Active investment commentary & analysis

Ongoing uncertainty around Brexit, Hong Kong riots & China’s response

Geopolitical events continue to buffett financial markets. Almost two years since Donald Trump opened up his assault on China’s trade practices, a manufacturing and investment downturn is hitting the global economy, unsettling business and increasing financial market volatility. Concerns over trade are being exacerbated by the ongoing uncertainty around Brexit, the rioting in Hong Kong and China’s potential response. Despite the ongoing uncertainties equities rose slightly over the quarter as policymakers loosened policy and investors focused on the potential for a trade deal ahead of next year’s US presidential elections.

Despite a raft of disappointing manufacturing data, a global recession is not a forgone conclusion. While investment and manufacturing are slowing, households at least for the time being, remain robust. Unemployment is at long term lows in many advanced economies and real incomes are rising. The US unemployment rate fell to its lowest level in 50 years at 3.5% in September: UK levels are at 45 year lows; and despite the prevailing gloom in the Eurozone its rate of 7.4% was the lowest in 11 years. For a recession to manifest itself the current manufacturing slowdown would need to spread to the consumer, absent a significant external event this looks unlikely. Historically, the financial sector has often acted as the transmission mechanism by which weakness in one segment of the global economy has spread more broadly. Credit spreads remain fairly well behaved although they will continue to be a function of the prevailing economic environment. The potential for contagion from funding strains in ‘disruptive’ businesses which hitherto have enjoyed an exceptionally low cost of capital should be monitored.

Of course, there are many profoundly uncomfortable elements to the current economic backdrop, not least the increased prevalence of negative interest rates. Such developments carry profound implications for the pricing of many assets and investors and businesses are struggling to incorporate this into their mental framework. The heightened discomfort over negative rates has highlighted the significant diminishing returns to monetary policy and increased the focus on the potential for fiscal policy to boost growth. The prospect of a more reflationary environment, exacerbated by extreme investor positioning, led to a significant factor rotation in the market and ‘value’ stocks significantly outperformed ‘growth’ stocks. For this to be sustained, however, will require a more marked stabilisation in the economic data, something that looks unlikely in the very short term.