Although the US and China had been widely expected to agree a trade deal, US President Donald Trump instead confounded hopes by announcing that tariffs on over US$200 billion-worth of imports from China would increase from 10% to 25%. In response, China raised tariffs on US$60 billion-worth of US goods. Share prices fell heavily in the US, and notwithstanding some encouraging economic data, Japan’s Government downgraded its view on the country’s economy as the US/China trade war has an adverse effect upon export activity and industrial production. Elsewhere amid rising speculation over the likelihood of a no-deal Brexit, gilt prices surged and yields plummeted as investors scrambled for investments perceived to be safe havens.
US/China trade war escalates
Global market review
The likelihood of reaching a Brexit deal before the 31 October deadline receded further during May as Prime Minister Theresa May finally announced that she was resigning as leader of the Conservative Party on 7 June. Her decision triggered a leadership contest alongside rising concerns over the possibility of a no-deal Brexit. Meanwhile, in the European Parliamentary elections, the Brexit Party secured 32% of the UK vote, followed by the pro-EU Liberal Democrats on 20%. The FTSE 100 Index fell by 3.5% during May.
The likelihood of reaching a Brexit deal before the 31 October deadline receded further
Share prices fell heavily in the US as the trade dispute between the US and China reignited. At the end of April, both countries appeared to be moving closer to reaching an accord; however, early in May, US President Donald Trump unexpectedly announced that tariffs on over US$200 billion-worth of imports from China would rise from 10% to 25%. China subsequently retaliated, raising tariffs on US$60 billion-worth of US goods from 1 June. Elsewhere, in a surprising move, President Trump unveiled a tariff of 5% on all imports from Mexico; this tariff will rise by five percentage points every month until October, when it will remain at 25% unless Mexico resolves the issue of illegal immigration to the US’s satisfaction. The Dow Jones Industrial Average Index dropped by 6.7% over May.
European investors were cheered by a relatively robust performance from pro-EU parties in May’s European Parliamentary elections, although nationalist parties in France, Italy and the UK saw an increase in support. The economic outlook for the euro area has deteriorated somewhat, according to the European Commission (EC), which downgraded its economic growth forecast during the month. The EC now expects the euro area to expand by 1.2% in 2019, before picking up to 1.5% in 2020, once uncertainties surrounding global trade and policy have eased. During May, the Dax Index fell by 5% and the CAC 40 Index declined by 6.8%.
Imports fell more quickly than exports in Japan during the first three months of 2019, helping the country’s economy to expand at an annualised rate of 2.1% during the period, and confounding fears of a contraction. Nevertheless, share prices fell sharply in Japan during May, undermined by wider concerns relating to the ongoing US/China trade conflict. Over the month as a whole, the Nikkei 225 Index fell by 7.4%.
Economic outlook dims for Japan
Asian Japan markets review
Japan’s economy expanded at an annualised rate of 2.1% during the first quarter of 2019. Imports declined more rapidly than exports during the period: imports fell by 17.2%, whereas exports declined by 9.4%. Meanwhile, manufacturing activity picked up to reach its highest level for three months in April, according to Nikkei-Markit, and business confidence in the sector rose to a five-month high.
The US/China trade war is having an adverse effect upon Japan’s export activity
Notwithstanding some encouraging data, Japan’s Government downgraded its view on the country’s economy during May. Although a strong labour market, improving private consumption, and high corporate profits are providing support for economic recovery, the US/China trade war is having an adverse effect upon Japan’s export activity and industrial production. Looking ahead, the Government recommended “further attention” to the global economic impact of the trade conflict.
Earlier in May, the Cabinet Office said that Japan’s Index of Business Conditions had turned to “worsening” for the first time since January 2013, triggering concerns about the outlook and raising questions over the planned increase to consumption tax, which is scheduled to take effect in October. Over the month as a whole, the Nikkei 225 Index fell by 7.4%, the Topix Index dropped by 6.5%, and the TSE Second Section Index fell by 5.2%.
