Market review - markets rebound even though global growth slows

Andrew Milligan

Politics and economics are important for financial markets. With Brexit negotiations making limited progress, a shutdown in parts of the US government, Germany only narrowly avoiding recession last year, and the International Monetary Fund (IMF) downgrading its views on the global economy, there’s been a stream of bad news.

However, Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, explains how financial markets are forward-looking – a positive policy response and upbeat corporate earnings reports have encouraged a sharp snap back in investor sentiment in January from December’s woes.

Brexit means…

Starting with Brexit, the possibility of a disorderly exit continues to concern investors who understandably ask: what’s the likelihood of a ‘no deal’ Brexit, and what could it mean for the UK economy, currency and stock market?

With so much political uncertainty, a simple but useful way of assessing the market’s views about Brexit is to look at Sterling versus the US Dollar or the Euro. When the pound was approaching £1.25 against the dollar in December, it was clear that global investors were worrying about buying UK assets. However, in recent weeks, sterling has risen to £1.30 – £1.31 against the dollar as the series of debates and votes in Westminster suggest a disorderly exit in March is less likely.

If the likelihood of a ‘no deal’ does increase due to policy errors in Westminster and Brussels, then, at Aberdeen Standard Investments, we’d expect the pound to fall rapidly towards £1.20 against the dollar. Similarly, we’d expect the Euro to sell-off versus other major currencies, due to uncertainty about the impact of such an unfavourable outcome on already weak European economies.

For the time being, a ‘no deal’ Brexit is seen as unlikely but clearly not impossible as negotiations enter an even more complicated phase.

The US government shutdown

Another source of worry was the lengthy shutdown of the US government, at 35 days the longest on record. However, it should be remembered that this only affected a small part of the government’s operations. All federal employees will eventually be paid now that President Trump has climbed down and agreed to funding – for three weeks at least.

Further ahead, the dispute casts a dim light on the ability of the President and the new Congress to work together over coming months on bi-partisan legislation. The question investors will be asking is – does this mean the President will focus more on foreign and trade policy in coming months?

Recent signs of trade talks between the US and China have been positive but we continue to caution about the strategic rivalry between these two giants of the world economy.

Germany avoids recession

News that German industrial production and retail sales slumped into year end, with the country just avoiding a technical recession, has raised concerns about Europe’s largest economy. Manufacturing was hurt by rising barriers to global trade, the slowdown in China and, in particular, weakness in global car sales. But it’s important to note that consumer demand in Germany has actually held up quite well. Unemployment is low in Germany and we’re starting to see wage growth.

As we move into the spring, we expect to see modestly positive growth, especially if the car sector starts to splutter back to life. However, the European Central Bank (ECB) seems unwilling or unable to do much about the economic slowdown across Europe.

For now, we await overseas developments, especially in China and the US, to trigger a renewed demand for European products.

Global growth to slow in 2019

According to the International Monetary Fund (IMF) the global economy is expected to grow 3.5% this year, down from its previous forecast of 3.7%. These downgrades were across the board – but remember that 3.5% economic growth for the world economy is perfectly decent.

Growth above 4% is seen when the world economy is synchronised, as happened in 2017, but monetary tightening has brought that to an end. On the other hand, global growth below 3% would be a concern as that would suggest more countries are entering a recession of some sort.

Looking ahead, if global growth stabilises into the spring and then recovers into the second half of the year, as we expect based on a broad range of stimulus measures seen in China and Europe, then equities can make headway. However we still don’t expect 2019 to be quite as good a year for investors as 2017 was.

Market volatility retreats

December saw a large sell-off in many equity markets due to concerns about US monetary policy, the pace of economic growth in China, and worsening trade tensions between the US and China.

Conversely, in January investors have been reassured by increasingly positive signals from the US central bank, more policy-easing in China, and promising signals about trade negotiations. In fact, January 2019 has been one of the best Januarys for the S&P 500 Index since 1989. Plus, the recent gain of 7.2% for the FTSE® All World Index puts December’s 7.1% drop into perspective.

Looking forward, we remain positive about the backdrop for global equities in 2019 – as long as companies can convince us that they can deliver positive profits growth. This view is strongly supported by the latest important announcement from the US central bank about keeping rates on hold for the time being.

Company profits matter

Now we’re in earnings season, our focus moves to company performance and investors want to know where they can find opportunities. This is difficult to answer at a sector level, with no clear leaders, so individual stock picking is still the order of the day.

We’re already seeing very different reports coming from the fourth quarter US earnings season. Many technology companies have reported weak demand for data centres or mobile phones, but the share prices of Apple and Facebook rose sharply on their profits announcements. In general, US firms are beating analyst expectations by about 2%, providing a helpful backdrop and inviting global investors back into equity markets.

However, it’s clear that analysts have an eagle eye on forward-looking statements and many stocks have been severely punished when they’ve disappointed.

For now, we hold a relatively large amount of emerging market and Japanese equities, as we think they’ll perform better than shares in other countries, and we’re broadly neutral on the US and Europe.

The information in this article should not be regarded as financial advice. Please remember that the value of your investment can go down as well as up and may be worth less than you paid in. Information is based on Aberdeen Standard Investments’ understanding in February 2019.

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