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The New Year ushered in new risks leading to volatility spikes in January. Firstly the killing of an Iranian general by a US drone strike escalated tensions in the Middle East however, this was short-lived and tensions between the US and Iran calmed down surprisingly rapidly. This positive outcome along with further signs of macro-economic stabilisation paved the way for markets to march higher intra-month, only to take another step back following the concerning news flow of the novel Coronavirus (2019-nCov) that hit world news after it emerged in the Chinese province of Hubei. The virus sapped the positive mood and markets began to focus on the potential repercussions of a global pandemic and the unknown economic ramifications of China essentially shutting down to combat the spread of the virus.
Whilst earnings have been positive from a surprises perspective, growth has been lacklustre and 2020 expectations are being revised down. The MSCI World ended the month down 0.68 per cent with the S&P500 in thee US outperforming at 0.16 per cent. Unsurprisingly emerging market equities were most affected by the Coronavirus outbreak with the MSCI Emerging Markets declining 4.69 per cent.
It is unknown risks like the Coronavirus that have led us to maintain our defensive positioning
So far more than 40,000 people have ‘officially’ contracted the disease, with 902 confirmed fatalities and it has spread to 28 countries. Somewhat alarming, in only three weeks it has surpassed the total SARS death toll. In comparison, the SARS outbreak of 2003 infected over 8,000 people, with 774 deaths. The market reaction to SARS was severe, reflecting its higher mortality rate but fortunately it was quickly contained and the rebound was sharp, with no meaningful global economic impact for the year. As we are still in the early stages of this outbreak, and given the incubation period of up to 14 days before symptoms present it is hard to gauge exactly how the situation will develop and the subsequent economic impact. However, with over 400 million people (3 provinces, 60 cities) currently facing lockdown in China, a drag on near-term growth is inevitable, with a strong impact felt in industrial, tourism and consumer discretionary sectors. Whilst the Coronavirus appears to be less deadly than SARS, it is also less easy to contain and critically, China’s share of the global economy is four times larger than it was in 2003. China is the ‘factory of the world’ and any disruptions in its production capabilities we believe will have repercussions on a global scale and this has not yet been factored in to analysts expectations.
The Q4 earnings season in the US started in January, with earnings 5.61 per cent above analyst estimates after 63 per cent of companies have reported. Central banks remained accommodative and the signing of the ‘phase one’ trade deal between the US and China on 15 January was welcome news, representing a thawing in tensions.
It is important to note that significant tariffs will remain in place and that the structural issues to be tackled in the next phase are not likely to be resolved easily. The agreement means the US will suspend its next planned round of tariffs, as well as cutting the existing tariff rates on around USD 110 billion of Chinese imports from 15 per cent to 7.5 per cent.
In exchange, China has committed to boost its imports from the US by around USD 200 billion over the next two years to allow greater access to its markets for financial services companies, enforce intellectual property protections, and be more transparent in its currency management practices.
We think that the UK stock market may be poised for a comeback.
The UK officially exited the EU on 31 January 2020. Very little will change as the UK now begins an 11 month transition period in which it hopes to negotiate a new free trade agreement. As a result, the risk of a hard ‘Brexit’ will persist to some degree, and may intensify by mid-year as news flow from the discussions hits the front pages. We were encouraged by the flash purchasing managers’ index releases for January, indicating a sharp improvement in both manufacturing and services, with the composite rising to expansionary territory from 49.3 to 52.4.
We think that the UK stock market may be poised for a comeback, especially given the attractive yield UK stocks offer in an income-starved world. With an overall dividend yield of 4.1 per cent, the UK equity market is one of the highest dividend payers. We favour exposure to UK domestic equities within our models due to attractive valuations and the potential for currency uplift further down the line – although we are monitoring for better entry points.
January was a negative month for commodities with the broad Bloomberg Commodity Index declining to its lowest level since 2016. Energy was the weakest market, with both crude oil prices dropping on the averted risk of seeing major military confrontation in the Middle East and natural gas prices falling from an unseasonably warmer winter in North America. Precious metals were the only positive commodity over the month with gold up 4.74 per cent as investors sought safety in traditional risk-off assets. Other traditional safe assets also performed well in January.
The US dollar and Japanese yen both appreciated and government bonds outperformed equity markets with developed market government bonds doing particularly well – US Treasuries and euro government bonds returned 2.4 per cent and 2.5 per cent respectively.
As we noted in our last commentary, heading into the new year, global stock markets appeared vulnerable to a correction. Valuations remain elevated and vulnerable to a correction despite the recent strong momentum and frothy sentiment. Whilst we expect moderate economic growth, subdued inflation and accommodative central banks in 2020, it is unknown risks like the Coronavirus that have led us to maintain our defensive positioning, in order to protect downside risk and minimise unnecessary volatility for our clients.
We are monitoring for better entry points.
At this stage it is unclear whether this is this the start of something more ominous, or just another blip in this 11-year-old bull market? We take the view that (not always rational) fears could lead to a further significant spike in financial market volatility, which we believe to be long overdue. It would provide us with an opportunity to allocate into equities and participate in their recovery, as soon as the virus spread slows and negative news has been fully priced in.