Australia’s Liberal-National Coalition retained power following May’s General Election. Prime Minister Scott Morrison remained in office, and the ASX All Ordinaries Index rose by 1.1% over May.
However, the Reserve Bank of Australia (RBA) reduced its forecasts for inflation and economic growth and indicated that it was contemplating a cut in interest rates if the rate of unemployment does not continue to fall. The RBA last cut its key rate in August 2016 to its current record low of 1.5%. Inflation is expected to pick up to 2% early in 2020 and to “increase a little further” by mid-2021. The central bank downgraded its forecast for economic growth this year from 3% to 2.75%.
A weakening housing market is undermining household consumption; retail sales volumes fell at a quarterly rate of 0.1% during the first three months of 2019, posting their first negative quarterly reading since 2012. Falling house prices are the principal risk to Australian credit markets over the next 12 months, according to credit ratings agency Fitch, which found that most fixed-income investors believe that property prices will continue to fall this year.
Trade wars bite
Emerging markets review
Although the US and China had been widely expected to agree a trade deal, US President Donald Trump instead confounded hopes by announcing that tariffs on over US$200 billion-worth of imports from China would increase from 10% to 25%. China’s Commerce Ministry warned: “No one emerges as a winner in a trade war”, and raised tariffs on US$60 billion-worth of US goods from 1 June. Meanwhile, at May’s Conference on Dialogue of Asian Civilisations, China’s President Xi Jinping emphasised China’s focus on openness, saying: “Civilisations will lose vitality if countries go back to isolation and cut themselves off from the rest of the world”.
Civilisations will lose vitality if countries go back to isolation
China’s manufacturing sector contracted in May, undermined by a fall in new orders caused by a drop in demand. Corporate earnings in the sector contracted at an annualised rate of 3.7% in April, compared with a rise of almost 14% in March. Profits of manufacturers in electronic and communication equipment – which are likely to be more susceptible to higher US tariffs – fell by 15.3% over the first four months of the year. The Shanghai Composite Index fell by 5.8% during May.
The number of corporate defaults in China is likely to climb to new highs this year, according to credit ratings agency Fitch, as companies struggle to cope with mounting refinancing pressure, a sluggish industrial sector, and deteriorating investment sentiment caused by the US/China trade conflict.
India’s Prime Minister Narendra Modi won a decisive victory in the General Election with his Bharatiya Janata Party (BJP). The result was generally well received by investors, but Mr Modi will now have to tackle India’s slowing economic growth. Having expanded at an annualised rate of 6.6% in the final quarter of 2018, India’s economy grew by 5.8% during the first quarter of 2019. The CNX Nifty Index rose by 1.5% during May.
Brazil’s economy contracted for the first time since the end of 2016 during the first quarter of 2019, shrinking at a quarter-on-quarter rate of 0.2%. The economy was hit by a sharp decline in the mining and quarrying industry that was exacerbated by the Brumadinho mining disaster. Policymakers at Brazil’s central bank maintained the benchmark Selic rate at its record low of 6.5%, citing the economic “softness” of late 2018 which has continued into early 2019. The Bovespa Index ended the month 0.7% higher.
Slowing European growth
Europe market review
Although European investors generally welcomed the results of the European Parliamentary elections, share prices across the region generally fell heavily amid concerns over Europe’s economic outlook and the future path of Brexit, and wider speculation over the impact of the intensifying trade conflict between the US and China. Pro-EU parties performed relatively well in the European Parliamentary elections, although nationalist parties in some countries – notably France, Italy and Germany – enjoyed an upsurge in popularity.
The European Commission downgraded its prediction for economic expansion in the eurozone
In its Spring Economic Forecast, the European Commission (EC) downgraded its prediction for economic expansion in the eurozone. The EC now expects the euro area to expand by 1.2% in 2019 – compared with growth of 1.9% in 2018 – before improved to 1.5% in 2020, once trade and policy-related uncertainties have lessened.
