April Commentary: April Showers More Gains on Equities

9 May 2019

At the end of last year, we correctly forecasted that global equity markets were poised to robustly recover from their late December lows.

Snapshot

  • The global stock-market recovery that defined early 2019 extended into April. Major developed-market government bond rates generally increased and oil prices climbed.
  • The UK and EU moved the Brexit deadline to 31 October, requiring the UK to hold European parliamentary elections in late May.
  • In a world where the best- and worst-performing asset classes tend to dominate headlines, it can be easy to forget that diversification has historically been a reliable approach for meeting long-term investment objectives.

The global stock-market recovery that defined early 2019 extended into April.

Major developed markets — the UK, Europe, the US and Japan — climbed steadily throughout the month.

Emerging markets also gained, but performance diverged in China, with Hong Kong slightly higher and mainland stocks essentially flat after a late-month selloff. Intermediate- and long-term government bond rates generally increased in the UK, eurozone and US, while short-term rates were mixed, resulting in steeper yield curves. Oil prices advanced for the full month, but peaked in late April before retreating a bit.

The UK and EU set a new Brexit deadline in early April, moving the UK’s departure from the EU to 31 October and requiring the UK to hold European parliamentary elections in late May. Citizens of England and Northern Ireland prepared for early May local elections as well; Conservatives appeared set to lose ground in polls for both elections, although by considerably more in EU elections as the new ascendant Brexit Party has sought to gain vote share. Tory-Labour negotiations in pursuit of a digestible Brexit solution continued into May, revolving around a customs union between the UK and EU (which is a must-have component of any Labour agreement but represents a deal breaker for many Tories) and a “Final Say” referendum (which would give voters the right to approve or deny the deal and is popular among party members but, on its own, does not have top-level Labour Party approval).

US-China trade talks continued through the end of April — touching on foreign access to Chinese markets — with China’s negotiators showing willingness to remove some ownership caps, lower barriers to entry in the financial sector, and allow agreements to apply outside of geographically limited free-trade zones. Subsidies for Chinese companies remained a point of contention, however, since China’s negotiators contend that a complex web of local, regional and country-level development initiatives makes enforcement intractable. Talks also covered whether and how far to remove tariffs erected by the U.S. and China against one another last year, and mutually agreeable enforcement mechanisms appeared to take shape as talks progressed. A Chinese trade delegation is scheduled to visit Washington, DC beginning on 8 May.

Elsewhere, Indians began casting votes in April for parliamentary elections that last more than a month and represent the largest democratic exercise on the planet. Early vote counts from April elections in Indonesia, the world’s fourth most populous nation (according to the United Nations), appeared set to grant President Joko Widodo a second term and deliver the largest share of seats in the legislature to his Indonesian Democratic Party of Struggle. Spain’s late-April election strengthened a governing centre-left coalition, and South Africans prepared to head to the ballot box on 8 May.

A small subset of the Venezuelan military publicly backed the opposition amid protests that began on the last day of April, amid a growing stream of military desertions across the border to Colombia and, to a lesser extent, Brazil. Volodymyr Zelensky, winner of Ukraine’s run-off presidential election in April, was forced to contend with an offer of citizenship from Russia to Ukrainian citizens living in the war-torn eastern regions of Ukraine under separatist control. The president-elect — in a statement posted to Facebook on 27 April — made a counter-offer of Ukrainian citizenship to “all people who suffer from authoritarian and corrupt regimes” and “to the Russian people who suffer most of all.”

Central Banks

  • The Bank of England’s Monetary Policy Committee did not meet during April, and voted unanimously on 2 May to abstain from any policy changes. Committee guidance retained a bias toward a higher Bank rate in the future, depending on the Brexit outcome.
  • The European Central Bank’s Governing Council also did not meet to address monetary policy in April, but minutes released from its March meeting showed that some members were interested in extending a hold on benchmark rate increases through the first quarter of 2020 (rather than the end of 2019) given a questionable outlook for the eurozone economy, although this did not come to pass.
  • The U.S. Federal Open Market Committee began its latest meeting on the last day of April and announced no new policy actions on 1 May.
  • The Bank of Japan held monetary policy steady in April with a zero-percent target for the ten-year Japanese government bond. It lowered the inflation target for 2020 and overall economic growth projections for 2019 and 2020.

Major Index Performance in April 2019 (% Return)

Chart: Major Index Performance in April 2019

Yellow: Fixed income. Orange: Equities. Sources: FactSet, Lipper. See “Corresponding Indexes for Fixed-Income Performance Exhibit” in the Index Descriptions section for more information.

Regional Equity Performance, April 2019 (% Return)

Chart: Regional Equity Performance in April 2019

Sources: FactSet, Lipper. See “Corresponding Indexes for Fixed-Income Performance Exhibit” in the Index Descriptions section for more information.

