Commentary, March 2019

Macro Overview

Since our last commentary on January 31st the Manufacturing economy around the globe continued to slow markedly whilst Services slowed only a little and included more pockets of strength than the industrial side of the economy.

Some of the more influential economic releases since the last commentary include the Caixin Chinese Manufacturing Index falling to 48.3 (50 is the thresholds of expansion/contraction), its lowest level since February 2014; Chinese New Year holiday spending growth of 8.5% year-on-year being the slowest since 2005; the UK Construction PMI (Purchasing Manager’s Index) falling to levels precariously close to the 50 level; UK Investment falling 3.7% year-on-year in December; North American truck sales falling a mere 68% year-on-year to a twenty eight month low; German Industrial Production falling 0.8% in January; Japanese exports falling 8.4% in January, the most in two years; Japanese Manufacturing PMI in contraction territory at 48.5 and finally European Manufacturing PMI falling to 49.2 from 50.5.

Pockets of strength included robust wage growth in both the US and UK; Japanese, UK and US Services PMIs rising and above 50; European Retail Sales rising 2.2% in January; European Composite PMI rising above expectations and comfortably above 50 and the US IBD/TIPP Economic Optimism Index rebounding to 55.7 from 50.3 post the end of the government shutdown.

The three charts below show how weak Economic surprises have been of late. Just over a year ago we used the same chart to comment on how strong the surprises had been and how they often reversed to negative shortly thereafter. As we have said before, this time it is likely the opposite will hold true. It should also be noted that in absolute terms the UK numbers are not that good – it is just that expectations were even worse!

Chart One to Three. Economic Surprise Indices of US, Europe and the UK (in that order)

Source; Franklin Templeton, Factset as at 01/03/19

However, this continuing slowdown has been overshadowed by policy developments. Firstly, every major Central Bank has at the very least pedalled back from current/potential tightening and in China, India and Europe actual easing has taken place, to various degrees. Here in the UK Mr Hammond has promised a £26.6 billion “deal dividend” of extra fiscal spending should we have an agreed Brexit. Even in the US the Federal Reserve has strongly hinted it will aid liquidity by ending the shrinking of its balance sheet by year end – earlier than expected and by a lesser amount than originally envisaged. The other potentially momentous policy shift by the Fed was the renewed musings about changing to an average inflation target over a cycle. This would give the Central Bank the option of allowing inflation to run above target for a period of time if it were merely playing catch up after a period of undershoot. The Fed Chairman did stress discussions were at an early stage and a high bar would be set for change. However, given his dramatic shift between November and December, investors took note of this chink in the armour.

Secondly, as alluded to above, there now seems to be far less chance of a disruptive hard Brexit whilst US-Sino trade negotiations seem to be heading for a more amicable conclusion than anticipated in October. The US Government is now functioning again too, boosting confidence over there.

In addition to interest rate cuts the Chinese authorities have taken several other measures to arrest the decline in economic growth they have been engineering since late 2017. These include tax cuts for Corporates and Households, a reduction in VAT and direction (orders) from the PBOC for banks to increase their lending to small and medium sized companies (by 30% in the case of very large banks who have historically dealt primarily with state owned behemoths).

With regards to the very weak performance of Europe, the Kiel Institute for the World Economy said that temporary factors had cost the German economy €34 billion in the second half of 2018 and without these economic growth would have been 0.5% faster in both Q3 and Q4. They did add that they only forecast a modest 1% expansion this coming year.


Equities have generally been strong since the last commentary despite widespread profits downgrades. Bonds have also made (modest) gains on lower growth and inflation expectations across the globe.

Sterling has strengthened amidst volatile trading, following the slings and arrows of Brexit whilst other currency markets have been remarkably calm, with moves generally being less than 1%.

Despite the investor flows discussed below, developed Western markets have picked up the baton after a few months of Emerging Markets leading performance.

The table below shows performance of several key asset classes from the 31st of January until the close of Asian markets on the morning of March 18th UK time.

Figure 1. Percentage change in markets and currencies from 31st January 2019 to morning of March 18th 2019

Oil has recovered all of December’s swoon as Saudi led and cajoled OPEC (and partners) to implement a cut in production of 1.2 million barrels per day. Crude was also helped by fears of an imminent global recession fading somewhat. Iron ore hit a four year high but this was due to Vale’s mining tragedy rather than changes in demand or orchestrated supply actions.

As a general rule the performance of sectors has flipped in comparison with Q4 2018, with Technology, Industrials, Energy, Real Estate and Tobacco leading whilst the stalwarts of Healthcare, Consumer Staples and Utilities have been lagging.