Presenting the Forecast, Pierre Moscovici reiterated that the economy of every EU member state is expected to continue to grow this year and next year, “albeit at a slower pace”. During 2019, growth is predicted to be above the EU average of 1.4% in Poland (4.2%), Spain (2.1%) and the Netherlands (1.6%). In comparison, economic growth in Germany is expected to be “particularly subdued” at 0.5%, compared with the EC’s previous forecast of 1.1%.
While deficit-to-GDP ratios are forecast to continue falling in the region, Italy’s deficit-to-GDP is expected to rise to 2.5% in 2019 and 3.5% in 2020 – contravening the EU’s Stability and Growth Pact (SGP), which has a threshold of 3%. During May, the FTSE MIB Index dropped by 9.5%.
In Greece, investors welcomed Prime Minister Alexis Tsipras’s decision to call a snap general election, which raised speculation that a more business-friendly Government might take office. The election will be held on 7 July. The Athens Composite Index rose strongly over the month as a whole, climbing by 7.4%.
Germany’s economy grew at an annualised rate of 0.6 % during the first three months of 2019. Although exports rose by 1.5%, their growth was outstripped by imports, which increased by 4.1%. The country’s economy still “lacks momentum” according to Ifo Institute’s business climate indicator. Meanwhile, a survey by GfK found that consumer sentiment in Germany had deteriorated as improving expectations for income failed to offset a weaker outlook for the economy and for household spending. The Dax Index fell by 5% during May.
Trade conflicts driven down yields
Global bond market review
Bond yields fell during May as the trade conflict between the US and China took an unexpected turn. Both parties had been considered close to reaching a deal at the end of April; however, early in May, President Trump suddenly announced that he would raise tariffs on more than US$200 billion-worth of Chinese goods from 10% to 25%. In response, China increased tariffs on US$60 billion-worth of US goods from 1 June. Investors’ nerves were further tested towards the end of the month as President Trump decided to impose a rising tariff on Mexican imports. The news sent bond yields spiralling and the yield on the ten-year US Treasury bond fell to its lowest level since 2016.
The US yield curve inverted for the first time since March
Although the escalation in trade hostilities are not expected to result in higher near-term credit risk in the US, credit ratings agency Fitch believes that “shocks linked to widening protectionism” could undermine individual corporate credit ratings across multiple sectors, with industrial and technology companies particularly vulnerable.
Signs that leading central banks – including the US Federal Reserve (Fed) and the European Central Bank (ECB) – have halted tightening measures have exacerbated the decline in government bond yields. The yield on German benchmark government bond remained in negative territory for the entire month, falling from -0.10% to -0.27%, while the benchmark French government bond yield dropped from 0.24% to 0.12%. Over May, the yield on the US ten-year Treasury bond fell from 2.53% to 2.22%, and the US yield curve inverted for the first time since March, fuelling concerns about the possibility of recession. Elsewhere, Greek government bond prices surged and yields declined following Prime Minister Alexis Tsipras’s announcement of a snap general election. The yield on the benchmark Greek government bond fell from 3.13% to 2.92% during May.
Demand for fixed income funds rose during April, according to the Investment Association (IA), which interpreted the trend as a sign that investors are managing their portfolio risk. Sales of fixed income funds reached £1.6 billion in April and £2.7 billion over the first four months of the year. Global Bonds and £ Strategic Bond were among the most popular IA sectors during the month, and UK Gilts and £ Corporate Bond also appeared in the top ten. In contrast, demand for funds in the Global Emerging Markets Bond sector fell sharply.
Brexit worries fuel demand for gilts
UK bond market review
Amid rising speculation over the likelihood of a no-deal Brexit, gilt prices surged and yields plummeted in May as investors scrambled for investments perceived to be safe havens. Nervousness in financial markets was exacerbated by concerns over the sudden escalation in trade tensions between China and the US. During May, the yield on the benchmark gilt fell to its lowest level since 2016; over the month as a whole, the yield on the benchmark UK government bond dropped from 1.12% to 0.87%, and the yield on the short-dated gilt declined from 0.74% to 0.62%.
