23 October 2019
The mess around the US-China trade war and Brexit negotiations frankly is getting old, but the markets are finally figuring out how to read between the lines. As we painfully watch the incessant ping pong of the US-China trade talks on top of the neverending Brexit negotiations, analysts are finally learning not to take signs of progress too seriously.
Today’s politics resemble a game of chicken: opposing parties like to up the pressure towards a negotiation only to back off and settle for something much less substantial. The back and forth is like a game of amateur table tennis. Or, maybe the noise is today’s version of the boy who cried wolf. Regardless of the cliche metaphor you prefer, the one thing you should take away from all of this is that the news won’t have a lasting impact on the markets.
As we mentioned in our last CIO Insights, there has been slight progress in the US-China trade talks, but Trump’s impeachment inquiry overshadowed any glimmer of hope the world had for a resolution. It wasn’t until 11 October, after months of needlessly escalating tensions, that President Trump finally settled for a partial trade deal with China. Due to President Trump’s constant flip flopping, it wasn’t until 19 October that China’s Vice Premier Lue was able to confirm that there truly had been substantial progress toward reaching a phase one trade deal. In the end, President Trump has had to let go of a lot of his initial demands, such as structural reforms in China’s business practices and intellectual property rights protection. In return, China promised to purchase more US farm products accompanied by unspecified commitments on intellectual property and currency.
On the other side of the Atlantic, although the EU and Boris Johnson finally completed a withdrawal agreement just in time for EU leaders to assess it at their summit talks in Belgium, uncertainty still lingers as the hung parliament in the UK still has to vote on whether to pass the withdrawal agreement. Keep in mind that the UK parliament hasn’t been able to agree on anything for the last 3 years and have already pressed Prime Minister Boris Johnson to delay Brexit by another 3 months…
In any case, the probability of a disruptive hard Brexit is quite low, and with each deadline extension, Brexit may never even happen. Your money is politically impartial and likes the sound of this because now the markets are doing well again.
Job growth in the private sector is showing signs of deceleration, and economic growth in the US has now also slowed down, meeting the rest of the world’s slowdown. We’re at a time in which the incoming economic data shows that growth is slowing down around the world, but surprisingly also in which the aftermath of prolonged political disarray may not be as severe as previously expected.
For years now, the market has been juggling an onslaught of political concerns and slowing economic growth around the world. Yet, major stock indices have still been resilient! Just look at the MSCI World Equity index and the S&P 500: they’re still trading close to their all time highs! In our view, the partial trade deal between the US and China ultimately lowers the probability that new tariffs could be put into effect. The markets love this.
We’re in a time of political uncertainty and weakening growth. We’ve been fortunate that central banks around the world have cut rates fairly swiftly, and that most of the central banks have expressed a readiness to provide further support whenever necessary. The central banks’ vocalised preparedness indicates that this is an environment in which the downside risk of growth-oriented assets is being managed.
Then, as yields remain or decline, we’re likely to continue to see rate-sensitive assets, such as REITs, perform well. But for now, we have to see whether the markets perceive the central banks’ easing as supportive and pre-emptive enough to ward off a recession.
Source: StashAway, Bloomberg
Tallying up the scores in Figure 1, we see that growth-oriented assets generally outperformed protective ones in the first half of October. Global ex-US REITs, Asia ex-Japan equities, and Emerging Market equities have led the pack with returns of 3.6%, 3.1%, and 2.7%, respectively. The exception in the well-performing growth-oriented assets are US energy stocks, which lost 3.1%. The biggest losers among protective assets are long-dated US Government bonds and Consumer Staples stocks in the US. They’ve lost between 1.3% to 2.1% in the first half of October.
As 2019 comes to a close, the pace of growth in the US is slowing, finally joining the global aggregate (see left hand side of Figure 2 for the US Conference Board Leading Economic Index). Sure, the trade war brought disruptions to global supply chains,corporates’ capital expenditures and hiring plans at a time when China’s economy was already slowing, but that’s old news, and the markets have priced it in. Based on rates of change of leading indicators, our models now show that other major economies, including China, are starting to stabilise. The right-hand side of Figure 2 shows that the rate of decline in the China Li Keqiang Index has slowed, and that there are even signs that the index is stabilising around the 6% level. While it’s still too early to judge whether this is an economic rebound, this rate-of-change figure is generally a reliable indicator, and in this case, it’s signalling that China’s economy could be bottoming out.
Source: StashAway, Bloomberg
As mentioned, economic data and leading indicators signal that now both the US and global economies are slowing down. So what does that mean for your investments?
At StashAway, our investment framework is entirely around risk management. In practice, our system determines your particular asset allocation to ensure that your investments never exceed your designated risk level. So, let’s say you have a 12% StashAway Risk Index (SRI); regardless of whether the economy is strong and growing, weak and contracting, or anything in between, you’ll always have a 1% chance of losing 12% of your capital, never more. We know from decades of fund management experience and stress tests that large downsides are not a reliable means to large upsides; rather, large downsides are too often the result of too much focus being put on return targets.
Only when the economic data indicate that an economic regime is changing would ERAA® make adjustments to your portfolio to reflect the risk associated with notable changes in global economic trends. As some of you may know, ERAA® re-optimised our clients’ portfolios in mid-August to reflect in each of our client’s portfolios the continued growth in the US, and the slowed growth of the non-US assets. In this instance, each of our client's portfolios were moved into an All-Weather strategy for non-US economies beause they are facing uncertain economic territory. The All-Weather strategy is designed to equip our clients with the resilience needed to navigate through changes in the economic environment. For the US economy, our system has maintained a growth-oriented focus for our clients' portfolios.
In the case that the economic indicators become strong enough to show that US growth’s momentum is unequivocally reaching slowdown territory, your asset allocation could once again be adjusted to accommodate the change in economic conditions and different asset class performance in these economic environments.
Some may say that this is an active or reactive management approach; whatever you want to call it is fine by us. Our stress tests through the 2008 Financial Crisis and our experience through the last 3 market corrections speak for themselves. Our system will continue making the asset allocation decisions it needs to make at the precise time it needs to make them in order to minimise your risk and maximise your returns, no matter the economic environment.
Here's to intelligent investing.