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Market Review – Q3 2018

By Charlotte Aspinall, Head Of Investment Management.

Investors continued to experience significant volatility in the third quarter of 2018 as geopolitics dominated headlines and created a fragile backdrop for global markets. The China-US trade war showed little sign of abating, with Donald Trump’s ongoing protectionist rhetoric a key factor in this. The consequences of this and a strengthening US economy provided an unfavourable environment for emerging market investors. In the UK, Theresa May’s chances of gaining parliamentary approval for her Chequers deal within the agreed timelines appear to be dwindling, whilst Europe continues to have problems of its own with Italy’s expansive budget plans focusing investor attention once more.

President Trump’s attempts at reshaping global trade in the United States’ favour – seen not only with China but also through the new NAFTA deal agreed with Mexico and Canada – has left markets wary of the extent to which he will go. With levies already imposed on $250bn of Chinese exports, further threats on $267bn worth of goods have been discussed too. Whilst the potential damage to global GDP growth has unnerved investors in China, it has also been a cause for concern for those countries which form part of China’s global supply chain and which could be impacted from Trump’s protectionist agenda.

Emerging Market equity and fixed income markets also witnessed a pronounced sell-off as the strength of the Dollar continued to weigh on sentiment. Turkey and Argentina particularly suffered in light of this as both countries have significant Dollar denominated debt, meaning that repaying it becomes more costly when the Dollar strengthens against their own currencies. Turkey’s Central Bank also failed to reassure markets as to its independence from the recently re-elected President Erdogan with concern lingering over how much authority he wields on monetary policy; this was particularly highlighted by Erdogan’s choice of his son-in-law as economy czar, with the lira plunging the most since the country’s failed coup in 2016.

The Dollar’s strength stems from an encouraging corporate and private sector backdrop in the US, with the unemployment rate further reducing to 3.9% and year-on-year average earnings rising to 2.9%. The robustness in the US economy means that with inflation likely to feed through, interest rate normalisation will likely continue going into 2019. The Federal Reserve’s actions contrast to those of other Central Banks across the globe which are likely to keep monetary policy accommodative, particularly in the near term.

Recent indicators suggest that GDP growth in the Eurozone weakened in the third quarter to c. 1.5% annualized – contrasting that of the US of 3%. The decision by the European Central Bank to hold back on any rate hikes at least until September 2019 appears prudent, especially given the ongoing concerns about Italy. There, investors remain wary of the anti-establishment coalition of the League and the Five Star Movement, which have threatened to breach European fiscal rules by increasing spending in 2019, bringing the public deficit to within 2.4% of gross domestic product. The previous government had told the European institutions that Italy’s deficit would be 0.8 percent in 2019.

Closer to home, the Brexit debate rumbles on with Prime Minister Theresa May determined to proceed with her Chequers proposal, in spite of strong opposition from both Brexiteers and European Ministers alike. The main point of contention is on how to prevent a hard border with Northern Ireland, with the UK Prime Minister favouring keeping the entire country in customs arrangements with the EU, and Brussels insisting on customs rules applying to the province alone. The EU summit in mid-October will be one of the last opportunities for both sides to reach an agreement and until they do, UK markets – strongly correlated to the directional strength of the pound – are likely to remain volatile.

The same recurring factors that have dictated the direction of markets since the start of the year remained in play during the third quarter and are likely to continue doing so until the end of the year and into 2019. The relative calm of 2017 appears a distant memory as markets now digest a strengthening US economy against a fragile backdrop across other parts of the globe. As ever, we continue to believe that the benefits of a diversified portfolio at asset class and sector level will help to navigate this volatility.