Market review - are investors right to be spooked?

Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, discusses the drivers of recent market volatility and implications for the global economy. He also looks at ongoing trade issues, interest rates and whether new age industries can continue to outperform old world industrial stock.

October’s global market sell off has certainly spooked some investors, while international trade and political tensions have worsened. Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, considers if market volatility is a sign of things to come and how the relationship between the US and China is impacting the global economy. He also takes a closer look at inflation and discusses whether new age industries can continue to outperform old world industrial stock.

Market volatility – October curse or bad omen?

The recent sell off in the markets has caused investor concern with some suggesting we’re nearing the end of the investment cycle. There’s a famous Mark Twain quote: “October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”

Twain was quite right that any month can experience volatility but October is well known among investors because of some of the more memorable events, such as the October 1987 crash.

However, we don’t think that the current high levels of market stress are a sign that the investment cycle is coming to an end. At Aberdeen Standard Investments, we continue to examine the situation closely. Although the global economy is slowing, there are very few signs that recession lies ahead - not before 2020 or even 2021 unless the US and China make some major policy errors.

We did highlight earlier this year that after a long period of rather calm markets, as experienced in 2016-17, it was likely that 2018 onwards would see a return towards more normal levels of market volatility. These provide buying and selling opportunities rather than ‘buy and forget’ styles of investing.

Time’s up for tech

New age industries have steadily outperformed old world industrial stocks this year but there are signs that the market place is evolving. Richly valued share prices are one of the reasons why the technology sector has sold off so much in this latest correction. We’ve seen the Nasdaq index fall well over 10% from its August peak. In the current earnings season, the technology companies who missed investor expectations were punished very sharply, while those who demonstrated that they could still create good revenue and earnings growth fared better.

Looking across all sectors, not just technology, it’s clear that many investors are still looking for growth in a slow growth world, so we’ve seen sectors such as healthcare attract attention.

One of the advantages of a sharp fall in share prices is the opportunity to buy attractive assets. That’s true of any sector, and one of the reasons we’ve selectively been buying into oversold emerging market assets in recent weeks.

Further Fed action ahead

We’ve seen US inflation rise steadily to 2.3%, and wage pressures have reached 2.8% year on year. There’s no doubt the US Federal Reserve (Fed) needs to take action. The question is – will the US central bank’s decisions frighten or reassure the market?

Investors have been told by Fed Governors to expect another two to four rate moves in 2019, depending on how dovish or hawkish the particular Governor is. At present all the signs suggest that companies will only pay moderate wage increases in the current environment, while technological factors help to keep underlying inflation under control.

If the Fed becomes aggressive, then we should certainly worry but while it remains on its current path we should not be unduly concerned.

US and China relations

In late November, President Trump should meet President Xi of China at a G20 conference. Markets are looking to this event with interest.

After a series of quite aggressive speeches from a range of US politicians about America’s relationship with China about trade, intellectual property, technological developments and regional defence – will there be some rapprochement?

For now, day to day volatility in financial markets is swift in its response to newsflow about this important economic relationship.

A slow period for China

China has experienced the slowest third quarter growth since the global financial crisis.

It’s worth noting though that China itself played a key role in this slowdown.

The Chinese government allowed a very sizeable build up in public and private sector debt over the past few years. Throughout 2017 and 2018, steps were taken to regulate parts of the financial sector much more rigorously and some of the impact has been seen in fewer housing and car sales.

Of course some of President Trump’s tweets about trade have worried Chinese companies and probably discouraged many of them from investing more in China – in some cases even encouraged them to move production capabilities to other countries like Vietnam. However, the main cause of the slowdown is domestic policy.

While it’s right for investors to be concerned there is good news; the government has recognised the negative feedback loops and has recently taken a variety of steps to begin to stabilise the economy and market. Its efforts in coming months will matter for China and many other economies too.

Europe, Brexit and interest rates

Despite all the volatility in financial markets, the European economy is displaying sufficient growth to bring wages and hence inflation slowly higher.

Hence the European Central Bank (ECB) has made it clear that it will halt its quantitative easing bond buying programme at the end of the year and raise interest rates in the second half of 2019. That’s assuming, of course, there are no further shocks to global trade.

There are still some risks ahead though: a disorderly Brexit in March would hurt regional activity, while the Italian government is certainly testing the system with its plans for a large budget deficit. But all in all, the ECB remains reactive, not proactive, to global events.

For now, at Aberdeen Standard Investments we’re wary of European bond markets and prefer European equities against this particular backdrop.

Budget 2018

The Chancellor approached this Budget with many of the most important decisions affecting the public finances already made for him, or at least out of his hands. The Prime Minister had already announced the “end of austerity” and a £20.5 billion increase in NHS spending by 2022.

As a result this Budget saw few changes to the UK savings market and markets didn’t move significantly – an outcome that the Chancellor is likely to be happy with. It was also delivered in the context of a global economy that, while growing, is experiencing a lessening of the benefits brought by quantitative easing and low interest rates. Therefore we’d expect the outcomes of events beyond our shores and the looming impact of Brexit to have more influence on UK markets than the Chancellor’s announcements.

The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your clients’ investments can go down as well as up and may be worth less than was paid in.

The information here has been provided by Aberdeen Standard Investments and is based on their understanding in November 2018.

Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments.

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