems that we have come back substantially from the doom and gloom of the December quarter to a continued melt up in markets globally through the month of February. What started as a post-Christmas rally was buoyed through February following expectations of a tapering down of trade tensions between the US and China, encouraging rhetoric from the Fed (where this market is concerned this is potentially the most important element, something we previously referred to as the government or Powell put) and on a more fundamental basis strong jobs growth in the US economy. 

Nevertheless, at this stage, it pays to be cautious and diversified. The biggest headwinds come from Europe where Brexit continues to cause significant chaos and continental Europe faces increasing uncertainty both geo-politically and from a macroeconomic perspective. Manufacturing data shows significant signs of weakness following political unrest in both Italy and Spain whilst the data from Germany shows a less than stellar performance, narrowly missing falling into a technical recession over the December quarter.
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Closer to home, February has been a strong month for the ASX. We would say the underlying sentiment has been driven primarily by the dovish commentary coming out of the RBA. Earnings have been on a solid footing overall though not exceptional while markets have been expecting (and pricing in) significantly more downside. The biggest risk factor still remains the policy uncertainty headed into elections with several proposed changes. The most important of these is franking and the potential changes to capital gains tax are also at the top of investors minds. An important consideration here will be to watch how the changes to these market incentives impact the long term composition of the market (i.e. domestic vs. international investors, consolidation of superannuation and its flow-on effects with industry super funds taking an increasingly proactive role).

United States

US equities continued their stellar performance through February despite the political environment. While the government shutdown that concluded at the end of January took a meaningful toll, the economy continued its upward trajectory with Q4 GDP growth indicating a robust Q-Q of 2.6% beating consensus. Earnings remain stable, in fact, just over 70% of earnings calls were better than analyst estimates. The caveat here is that expectations for future earnings growth remain on the downside due to the one-off nature of the tax cuts and slow (but steady) global growth outlook.

On the policy front, while it is perhaps beyond our capabilities to assess the policy trajectory of the White House, the rhetoric so far has been rather benign. With some of the posturing by the administration becoming less confrontational where it concerns China, we would say they have enough to deal with at home with an increasingly confrontational Congress and the less watched investigations by the State Attorney-General’s office in New York. It would be reasonable to assume that the administration is looking for a win at this stage leading up to the elections and the elephant in the room is the China trade talks. However, the markets have seemed to react with a sigh of relief through February.
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From a tactical perspective, patience has been rewarded. The minutes of the Federal Open Market Committee has confirmed market assumptions of a dovish pivot with what is likely to be a continuation of the status quo (i.e. maintaining a larger balance sheet and effectively putting an end to the quantitative tightening at least till year end).

Europe

​The saga continued through February for Europe with the stagnation of Brexit, Italy entering into recession, political uncertainty in Spain and poor manufacturing and growth data coming out Germany. Though Eurozone equities gained through February in conjunction with their global counterparts following progress of US-China trade talks, structural issues continue to be on top of investors minds despite the relative cheapness of European equities. 

The one bright spot seems to be consumer sentiment which appears to have ticked up. This weak outlook has led to the ECB suggesting that a restart of its targeted long-term financing operations could be on the table again. For those of you unaware of what this entails, simply they offer cheap loans to banks who are supposed to then pass them on through credit growth to the general economy. This meant that broadly the best performing sector has been the financials followed closely by industrials and materials. Conversely as one could have imagined, the weakest sectors have been real estate and utilities. 

In the UK, equities also performed well with the large caps lagging somewhat behind smaller companies. As we previously elaborated upon, the FTSE 100 tends to have an inverse relationship with the Pound Sterling given that these mostly global companies have the majority of their revenues denominated in currencies other than the Pound. The markets recovered considerably on the back of hopes that the country could avoid a disorderly Brexit (something which in retrospect is looking more and more unlikely). On a fundamental basis, wage growth seems to have been kickstarted in the UK once again and inflation remains steady leaving limited flexibility for the Bank of England. At TAMIM we still remain cautious when it comes to Europe despite the cheaper valuations which may potentially be a value trap.

Asia & Emerging Markets

On a fundamental basis, the challenges for emerging markets continue to persist broadly because of political uncertainty in India with upcoming elections, continued turmoil in Venezuela and slowing growth in China. However, given the significant sell-off that has taken place since October of last year, emerging markets benefited substantially from the risk-on trade as money continues to flow back into equity markets, especially across Asia. Tactically speaking we would suggest the shorter performance of these markets will be more reliant on fluctuations in the USD (inverse relationship). 

However, on a long term basis, we continue to view Asian equities as providing a good opportunity for significant gains especially if the trade tensions continue to ease. We continue to believe that the policy environment in Beijing is amenable to shorter-term stimulus measures and continued structural changes to the economy especially when it comes to boosting domestic consumption. Policymakers continue to implement a mix of measures both fiscal and monetary to support growth with local government bond issuance increasing and new rounds of infrastructure spending.

Outside of China, India continues to be hampered by an election budget (which tends to be on the optimistic side, to say the least) and currency depreciation taking a heavy toll on core inflation (India being a net importer of both oil and commodities). Turkish inflation meanwhile has climbed above 20%.

Japan also showed signs of positive swings. The fourth-quarter GDP growth rebounded up to 1.4% lifted by a bounce in consumption and capex. However, the biggest hurdle remains the manufacturing data and BOJ’s inability to meet its inflation targets (the loose monetary policy story looks set to continue even here). From an equities perspective, we continue to take a bullish position on Japanese prospects given the relatively cheap valuations and the export orientation of most of the companies that will benefit from positive long-term catalysts in the form of the South East Asian growth story. We believe the Yen still remains undervalued due in no small part to its ‘safe haven status’ and negative correlation with global equities.