Activity & Positioning

Since our last commentary at the end of January we took advantage of the strong markets and trimmed two positions after adding to risk assets during the downturn. This is in line with our long held practise. We also switched some Japanese exposure into UK equities as the UK market remains the most unloved market globally, domestic facing companies have been de-rated, the Pound looks to be stabilising and there is light at the end of the tunnel (hopefully not an oncoming train) regarding a Brexit resolution. Although we like the Japanese restructuring long term there are more near term headwinds this year for the Japanese economy and we don’t want to be overly exposed to equities, despite them being our favoured asset class.

Furthermore, one of the biggest changes we made within our UK equities exposure was to switch into the Woodford Income Focus Fund from the Woodford Equity Income Fund. We did this prior to the press furore when our ongoing analysis of the fund uncovered the fact unquoted and early stage company exposure had ballooned to nearly 20% from our soft limit of 10%. This was partly due to redemptions but nevertheless it is a level beyond which we are comfortable with. The Income Focus Fund actually increases both the yield we can garner and the UK derived revenue. These are two developments we are pleased with.

At least minor encouragement should be taken from the fact that the gargantuan Norwegian Wealth Fund has decided to up its weighting in all of UK equities, property and bonds. At least someone likes us, even if we don’t even like ourselves at the moment!

Several commentators are concerned that we have rallied hard year-to-date, pointing out that equities have had their best January and February since 1991, despite negative profit revisions. However, it should be pointed out (once again) that December was the worst (for US equities at least) since 1931 and equity funds suffered what the FT described as “an unprecedented” $100 billion of outflows “during the closing month of 2018.” The venerable RJIS strategist Jeff Saut (nearly 50 years in the markets) noted that all seven times since 1960 that equities have started the year in a similar manner to this they have made further gains through year end.

Sentiment has obviously improved and there could easily be a short term “sell on the news” in April but there is not universal optimism out there yet. For example, in January the UK had the lowest issuance of corporate bonds since 1995 whilst Europe has suffered continual outflows from equities. Indeed the week ending 13th February saw €5.9 billion flow out of European Equity Funds – the second highest number since 2000 – in what was the 19th consecutive week of money leaving the area. China has, however, enjoyed $9 billion worth of inflows in January and indeed Emerging Markets are now the most crowded long in the Bank of America Merrill Lynch fund manager survey after being a shorted asset class as recently as December.

In what has been a long running saga, one that keeps a lid on fund manager sentiment, HSBC reveal that in the first two months of the year a further $44 billion has been withdrawn from actively managed equity funds with $41 billion flowing into bond funds. Barclays chip in with the fact that over the twelve months to 28th February, $248 billion has flown out of active funds whilst $243 billion has been attracted into passive funds. Such inflows from indiscriminate buyers cause short term dislocations but create attractive long term opportunities and there are these aplenty at the moment.

Figure 2. Portfolio changes since 31st January 2019 – RJIS


So in conclusion, in tandem with economics being more or less the opposite position of early last year, so are Central Banks around the world. Last year the onus was very much on tightening and slowing things down. Now the “Central Bank Put” is back with almost every Central Bank trying to stabilise economies and financial markets.

Corrections are part and parcel of market cycles and we could very well have one soon, as postulated above. If it’s not “sell on the news” it could be a knee jerk reaction to potentially disappointing Q1 profits in a currently weak manufacturing and trade environment. However, led by China, then Asia and then Europe, growth will stabilise in the coming months in the absence of a breakdown in trade talks. This should enable equities to look ahead to easier comparisons in the second half of the year.

Best Regards,
Ian Brady
Chief Investment Officer

18th March 2019

Current Asset Allocation

Important Information/Risk Factors:
Past performance is not a guide to future performance and investment markets and conditions can change rapidly. Investments in equity markets will be more volatile than an investment in cash or fixed deposits. The value of your investment may go down as well as up. There is no guarantee you will get back the amount invested. If you fund invests in overseas markets, currents movements may affect both the income received and the capital value of your investment. If it invests in the shares of small companies, in emerging markets, or in a single country or sector, it may be less liquid and more volatile than a broadly diversified fund investing in developed equity markets.

The views expressed herein should not be relied upon when making investment decisions. The article is not intended as individual advice and if you require advice or further information you should contact us.

Copyright © Harpsden Wealth Management Limited 2019 (unless otherwise indicated). All rights reserved

Download the full commentary here