The yield on the benchmark gilt fell to its lowest level since 2016
Uncertainties over the possibility of reaching any Brexit deal were exacerbated by the European Parliamentary elections, in which the pro-leave Brexit Party received 32% of the UK vote, followed by the pro-remain Liberal Democrats on 20%. With the future of any Brexit deal appearing to hang in the balance, Mrs May called for compromise, saying: “A consensus can only be reached if those on all sides of the debate are willing to compromise”.
The risk of “no deal” has increased, according to credit ratings agency Fitch. Looking ahead, Fitch believes that the UK’s next Prime Minister will “face the same challenge of overcoming the lack of consensus in the UK Parliament … (and) how this deadlock will be broken remains unclear”.
UK economic growth picked up from 0.2% in the final three months of 2018 to 0.5% in the first quarter of 2019. Growth was boosted by a stronger contribution from the manufacturing sector, which posted its fastest rate of expansion since 1988, driven by Brexit-related inventory building.
In its Quarterly Inflation Report, the Bank of England (BoE) upgraded its forecast for UK economic growth in 2019 from 1.2% to 1.5%, citing signs that global growth is showing signs of stabilising. If the UK economy performs in line with the central bank’s expectations, policymakers may consider raising interest rates more quickly than previously expected, according to BoE Governor Mark Carney; however, the BoE’s forecasts assume a smooth Brexit transition, which now looks questionable.
The annualised rate of consumer price inflation rose above the BoE’s 2% target during April, increasing from 1.9% in March to 2.1%, its highest level since December 2018. Inflation was driven up by higher energy bills following a change to Ofgem’s price cap on gas and electricity prices.
Brexit tensions intensify in May
UK equity market review
Escalating political upheaval knocked investors’ confidence in May. Share prices suffered: the FTSE 100 Index fell by 3.5% during the month, while the FTSE 250 Index declined by 4.3%.
The news triggered fresh anxiety over the future path of Brexit
Initially, it appeared that Prime Minister Theresa May was not willing to give up on the possibility of getting her Brexit deal through Parliament. However, as time went on, it became apparent that this was likely to prove fruitless, and eventually Mrs May announced that she would resign as leader of the Conservative Party from 7 June. Her resignation ignited intense speculation over the identity and Brexit stance of her successor – the next Prime Minister – and, by the end of May, the number of candidates for the Conservative Party leadership had reached double figures.
The news triggered fresh anxiety over the future path of Brexit, with many questioning whether it will be possible to reach a deal by the 31 October deadline. The British Chambers of Commerce (BCC) urged the new Prime Minister to “work to avert a messy and disorderly exit”, while the Confederation of British Industry (CBI) insisted that a Brexit deal was “the best way forward” for UK firms, warning: “Short-term disruption and long-term damage to British competitiveness will be severe if we leave without one”.
Investors experienced a sizeable number of profit warnings during May. Travel company Thomas Cook issued its third profit warning in under a year, blaming an “uncertain consumer environment” and warning of “further headwinds” for the rest of its financial year. Funeral services provider Dignity issued a profit warning, citing a “significantly lower-than-expected number of deaths”, and warnings were also issued by metrology company Renishaw, banknote printer De La Rue, and value retailer The Works. Fashion retailer Superdry issued its third profit warning in eight months, and shopping centre owner Intu downgraded its rental income forecasts, highlighting a “challenging” 2019. Having risen at an annualised rate of 6.7% in March, UK retail sales growth slowed to 5.2% year on year in April as higher demand for clothing helped to offset falls in other main sectors. Elsewhere, Metro Bank raised £375 million from shareholders to shore up its capital position. The Prudential Regulatory Authority (PRA) stated that Metro Bank “is profitable and continues to have adequate capital and liquidity to serve its current customer base”.
Brexit drives up equity yields
UK equity income market review
UK share prices fell during May as Prime Minister Theresa May announced that she would be standing down. The announcement – which triggered a Conservative Party leadership contest – stoked uncertainty over the eventual outcome of Brexit and undermined sentiment towards UK equities.
