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Substantial but fragile New Year recovery

11 January 2019

While the UK public were stunned and distracted by the live constitutional drama between parliament and government over Brexit, equity markets continued their New Year’s recovery rally. Since the pre-Christmas lows, Global stock markets have handsomely recovered approximately 40% of their Q4/2018 losses, gaining around 8%. In the US, that recovery is over 10%.

Considering the standoff in the US between president and Congress continues with a partial government shutdown and the UK is descending to unprecedented levels of political uncertainty and instability, this must astound the uninitiated observer. But it does make some sense. The combination of central banks easing monetary conditions either through softer forward guidance (US – Fed) or by providing actual liquidity (China’s PBoC) and the end of quarter fund redemptions pressures has eased liquidity conditions. This is enough for bargain hunters to bid stocks back up to levels which no longer suggest imminent recession.

While we are certainly relieved that some of the overblown Q4 market reactions to the slowing of the global economy are reversing (as we had expected and expressed on these pages) the potential issues that could turn the slowdown into falling corporate earnings have not really gone away. Particularly, Donald Trump’s two front ‘˜war’ is leaving its mark on the US economy. On one side, he’s enacting trade measures to curb China’s surging economic power and on the other he’s shutting down government indefinitely to blackmail Democrats into funding his border wall with Mexico. The UK’s Brexit predicament is so well covered by the domestic media that we will refrain from adding any more redundant comments, except perhaps repeating from last week that the UK’s economic outlook for 2019 is currently at best as uninspiring as the year we just had.

The start of the Q4 corporate earnings announcement season is imminent and should show just how much the economy has actually slowed and to what extent the widespread souring of market sentiment really is, when weighed against the businesses’ outlook that they will present together with their results. As a result, our second article this week looks at the first batch of forward-looking macro indicators that were released this week and how they compare against the current level of earnings expectations. Certainly, earnings’ upside look less exciting than 12 months ago, but still growing strong at around 10%. This puts even more emphasis on businesses’ forward earnings guidance than usual.

With fears of an imminent central bank policy error fading fast, we turn to the other most feared potential economic disrupter – Trump’s trade war and the slowing of China as the 2nd global growth engine after the US. Here, any conclusion is weighed down by even more uncertainty. Markets took it more positively than we thought justified that the two sides appeared to negotiate in earnest, because the outcome was only statements of how far apart they still are. Meanwhile, China’s old manufacturing economy shows further signs of slowing, while the new domestic service economy is doing much better – an encouraging sign that the structural reform efforts may be finding traction.

Turning to Europe, economic conditions appear to continue to cool – driven by the decline in global demand, the car industry’s woes, social unrest in France, but also the Brexit uncertainty slowing investment there as well now. One easily overlooked detail in all the noise is that unemployment has fallen to a multi-year low, which bodes well for resilience of domestic consumer demand once sentiment begins to improve.

Back in the UK, we shed some light on an asset return conundrum that readers may have spotted in last week’s 2018 returns table, where commercial property featured as one of the very few investment categories to seemingly generate positive returns, despite all the headwinds. I say ‘seemingly’ because it may very well have more to do with the illiquidity and valuation practices of the sector than actual growth in value.

Lastly, we cover some highlights of this year’s consumer electronics show in Las Vegas (CES), because technology innovations always have the potential to bring economic paradigm shifts. Artificial meat that proves indistinguishable from the real thing and assisted mobility devices that may transform old age quality of life or recuperation periods get my vote.

After this week’s renewed Brexit drama, we can probably not entirely get away without offering at least a speck of a view as to what all this may do to investments. On that note, we were pleased to observe that the coalition against a ‘˜no deal crash Brexit’ appears to be the only one enjoying a stable and growing majority in Britain’s parliament. Given pretty much every other outcome than the disorderly EU exit is all but priced in to UK risk assets, we are increasingly confident that our UK portfolio assets contain more upside than downside potential.