2 Comments 2 Commentsby Pathfinder Asset Management
By: Hamesh Sharma
Headlines in 2019 were dominated by trade wars, astronomical valuation multiples for some technology stocks, the long-awaited correction (and unexpected recovery) in housing across Australia and New Zealand, and importantly – central banks around the globe drastically changing their stance on interest rates; lowering rates to keep the economy and markets moving forward.
This was a major difference to 2018, which saw monetary policy tightening.
The optimistic bull investors still have strength in numbers, but an increasing number of negative bears are emerging from hibernation. Those who argue that benign market conditions will continue courtesy of central banks are crossing swords with those who believe markets aren’t pricing in any/enough risks, and/or valuations are stretched.
Markets are basking in the after-glow of the partial US-China trade deal and continued encouraging signs of stabilisation in the global growth slowdown.
The China-US trade situation, for the moment looks to be tucked into bed – with the US and China signing a partial "phase one" trade deal last week. There has been a marked de-escalation in trade tensions as we start 2020. However, we believe the rise in power of China will create multi-year conflicts with the US which cannot be solved overnight.
In terms of global economic growth, European industrial activity continues to be held back by the German manufacturing sector, but by contrast the US housing sector is revelling in the lower level of interest rates over the past year. If there is a return of growth globally, that will also translate into company profit/earnings growth.
Another event which caught headlines in 2019 was Brexit, and it appears as though the Brexit saga is close to ending. In the UK, re-elected Prime Minister Johnson pushed through a bill in Parliament to ensure there would be no Brexit extension beyond 2020 even if the UK had failed to negotiate an EU trade deal.
While this potentially still leaves open the risk of a "hard Brexit", markets at this stage seem to be counting on both the UK and EU striking a deal in time.
Markets have digested events at the start of the year with relatively little volatility.
There was a short-lived spike in the price of crude oil as US air strikes in Iraq and Syria killed Qassem Soleimani, commander of Iran’s elite Quds Force and architect of its growing military influence in the Middle East. Soleimani, a general, was regarded as the second most powerful figure in Iran.
Closer to home, the Australian bushfires have ramifications for a number of Australian stocks and create uncertainties particularly in the agricultural space – although in recent days risks have diminished somewhat given the arrival of rainfall.
The Chinese economy is also stabilising, with the People’s Bank of China supporting growth by cutting its reserve requirement ratio by another 0.5% this month.
Looking at the overall macroeconomic backdrop, central banks around the world (importantly the US Federal Reserve, European Central Bank and Bank of Japan) have made a commitment to continue to provide liquidity in markets as long as inflation stays low – we believe a shock of higher inflation is the one major risk for markets, as it will force global central banks to raise interest rates.
Lower interest rates for longer around the globe is a key driver of the current rally, and we cannot emphasise enough that the low rate environment is crucial in terms of supporting stock markets at current levels.
In the immediate future, the focus of markets will be earnings season in the US as companies announce their profits for the fourth quarter of 2019. Looking ahead into 2020, it should be easier for US corporations to publish stronger results given they will be compared to a relatively "weak" 2019 year, as the impact of the Trump Administration’s tax cuts are no longer influencing earnings numbers.
Later in the year there will be a presidential election in the US, with many market commentators believing Trump will likely be re-elected. There is likely to be a market reaction as we get closer to the election and as front-runners emerge, in particular, the US election will be an increasing focus if a hard-left candidate wins the Democrat nomination. However, historically markets have usually trended sideways in the months heading into a US election.
For NZ-based investors, there will also be an election in the latter months of the year here in New Zealand.
In the last week a new risk has emerged for markets – coronavirus, which is being likened to SARS in 2003.
The timing could not have been worse, coinciding with the Chinese New Year holiday period, the highest travel period for Chinese, and cases reported are growing at a rapid pace. It is too early to tell if there will be a sustained market or economic impact, but in the short term China-exposed names and tourism-related companies have been hardest hit.
It is notable that Chinese authorities appear to be behaving more openly and transparently than they have in the past.
In summary
Overall, we think 2020 will be another year of positive returns for equity markets, but likely at a much more modest rate than 2019 – we are clearly late in the market cycle.
The US Federal Reserve and other central banks' narrative appears to be outweighing unquantifiable worries about trade war uncertainty, geopolitical uncertainty and fiscal policy uncertainty. Some major downside risks to the global economy have been avoided, and market concerns over a possible recession are diminishing (barring a major external shock).
We agree that stock valuations in many areas look stretched and continue to favour stocks exposed to our top investment themes such as a rising Asian middle class; water; an ageing population; the explosion of data; and software as a service. We would like to reiterate that we are medium-term investors and some of our best ideas are ones we have supported for many years.
While we’re starting 2020 with less concerns than last year, as is always the case, there’s never any room for complacency as a number of market risks linger.
Pathfinder is an independent boutique fund manager based in Auckland. We value transparency, social responsibility and aligning interests with our investors. We are also advocates of reducing the complexity of investment products for NZ investors. www.pfam.co.nz
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