In stark contrast to a year earlier, 2019 comes to an end with financial markets having provided exceptional returns as a number of political risks alleviate. In the fourth quarter, a wave of merger activity that included Charles Schwab’s $26bn all stock takeover of TD Ameritrade and LVMH’s $16.2 acquisition of Tiffany & Co, led the S&P 500 up +8.15% to new highs. A weakening Yen and a significant upward revision to Japanese Q3 GDP growth led the Nikkei up +9.5%. European markets also fared well with the CAC 40 rising +5.6% and the DAX up +7.0% as concerns over reduced manufacturing activity waned. UK markets rebounded following the election in December, but the strengthening pound resulted in gains of only +3.6% for the FTSE All-share; however, this is comparable to the returns of other global markets in sterling terms. The ‘risk on’ sentiment in equity markets has also led to rising global 10-year Government bond yields and a fall in the price of gold and silver.
In the second half of 2019, market direction has hinged on a US-China trade deal with a Phase 1 deal finally being agreed in December. While we are unlikely to see the details of the deal until January, the immediate effects are the halving of existing levies on c.$360 billion of Chinese goods and the cancellation of additional tariffs, which had been proposed for December. In return, China is to buy $50 billion worth of goods in 2020, predominantly agricultural goods and energy, but added the caveat that these would be subject to market conditions and WTO restrictions. Should they fail to make the agreed purchases, the original tariff rates would be re-imposed by the US. To give some perspective, China bought only $8.6 billion of agricultural goods last year, according to the Wall street Journal. While the deal may therefore give rise to some scepticism, it kicks trade war tensions sufficiently ‘down the road’ to act as a tailwind to markets in the near term.
The House of Representatives also passed the US-Mexico-Canada Agreement, which will replace NAFTA. Removing NAFTA has been a key policy for Trump and the risk of the US withdrawing without a deal has been a lingering political threat. In addition, Congress approved a $1.4 trillion funding package that, if signed by Trump, will avert another US government shutdown and continue to stretch the fiscal deficit.
Boris Johnson’s landslide victory will lead the Conservative party to their largest parliamentary majority since 1987 and MPs have voted in favour of the EU Withdrawal Agreement Bill. The UK is now scheduled to leave the EU on the 31st January and enter a transition period until December 31st 2020. The agreement includes a clause that makes it illegal for parliament to extend the transition period beyond this date. While this reintroduces the risk that the UK may yet face a no deal Brexit scenario, it is more likely that he would renege on his promise of not extending, in favour of a phased approach, much like the US and China. Trade deals of this scale have typically taken several years to negotiate so concluding one within a year could prove too optimistic. However, it is conceivable that a limited free trade agreement could be reached; one that covers a number of important industries but leaves other sectors for future negotiations.
For the UK, a pragmatic leader with a strong majority provides potential for progress following a decade of weak leadership. On top of a pick-up in business investment, which should follow any certainty provided by a trade agreement, the fiscal expansion pledged in the Conservative manifesto could also be a boon for the economy; at circa 1.0% of GDP, this was actually a more cautious set of policies than those put forward in Theresa May’s general election campaign. With Gilt yields not far from historical lows, Johnson could be much bolder, borrow to invest in infrastructure projects that benefit the newly won northern Tory constituencies, and cement his position for the next election. It certainly looks like the UK is poised for a progressive term.
Germany narrowly avoided recession with 0.1% GDP growth in Q3 as sinking manufacturing PMIs flattened. Global manufacturing PMIs remain subdued but Service PMIs have remained robust and a US-China Phase 1 deal could mark the bottom. A number of emerging market central banks will continue to ease into 2020 and global central bank policy broadly remains supportive in response to signs of stagnating economic growth. The Federal Reserve cut interest rates by a further 25 basis points but suggested it may pause at this stage of the cycle. The Federal Reserve also signalled it may expand its balance sheet but as a technical adjustment rather than a resumption of quantitative easing. Rhetoric is beginning to turn to fiscal stimulus in the place of monetary easing, should global growth continue to falter.
Whilst US election years are not typically the best years for stock markets (particularly in years when there is a change of president), market sentiment is now optimistic, with key political issues beginning to dissipate; however, the global economy will remain dependent upon liquidity in the year ahead to keep recession risk low. The corporate sector remains resilient and we remain constructive on the potential for economic activity to improve.
Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.