Economic Data

  • British retail sales volumes showed strength in April, rebounding from a soft March, and a promising projection for May. Manufacturing conditions cooled in April following a spike during the prior month. The services sector, meanwhile, maintained pace in April after contracting in March. The UK clamant count unemployment rate edged upward again in March, to 3%; average year-over-year earnings growth for December-February increased to 3.5%, while the UK unemployment rate remained unchanged at 3.9% for the three-month period.
  • Eurozone manufacturing conditions contracted again in April, while an early estimate of services sector activity showed continued modest growth. The unemployment rate edged down to 7.7% in March due to large labour-market gains in Italy and Spain, which have struggled with higher unemployment. The broad eurozone economy grew at a 0.4% quarterly rate in the first quarter, improving on the results of recent quarters.
  • US manufacturing activity expanded at a measured pace in April, while services sector growth slowed. Inflation, as measured by the core personal consumption expenditures price index — the US Federal Reserve’s (Fed) preferred measure — continued to edge lower in March, touching 1.6% year over year. The US economy grew at a 3.2% annualised rate during the first quarter, surpassing the fourth quarter and handily beating expectations.

Our View

At the end of last year, we correctly forecasted that global equity markets were poised to robustly recover from their late December lows. We assumed the sharp price correction sustained during the fourth quarter overstated the weakness in economic fundamentals and various uncertainties that plagued markets throughout much of 2018. We firmly believed that most global equity markets were deeply oversold.

Today, there’s no denying that a synchronised global growth slowdown is underway. However, it does not mean that the global economy is in recession or that it will soon fall into one. China and the UK, for example, are the second and fourth worst-performing countries, according to the Organisation for Economic Co-operation and Development’s composite leading indicators. Yet China continues to post gross domestic product growth in the vicinity of 6%, while the UK recorded an increase of 1.3% last year (both in inflation-adjusted terms).

The spread between 3-month and 10-year US Treasurys briefly went negative in March after narrowing throughout much of the expansion. Recession historically occurs within 12 to 18 months of the yield curve either narrowing to 25 basis points or inverting. The only time recession did not follow a yield-curve inversion was in the 1966-to-1967 period—although US economic growth slowed dramatically.

Deeper recessions usually cause sharper share-price declines (as was the case in 1973). More expensive stock markets (as seen following the 1998-to-2000 tech bubble) also are more vulnerable. But the time between an initial yield-curve inversion and the emergence of a bear market can be extremely long.

The Fed’s change in rhetoric at the start of the year certainly has been a helpful catalyst in sparking the risk-asset rally and credit-spread narrowing. By stressing patience and data dependence, the US central bank signalled that the pace of US interest-rate increases will slow considerably from that of the past two years. The Fed’s decision makers approvingly noted that the benefits of the long economic expansion are finally being distributed more evenly as the labour market tightens; they seem confident that the economy can grow without generating worrisome inflationary pressures, even as most measures of labour-market activity point toward accelerating wage inflation.

Regional Equity Performance, April 2019 (% Return)

Chart: Regional Equity Performance, April 2019

Yellow: Countries. Orange: Regions. Sources: FactSet, Lipper. See “Corresponding Indexes for Regional Equity Performance Exhibit” in the Index Descriptions section for more information.

Global Equity Sector Performance, April (% Return)

Chart: Global Equity Sector Performance in April 2019

Yellow: Defensives. Orange: Blends. Red: Cyclicals. Sources: FactSet, Lipper. MSCI ACWI Index Sector Components (Cyclicality determined by SEI).

We see plenty of opportunities in emerging equities as investors gain confidence that the worst is behind us for the asset class. But a sustained improvement depends on better global growth. In our view, China is the linchpin; we are optimistic that the country’s economic conditions will improve as it begins to feel the lagged impact of easier economic and monetary policies. We also expect domestic political pressures will likely force the Chinese government to ease further. Those political pressures certainly are influencing China’s trade discussions with the US. Meanwhile, President Trump is grappling with similar pressures on the American side of the negotiating table; he does not want the US economy to sputter or the stock market to turn down as the country heads into a presidential election year. To put it bluntly, the leaders of both countries need a “win.”

While many view the delay in finalising a trade deal as a bad sign, we see it as a sign that both sides are willing to grapple with the hard, substantive issues that would make a broader, more meaningful agreement.

We therefore think China and the US could reach a broader trade agreement than most observers currently expect. This is a more optimistic view than we expressed three months ago. Since that time, the Trump administration has deferred tariff increases. Both sides now recognise the damage that the trade standoff has caused to their respective economies and financial markets. While many view the delay in finalising a trade deal as a bad sign, we see it as a sign that both sides are willing to grapple with the hard, substantive issues that would make a broader, more meaningful agreement.

A more expansive trade agreement would provide a much-needed boost to the Chinese economy. It also would benefit nations that have high export exposure to China, both directly and through the supply-chain network. MSCI Emerging Markets Index performance will depend on the economic fortunes of China, South Korea and Taiwan, which now account for 57% of its market capitalisation.

Investor pessimism about Europe appears overwhelming. The European Central Bank recently cut its forecast for 2019 eurozone gross domestic product growth to 1.1% from 1.7% just three months earlier. It’s a wonder that the year-to-date performance of European equities managed to nearly keep pace with that of US equities.

