Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, considers what current events mean for investors and what the implications are for the global economy.
Tensions between the US and China appear to have diminished as President Donald Trump and his Chinese counterpart, Xi Jinping, reached a trade war truce. Politics remains a market driver though. In the UK, the prospect of a no-deal Brexit hangs in the air, while emerging markets are responding to political strains between the US and Iran. Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, considers what these mean for investors and what the implications are for the global economy, especially whether the US central bank will soon cut interest rates.
We’ve definitely seen financial markets waxing and waning as they’ve responded to a series of mixed messages from various politicians and officials in the US and China.
An important set of negotiations has been taking place partly behind closed doors and partly in public, with both sides needing to reach a deal which ‘saves face’ and can be sold to key supporters.
On 29 June, US President Trump and Chinese President Xi Jinping struck a trade war truce, as Washington vowed to hold off on further tariffs and declared trade negotiations with China to be ‘back on track.’
The key thing for investors to remember is that even though trade matters have been put to bed for the time being, there are still many other difficult issues between the two countries that need to be sorted out. The whole debate about 5G and Huawei is just one example.
All in all, we believe the ongoing rivalry between the US and China is one reason to dial down risk levels slightly in portfolios – and be ready for bad news at some point especially as the US election approaches.
Tensions between the US and Iran have risen after the downing of a US drone and attacks on tankers in the Gulf of Oman. This escalating rivalry is having some effect on emerging market assets in general, and particularly in the Middle East.
Higher and lower costs of energy can have an impact on everything from the attractiveness of commodity and oil producers, and oil services companies, to tax revenues and household disposable incomes.
At Aberdeen Standard Investments, our models of the oil market suggest that in the short term the geopolitical risks in the Middle East are likely to push the oil price towards the top of its trading range. However, as we move into 2020, it’s likely that there will be fewer barriers to the US exporting oil, as it becomes more able to deliver shale oil to overseas customers. This should reduce oil prices within their trading range.
Facebook has been making the headlines again, this time with the announcement of a digital currency called Libra that will allow billions of users to make financial transactions worldwide. If this new cryptocurrency is launched next year it poses a number of questions for regulators, major banks and financial institutions.
Key issues include how to prevent money laundering, how to guarantee the safety of any savings, how to ensure the reliability of the trading system and how to prevent cyber-attacks.
Central banks, such as the Bank of England, have been considering digital currencies for some time. In countries which already have a mainly cashless economy, such as Sweden, the benefits are recognised. For example, removing cash from an economy can provide a small but definite boost to economic activity, and allow transactions and savings flows to be monitored much more closely.
For now though, the format proposed by Facebook isn’t backed by any government – it’s simply an electronic form of the dollar. The form in which money is held and used does change over time. But there are dangers of moving too quickly, as many a financial crisis over the years has shown. Expect the regulators to look at Libra very closely.
Gold reached a six-year high in June as we saw investors take shelter from market volatility. However, we’ve also seen bond markets and equity markets hit new highs. As these aren’t typically correlated, investors need to look more closely.
At times there are common drivers for what’s happening in financial markets, at other times we must look at different factors. At the moment, I suggest that one factor is dominant – interest rate decisions by the major central banks.
As global trade growth has slowed and the manufacturing sector recession has become more widespread, so central banks in the US, Europe, China, Australia and India have signalled that they’ll either cut interest rates or provide more liquidity to the global economy via quantitative easing (QE).
A world of flat or even negative yields is highly supportive of the gold price, especially if there are rising geopolitical risks as well. We’re seeing stock markets take advantage of a revaluation effect at present. As long as central bank actions can ensure profits growth ahead, then lower interest rates will boost share prices.
Of course it’s important to remember that financial markets can quickly swing from one paradigm to another.
A deeper recession, a rapprochement between the US and China, or a rise in inflation would all lead to different moves in bonds, gold and share prices.
Will we see a deal or no deal? The answer to this question varies day by day depending on the latest statements from the candidates in the Conservative party leadership election, analysis of what they actually meant, and surveys of voting intentions.
Scenario analysis is needed on a range of possible outcomes. If it’s a no deal, will we see a second referendum, an extension of Article 50, another election or some other outcome? Even the terms ‘hard’ or ‘soft’ Brexit need to be defined carefully as the devil is in the detail.
All in all, we continue to point to sterling against the US dollar or the euro as a good measure of how much concern is priced into the market place. For now we think the probability of an outcome which would be poor for the UK economy has largely but not wholly been priced in.
In June, Federal Reserve chief Jerome Powell issued the strongest signal yet that the central bank would soon cut interest rates. What does this mean for investors?
A cut in interest rates by a central bank can be interpreted in one of two ways. At present the markets are taking a positive view. As a moderate slowdown has been seen in the global economy, largely caused by political risks, then a move or two by the US central bank is an insurance policy intended to extend the business cycle and remove the pain from trade tensions between the US and other countries. In other words, lower interest rates provide a positive boost to the valuations of other assets, such as share prices, real estate and high-yielding bonds.
The danger for investors is that central bank rate cuts are also often associated with slow growth, or even recession. After all, why else is the central bank acting? What does it know that we don’t?
This explains why the Federal Reserve has been at great pains to explain that it will be cautious, not hurried, that inflation is under control and it can act in a suitable manner to support the economy. A solid start to equity markets in the first half of 2019 suggests most investors trust them to do the right thing.
The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your client’s investments can go down as well as up and may be worth less than you paid in. Information is based on Aberdeen Standard Investments’ understanding in July 2019.