By Charlie Buxton, Investment Manager.
Geopolitical tensions continued to dominate the second quarter of the year as President Trump pressed ahead with his protectionist agenda.
In Europe Italian elections highlighted the ongoing rise of the populist movement. In the UK, unemployment data remains at a record low, although the lack of clarity on Brexit continues to overshadow investor sentiment.
One of the biggest questions facing the UK Government on leaving the EU is that of trade, with the British Chambers of Commerce publishing a list of twenty three ‘real world’ questions that it urgently needs answers to. With business sentiment already fragile and the increasing risk of leaving the EU without a deal (a ‘hard’ Brexit), many firms – including Airbus and BMW – have warned that they could relocate production abroad. Although the macro-economic picture is encouraging with wage data continuing to improve, any interest rate increases are likely to remain gradual until greater clarity on Brexit is attained. That said, the FTSE All-Share returned 9.2% as weaker Sterling benefitted the more export focused larger companies. (A weaker Sterling typically benefits companies which have strong global revenues, as the value of their revenues are worth more when converted back to Sterling.)
Further signs of the growing right wing influence in Europe gathering momentum came with the formation of a coalition from the Five Star Movement and Lega parties, prompting a strong sell off in Italian bonds and 10 year yields spiking to over 3% (resulting in higher funding costs for Government spending.) Market concerns centred on the likely fiscal indiscipline of the new coalition, as well as its anti-Europe stance which could further derail the European project. Towards the end of the quarter, the European Central Bank announced its plans to fully unwind Quantitative Easing by the end of the year, in addition to committing to keeping any interest rate hikes on hold until the summer of 2019. Whilst this could be viewed as a sign of the increasing resilience of the European economy, political concerns in both Italy and Spain (under new leadership), not to mention Greece’s bludgeoning debt piles, are likely to keep markets cautious.
Further afield, a strong US economy gave the Federal Reserve the confidence to raise interest rates again in June and to signal two further rate hikes to come this year. Retail sales data shrugged off a first quarter blip and reported growth by over 6% year on year in May, whilst unemployment fell to 3.8% – the lowest level since 1969. Providing further evidence of the strength of the US economy, the US ISM Manufacturing index beat expectations, hitting a four month high in June. The positive data was reflected in the S&P 500’s 3.4% local currency return or 9.9% return when converted back to Sterling. Whilst these figures reflect a buoyant economy, the most obvious threat remains that of its ongoing trade disputes with China which could lead to weaker equity markets and increasing corporate cautiousness.
The same threat of protectionist agendas through trade wars also impacted Emerging Markets (‘EM’) over the quarter, with Turkey and Argentina finding themselves at the forefront of investor concerns. The stronger Dollar also impacted EM as investors re-allocated monies into the US in anticipation of faster interest rate rises from the US. With both the US and Argentina exposed to large amounts of Dollar debt – more so than other EM economies – a stronger Dollar means that servicing those debts becomes all the more expensive. Whilst our outlook on Emerging Markets remains positive, the short-term headwinds are clearly apparent as geopolitics dictate market sentiment. Japan too – returning 3.8% in Sterling terms – remains an attractive investment opportunity and we continue to believe that the corporate governance cycle is changing for the better, with a growing emphasis on higher shareholder returns.
Overall, the second quarter of 2018 highlighted the challenges faced by investors as Central Banks slowly start to change policy, ongoing trade disputes risk escalation and the rise of populist movements continues in Europe. The importance of a well-diversified portfolio has become increasingly evident and we continue to believe that – at both sector and geographical levels – the portfolios are well insulated to navigate these uncertain times.