Many of Europe’s problems are structural and difficult to improve. Its demographic profile, for example, looks rather bleak. Europe is the only major region where the population is expected to contract between now and 2050. The unemployment rate for Europeans aged 25 to 29 is still in double digits (by comparison, the average annual unemployment rate in the U.S. for this age group is approximately 4%). Of course, demographics alone do not explain Europe’s poor economic performance. A well-developed welfare state has its costs in the form of high taxation, extensive work rules, and regulations.

Bottom-up analysts expect UK earnings to decelerate to just 1.8% in 2019, which is in stark contrast with last year’s surprisingly strong rate of 10.9%.

The shadow of a looming trade war with the US surely hasn’t helped sentiment in Europe. We doubt tariffs will be imposed on European autos, but headline risks may continue to have negative impacts — and it’s still possible that Trump will turn his full attention to trade with Europe once his administration concludes negotiations with China. Speaking of which, China’s slowdown is an additional factor behind the slide in Europe’s exports. Not only was European industrial production in decline for the 2018 calendar year, but it started this year 23% below its January 2008 level.

The EU extended the Brexit deadline (to 31 October) for the UK to decide on its course of action. A longer delay could entail another referendum or even a change of government. It also means that the UK must participate in EU Parliament elections starting 23 May.

In our view, the best-case scenario is one in which the UK maintains close ties to the EU through a customs union. Failing that, now that voters have a better understanding of the costs and consequences of leaving, we think a second referendum either on Brexit alternatives or on Brexit itself makes sense. However, a referendum on reversing Brexit would risk political upheaval given the number of people who still support the divorce. Both Prime Minister May and UK Parliament will also have to reverse their stated positions. It would be nice to say that a no-deal Brexit is off the table, but that’s not the case.

The uncertainty surrounding Brexit outcomes and timing remains a depressant for economic growth in the UK and the rest of Europe. Bottom-up analysts expect UK earnings to decelerate to just 1.8% in 2019, which is in stark contrast with last year’s surprisingly strong rate of 10.9%.

The plunge in risk assets during the fourth quarter and subsequent bounce back in the first quarter of this year is a reminder that one should always expect the unexpected when it comes to investing. Cash was king in 2018, providing a 2.1% return. However, cash was consistently one of the worst performers in most other years going back to 2009. Emerging equities fell at the other end of the performance spectrum in 2018, sustaining a total-return loss of 14.6% — but was the strongest category in 2017 and posted a double-digit return in 2016.

In a world where the best- and worst-performing asset classes tend to dominate the headlines, it can be easy to forget that diversification has historically been the most reliable approach for meeting long-term investment goals — especially when looking through the lens of risk-adjusted returns. While a diversified portfolio rarely wins from one year to the next, it also rarely loses — and therein lies its beauty.

* All references to performance are in US dollar terms unless otherwise noted. 

 

Glossary of Financial Terms

  • Dovish: Dovish refers to the views of a policy advisor (for example, at the Bank of England) that are positive on inflation and its economic impact, and thus tends to favour lower interest rates.
  • Federal-funds rate: The federal-funds rate is the interest rate at which a depository institution lends immediately-available funds (balances at the US Federal Reserve) to another depository institution overnight in the US.
  • Price-to-earnings ratio: The price-to-earnings ratio is the ratio of a company’s share price to its earnings over the past 12 months; it can be is used to help determine whether a stock is undervalued or overvalued.
  • Quantitative easing: Quantitative easing refers to expansionary efforts by central banks to help increase the supply of money in the economy.
  • Yield curve: The yield curve represents differences in yields across a range of maturities of bonds of the same issuer or credit rating (likelihood of default). A steeper yield curve represents a greater difference between the yields. A flatter yield curve indicates that the yields are closer together.

Corresponding Indexes for Major Index Performance Exhibit

  • MSCI ACWI ex-USA Index: The MSCI ACWI ex-USA Index includes both developed- and emerging-market countries, excluding the US.
  • MSCI Emerging Markets Index: The MSCI Emerging Markets Index is a free float-adjusted market-capitalisation-weighted index designed to measure the performance of global emerging-market equities.
  • MSCI World Index: The MSCI World Index is a free float-adjusted market-capitalisation-weighted index that is designed to measure the equity market performance of developed markets.
  • Bloomberg Barclays Global Aggregate Index: The Bloomberg Barclays Global Aggregate Index is an unmanaged market-capitalisation-weighted benchmark that tracks the performance of investment-grade fixed-income securities denominated in 13 currencies. The Index reflects reinvestment of all distributions and changes in market prices.
  • Bloomberg Barclays Global Aggregate ex-Treasury Index: The Bloomberg Barclays Global Aggregate ex-Treasury Index is an unmanaged market index representative of the total return performance of ex-Treasury major world bond markets.
  • Bloomberg Barclays Global Treasury Index: The Bloomberg Barclays Global Treasury Index is composed of those securities included in the Bloomberg Barclays Global Aggregate Index that are Treasury securities.

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