By Max Newman – Research Manager
Markets continued their general upward trend in the second quarter, enjoying the ‘comfort blanket’ once again provided by central banks. Both the US Federal Reserve (the Fed) and European Central Bank (ECB) have indicated that renewed monetary stimulus could be on the way should there be any further deterioration in economic data. Pricing in two rate cuts from the Fed and potential for further ECB quantitative easing, returns in Q2 were positive for both developed market equities and bonds. After four months of uninterrupted gains, there was a blip in May after trade negotiations between the US and China broke down. Investors had to contend with tariff increases on US imports from China, although plans from the Trump administration to slap tariffs on a greater value of imports were put on hold pending the G20 summit in Osaka, Japan.
In this context there has been a quite substantial narrowing of returns within equity markets towards “quality growth” stocks that, despite valuations being well beyond historical norms, are seen as defensive. In the UK this is best seen across Pharmaceuticals, Consumer Staples and even Tobacco. All of these companies have similar qualities – they have non-cyclical growth (albeit in the low single-digits), earnings stability and generally strong balance sheets. These companies now trade on very high valuations and we have become more cautious on this part of the market for this reason.
Focusing just on the UK for a moment, political uncertainty is affecting construction and manufacturing sectors, with survey data pointing to a contraction in activity. Services, the dominant driver of the economy, nevertheless remains resilient in light of solid wage growth. This is the likely reason for the Bank of England’s decision to hold interest rates at 0.75% and refusal to adopt a similar stance to the other main central banks. Despite this, the continued weakness in Sterling has been supportive for share prices in companies that derive a majority of profits from outside of the UK.
The world economy does indeed appear to have lost some momentum in the second quarter. Survey data implies that US growth slowed towards the weak pace already experienced elsewhere among advanced economies. I have previously highlighted that the slowdown appears to be more specifically related to global industry and this is again reflected by the decline in global manufacturing output over the period. Tariffs would be an obvious explanation for this but there are also specific factors at play such as weakness in the auto sector. This last point is best viewed through the German economy, which has softened somewhat in recent months. Past monetary stimulus in China also appears to have worked its way through and is dampening global GDP growth.
It may just be that this ‘synchronised’ global slowdown is due to the highly integrated nature of global industry. Looking more specifically at the country level, household consumption has help up reasonably well, perhaps unsurprising given tight labour markets and solid wage growth in developed markets. This may suggest that the manufacturing-led slowdown has not spilled over into general business confidence and employment. We continue to monitor this and US jobs data in July will be an important indicator on the health of the domestic US economy.