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Market Commentary – Q2 2019

Investors hate uncertainty! Unfortunately there is an abundance at the moment and thus stock markets are finding it difficult to discern just what the future will bring. Year to date stock market returns have been good, led by the United States which is up over 18% in sterling terms in the first half of 2019 and the world index is up by 16%. It appears that memories of the market falls in the final quarter of 2018 have been banished. And yet there appears to be little investor euphoria. Why?

Let’s consider the United States first. The yield on debt issued by the US government has fallen in recent months. This means that investors are anticipating the US will cut interest rates, a change in stance in the past year when the talk was of rising rates. Why? The continuing trade spat between the US and China is not helping and threatened tariffs on Mexican and Indian is a further escalation.  Many investors are now expecting interest rates to be cut in anticipation of the above slowing US economic growth. And it is this anticipation that has driven the US stock market to new highs in recent weeks. Any hint of a recession and the central bank comes to the rescue, reducing borrowing costs for both companies and consumers once again.

Not wishing to bore our readership but it would be remiss not to mention Brexit. A further three months on we are none the clearer as to the future relationship with a bloc of countries that are our largest trading partners. Add an election for a new Prime Minister and promises to leave by the end of October, deal or no deal, and you have the perfect recipe for continuing “fog in the Channel” so to speak. This weather pattern will be reflected most quickly in the sterling exchange rate. Remember a weaker sterling is not all bad news as exports become more competitive and overseas earnings worth more pounds.

Like the US interest rates in the UK may fall. Inflation remains at a comfortable 2%. Add cuts in investment by industry and the possibility of a no deal Brexit, The Bank of England will likely cut rates to maintain demand even though an expected fall in sterling would raise import prices.

Moving over the Channel and it is easy to forget the EUs own problems. There is no question a hard Brexit would impinge upon growth in Europe but perhaps more importantly a reduction in world trade would hit European exporters such as Germany, a country known for its export prowess. Growth in the latter is expected to be just 0.9% in 2019. There is even lower forecast growth in Italy (just 0.1%). Italy matters as it is the third largest EU economy, but it has barely grown for many years. A wish to spend to raise growth is likely to upset Brussels as it will breach the latters’ spending rules. Perhaps it is no wonder that the outgoing President of the European Central Bank (ECB) announced the possibility of further interest rate cuts to raise inflation and growth in the monetary area.

Hopefully during the rest of 2019 one of the major asset classes will be proved right; bonds predicting a recession or share prices anticipating that the good times for investors will continue. However perhaps investors are looking at the above the wrong way. A respected commentator Anatole Kaletsky of Gavekal posits the following thoughts: low interest rates are perhaps signalling that the world is in an ear of persistent low inflation, and share prices are signalling continued growth and profits. Perhaps strong growth does not always lead to higher inflation as was the case before the crisis of 2008. The link between growth and inflation may have broken down. And if that is the case perhaps the combination of low rates and rising stock markets can continue for a while yet.

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