Global dividends posted headline growth of 7.8% during the first three months of 2019
The FTSE 100 Index dropped by 3.5% during May, while the FTSE 250 Index – representing medium-sized UK companies, which tend to have more exposure to the domestic economy than their blue-chip counterparts – fell by 4.3%. Meanwhile, the yield on the FTSE 100 Index rose during May from 4.36% to 4.56%, while the FTSE 250 Index’s yield climbed from 3.15% to 3.25%. In comparison, the benchmark UK government bond yield fell from 1.12% to 0.87%,
Over the first five months of the year, the best-performing FTSE industry sectors have been leisure goods, technology hardware & equipment, and food & drug retailers. At the other end of the performance spectrum, the worst performers include automobiles & parts, fixed-line telecommunications, and oil equipment & services.
Vodafone cut its dividend payment for the first time from 15.07 eurocents per share to nine eurocents per share. CEO Nick Read said that the decision to “rebase” the dividend was taken to allow the company to reduce debt and facilitate future growth. Elsewhere, M&S unveiled a dividend cut of 25.7% in a bid to “restore the … dividend payment to a sustainable level” alongside a one-for-five rights issue to raise around £600 million to finance its joint venture with Ocado.
During May, the Investment Association (IA) called for companies to increase the transparency of their dividend payment policy, urging firms to publish a “distribution policy” that sets out their approach to paying dividends to shareholders. The IA found that 22% of dividend-paying FTSE-listed companies do not hold annual votes on the payment of the final dividend, and 12 of the top-20 FTSE companies had paid dividends without a shareholder vote.
Global dividends posted headline growth of 7.8% during the first three months of 2019 to reach a first-quarter record of US$263.3 billion, according to Janus Henderson’s Global Dividend Index. Underlying growth was 7.5% as the effects of special dividend payments were offset by currency movements. In the UK, a substantial special dividend from miner BHP drove headline dividend growth to 10.5%; underlying growth, however, was below the global average at 4.4%.
The “Tariff Man” strikes again
UK equity income market review
Having hit new highs during April, share prices plummeted in May as the trade war between the US and China took an unexpected turn. Hopes had risen at the end of April that both parties were nearing agreement; however, in May, President Donald Trump announced that he would increase tariffs on over US$200 billion-worth of imports from China from 10% to 25%. In addition, the US began to impose the full 25% tariff on a further US$325 billion of Chinese goods.
No one emerges as a winner in a trade war
Nevertheless, President Trump described his relationship with China’s President Xi as “very strong”, and going on to warn: “China should not retaliate – will only get worse!” Despite this, China increased tariffs on US$60 billion-worth of US goods from 1 June, and the country’s Commerce Ministry commented: “No one emerges as a winner in a trade war”.
In other trade-related developments, the US and Canada agreed that tariffs on steel and aluminium imports would be lifted. Elsewhere, investors were surprised by a shock decision from President Trump to impose a tariff of 5% on imports from Mexico; this tariff will increase at a monthly rate of five percentage points until it reaches 25% in October. President Trump plans to maintain this 25% tariff until Mexico settles the thorny issue of illegal immigration.
The Dow Jones Industrial Average Index fell by 6.7% in May, while the Nasdaq Index dropped by 7.9%. The S&P 500 Index fell by 6.6% and posted four consecutive weeks of losses for the first time since October 2014, according to S&P Dow Jones Indices.
During May, the US added Chinese technology company Huawei to its “Entity List”, meaning that US companies cannot trade with Huawei without a licence, while China announced that it was creating a list of “unreliable” foreign entities.
The Federal Reserve (Fed) maintained its key interest rate at 2.25% to 2.5% and continued its “patient” monetary stance. According to Fed Chair Jay Powell, policymakers believe the current subdued inflationary backdrop is likely to prove “transient”. The rate of unemployment fell from 3.8% in March to 3.6% in April to reach its lowest level since December 1969. However, this decline was largely caused by 490,000 people quitting the labour force during the month. The US economy added a stronger-than-expected 263,000 jobs in April, and average earnings posted an annualised increase of 3.2%.
The briefings above were written & supplied by Adviser Hub June 2019