Risk assets continued to perform well in November and – having largely recovered from the late summer setback – are on track to record strong gains this year. The combination of supportive financial conditions, renewed central bank asset purchases, better than expected corporate profits and positive news on a Phase 1 US/China trade helped allay fears that the US economy is heading for recession.
Global equities returned 2.6% over the month as the US market gained 3.5% and moved onto new highs. A recovery in cyclical stocks supported a 2.6% rise in continental Europe. The FTSE 100 lagged – up 98 to 7,346 – although mid-cap companies continued their strong run with a return of over 4%. Japan, Asia and emerging markets also recorded modest gains.
A slight steepening of the yield curve saw 10 year yields rise to 1.74% in the US, -0.34% in Germany and 0.7% in the UK. Diminishing fears of a hard Brexit-induced spike in inflation resulted in a sharp fall in break-even rates on indexlinked gilts. After appreciating sharply in October, sterling closed unchanged against the dollar at $1.29. Brent crude recovered to $62 per barrel, reflecting pricing discipline and the prospect of more OPEC production cuts. Gold fell 3% to $1,473.
The global economic backdrop continues to soften but sentiment indicators – especially for manufacturing – have been slightly better than expected, although they are still in contraction territory. Like the rest of the world, the US is suffering from the global trade downturn but the ISM manufacturing survey stabilised in November after six months of decline. An upward revision in Q3 GDP, the ending of the autoworkers’ strike, an uptick in aircraft production and a bounce in durable goods all helped sentiment, while a sharp drop in imports improved the trade balance. Consumption remains the main GDP driver and – albeit confidence surveys are giving mixed messages – unemployment is low, jobs growth is solid, wages are rising at 3% and interest rate cuts have bolstered the housing market.
Consumers are also the principal contributor to growth in the eurozone, where confidence has held up despite the downturn in manufacturing and trade. While manufacturing remains weak across the region, Germany’s November PMI showed its largest rise for two years. While it remains deep in contraction territory, the forward orders component indicates a turning point may be approaching. Manufacturing in France also flagged a small improvement. The eurozone services PMI is still in expansion territory and other confidence surveys, such as the German ZEW, also point to some stabilisation.
Japan faces similar external challenges to Germany and should also benefit from any upturn. However, unlike the eurozone, consumption is sluggish and is being impacted by the consumption tax increase.
While there may be signs of manufacturing stabilising, investors remain cautious about the outlook for China and India, with both economies continuing to slow. The outlook for China is still challenging despite optimism on a Phase 1 trade deal. This may not materialise until close to the US presidential election and is unlikely to resolve more contentious issues such as subsidies to Chinese state-owned enterprises (SOEs) and the transfer of technologies. The best markets can probably hope for is that a partial agreement will forestall the next round of tariffs and a further deterioration in global trade and GDP. Meanwhile, the change to internal policy in China from private enterprise to carefully targeted monetary and fiscal measures that favour SOEs could dampen demand.
UK economic growth has stalled and weakness in manufacturing is now spreading to services. Disappointing October retail sales and a softening labour market indicate that Q4 GDP will be flat. Polling suggests the general election will give Boris Johnson a majority with a Labour minority government or hung parliament the less likely outcome.
A Conservative majority could mean an orderly resolution of Brexit followed by trade negotiations during the transition – although finalising these by late 2020 appears unrealistic given that EU trade talks last seven years on average. However, assuming the Conservatives do not opt for a “no deal” exit – 45% of UK exports are to the EU and represent 16% of GDP – a combination of improved consumer confidence and mild fiscal stimulus (equivalent to 0.5% of GDP) could lead to higher economic activity and a modest appreciation in sterling. To a large extent, financial markets are discounting this scenario so any other outcome is likely to have an adverse impact on markets.
In the absence of a meaningful US/China trade deal, global growth is expected to be around 2.7% again. Emerging market GDP growth of just over 4% will again exceed a projected 2% for advanced economies. This year’s dramatic shift in monetary policy will not be repeated although financial conditions and fiscal policy will remain supportive.
Global corporate profits – which have been held back by the energy, industrials and semiconductors sectors – will increase by just 1% this year so 2020 should see an improvement. However, expectations of a 10% rise based on a strong cyclical upturn could prove over-optimistic. With equity yields at higher absolute levels than sovereign bonds, the most attractive companies are those able to increase their dividends from cash flow.