Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, reflects on how these factors are positively affecting global markets but also considers whether a recession might lie ahead.
A ceasefire for the US-China trade war?
Share prices are definitely reacting positively to signals from both Beijing and Washington about an approaching trade deal.
There’s even some optimism that the agreement could move beyond ordinary trade matters and start to focus on some of the other major concerns of the US government, such as intellectual property protection and the transfer of technology.
On days when economic news has been poor but trade reports have been upbeat, we’ve seen investors focus on political rather than business news. However, there are two other key issues investors need to think about. Firstly, it seems very likely that China will increase its purchases of US goods, such as aircraft, cars and soya beans. That means it will probably reduce its imports from other countries, so some emerging markets could find life more difficult.
Secondly, if President Trump reaches an agreement with China, he may quickly turn his attention to Europe where he sees another large trade deficit. The risk here is not only that Washington launches a new campaign, aimed at the car industry, but also that Brussels responds forcefully with a series of countermeasures aimed at voters in key US states.
So the news could get worse before it gets better as we find ourselves in a political rather than an economic cycle.
Sterling versus the euro
At the time of writing (6 March 2019), the pound is about 5% higher against the euro than at the end of 2018. There are usually several reasons why two currencies move against each other but in this case one reason is certainly Brexit. As parliamentary negotiations have edged forwards and the risk of a hard Brexit has reduced, investors have become more positive about the pound and it has strengthened against the euro.
The second reason is expectations for interest rate moves in 2019 and 2020. Both the EU and UK economies are quite weak at present and getting close to a recession in parts of the manufacturing sector. Nevertheless, as the UK has slightly higher inflation, markets are pricing in the possibility that the Bank of England will raise interest rates a few times by the middle of 2020. Meanwhile, the prospect of the European Central Bank (ECB) raising interest rates seems to be getting more and more unlikely.
The European Parliament also faces some difficult elections in May, with the populist vote expected to be high. In addition, when there are concerns about the global economy, the dollar is generally seen as more attractive than the euro. As such, at Aberdeen Standard Investments, we’re relatively neutral on the pound at present, but we prefer the US dollar to the euro.
The Fed makes a U-turn on interest rates
When the US Federal Reserve (the Fed) first indicated a few weeks ago that there wouldn’t be any further interest rate hikes, the dollar did fall back against other currencies. However, it recovered once investors began to realise how weak activity was in other parts of the world too and that potential interest rate increases elsewhere needed to be reconsidered.
Of course, there are other factors in play when it comes to the dollar. These include capital moving in and out of the country, the level of government and corporate debt, political risks, and where the currency stands in relation to long-term valuations. We take all of these into account when we’re analysing foreign exchange positions.
On balance we believe that the dollar won’t move much higher against other currencies unless there’s a major inflation shock in the US, and there are grounds to expect a decline against emerging market currencies as and when investor optimism improves.
What’s next for emerging markets?
Emerging market (EM) assets have performed well in the past few months despite emerging market economies being rather downbeat from last summer onwards. This is because many investors are looking through the gloomy headlines and searching for value in their investing.
Many investors are looking through the gloomy headlines and searching for value in their investing.
At Aberdeen Standard Investments, we’ve been positive about emerging market equities, although more recently we’ve moved into a broader selection of global equities, and indeed EM debt as well. When this period of slow growth in emerging market economies comes to an end, we expect a wide range of companies and governments to benefit.
Mere headwinds or recession ahead?
Global political risks and more normal monetary policy normalisation (less quantitative easing and more stable interest rates, even a return to rate hikes in America) are clear headwinds for 2019. Financial markets have already priced in the fact that we’re very close to recession in parts of Europe. Now the issue for investors is whether or not we’ll see weaker growth in the other two major blocs: China/Asia and North America.
Much of Europe faces a manufacturing sector recession, partly due to the slowdown in global trade and partly because of a series of one-off shocks to key sectors such as automobiles.
With policymakers unable to do much in Europe, it will take an external force to stimulate a recovery.
On the other hand, prospects for consumers in China and the US look reasonable this year. The latest government announcements indicate more stimulus and possibly more ahead. And if a trade agreement is reached then we expect manufacturing to stage some recovery in these countries and their trading partners.
Our research indicates that the risk of recession in the next 12-24 months has risen but still remains low by historical standards. We’d need to see a major policy error by a government or central bank, or an external shock to bring one about. Until then our portfolios are in ‘risk-on’ mode; meaning we’re holding riskier and potentially higher yielding investments as we feel quite positive about global economic prospects.
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 March 2019.