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Monthly Market Commentary - January 2020

Global shares returned 3% in December and 9% over the final quarter although this was largely eroded by an 8% rise in sterling to $1.33 for UK-based investors. While the decisive Conservative election victory helped the FTSE 100 gain 196 points last month to 7,542, the total return of 3% (including dividends) lagged trade-related rallies in the US, Japan and Asia (9%) and the eurozone (5%).

Despite periods of extreme volatility, 2019 was one of the best years for equity returns in three decades with Wall Street closing at an all-time high. An early rally spurred by the Federal Reserve’s pivot towards looser monetary policy was followed by a lengthy consolidation as slowing global growth raised fears of recession and the US/China tariff war escalated. A potential ‘Phase 1’ trade deal alongside further support from the Federal Reserve and European Central Bank led to a strong fourth quarter as investors looked beyond flat corporate earnings and Brexit uncertainties.

In local currency terms, global equities returned 28% – over 30% in the US and 27% in the eurozone. Returns of around 20% in the UK and Japan were more modest although the domestically focused FTSE 250 mid-cap index gained 29%. Asia and emerging markets faced global trade headwinds but still returned around 16% for sterling investors.

Despite a rollercoaster year, UK gilts returned around 6% – well ahead of inflation at 1.5% (CPI). Yields on conventional gilts – predominately influenced by global markets rather than Brexit – dipped to 0.35% in early September before rising to 0.84% or 0.4% below where they were at the start of 2019. Index-linked breakeven rates fell sharply after the election while corporate bond spreads (the difference between government and company borrowing costs) fell.

Commercial property declined an estimated 3% with increasing structural challenges for retail property detracting from more stable returns from the industrial and office sectors. Measures by OPEC and other oil exporters to limit shipments boosted Brent crude 30% to $66. Gold rose nearly 20% to $1,517 reflecting safe-haven buying fuelled by geopolitical tensions and renewed quantitative easing.

An increasingly uncertain economic backdrop during the year reflected the ‘normalisation’ of US interest rates, tension between the US and China and fears that the yield curve inversion signalled an end to the current expansion. The change to Federal Reserve policy – interest rates were cut three times between late July and 30 October to 1.5% and its balance sheet expanded – combined with a strong labour market and robust consumer spending avoided a US recession.

However, 2019 global growth of 2.6% was below expectations in both the advanced economies (1.7%) and emerging markets (3.9%). Manufacturing orientated economies were hardest hit with the eurozone and Japan expanding 1% while prolonged Brexit uncertainty reduced UK GDP growth to a similar level – the lowest for a decade. China held up reasonably well at 6% as the transition to a self-reliant economy makes it less dependent on exports. Most Asian economies – particularly India which also faced political challenges – experienced slower growth despite production being reallocated away from China to avoid higher tariffs.

Business surveys towards the end of the year suggested that the widespread decline in global manufacturing was starting to stabilise, although a meaningful cyclical upturn appeared unlikely unless trade tariffs were rolled back. Given unemployment at near record low levels, wage rises have been surprisingly contained and, while 1.4% industrialised world inflation (CPI) was slightly higher than expected, it remained well within the 2% targeted by central banks. This allowed accommodative monetary policy to be maintained or expanded and all the major economies ended 2019 with negative real interest rates. However, another year of nominal rates close to zero means politicians are under increasing pressure to implement new fiscal measures in order to avoid stagnation.

The Brexit impasse led to December’s general election where the Conservative party gained a sizeable majority. Despite a collapse in new investment and falling exports, consumer spending has been underpinned by a strong labour market with record numbers in employment. Interest rates remain unchanged at 0.75%. Short sterling positions were unwound in the fourth quarter but Boris Johnson has been quick to rule out extending the transition timetable beyond the end of 2020, leaving the government little time to negotiate a new trade agreement with the EU. Continuing trade uncertainty and the lack of new initiatives since the 2016 referendum suggests that the government will use its majority to expand fiscal policy and rebalance the economy to minimise the fallout from Brexit.

Global corporate profits were unchanged in 2019 with modest increases in the US and eurozone offset by declines in the UK, Japan, Asia and emerging markets. However, many companies – notably healthcare, pharmaceuticals, financials and software that also benefitted from share buybacks – increased earnings with the detractors narrowly concentrated in the energy, materials and telecoms sectors. Those demonstrating consistent “growth” characteristics again outperformed cheap “value” companies, despite some signs of rotation at the end of the year. Dividend growth – rather than high yield – was also a winning characteristic.

Assuming the US and China sign a ‘Phase 1’ trade deal on 15 January, the decade long economic cycle should continue with GDP growth stabilising around current levels. However, the deal is unlikely to remove uncertainty as it is expected to include only a limited rollback of existing tariffs and a “snap-back” clause. Meanwhile, US fiscal policy will act as a slight drag and the Federal Reserve will again be under pressure to cut rates.

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