Fears over the potential for a global recession ebbed away over the quarter as a combination of factors instilled confidence in markets, including better than expected economic growth indicators from the US and China, rising expectations for a ‘phase one’ trade deal being signed between the two countries, the US Federal Reserve (Fed) flagging that interest rates are likely to be on hold for the best part of 2020 and greater clarity over Brexit following an emphatic victory for the Conservative Party in the UK’s General Election. This set the scene for strong performance across all markets, with assets more exposed to economic growth performing particularly well.
The period began on a cautious note, as China reported a further slowdown in GDP growth, falling to 6.0%, with markets blaming the trade war. Unlike in previous years, expectations for policy stimulus in China were muted, as any desire to support economic growth in the face of US trade tariffs was limited by ongoing attempts to deflate a debt bubble built up since the Global Financial Crisis (GFC). However, many other Emerging Market countries cut interest rates against a background of moderating growth and low inflationary pressures, including India, Korea, Indonesia and Russia. Such moves were not confined to developing countries, with the US cutting interest rates for the third time since the start of the year and the European Central Bank resuming Quantitative Easing through further bond purchases.
In aggregate, this easing of monetary policy was one of the most significant efforts by policy makers to avoid an economic downturn since the GFC of 2008/09. The result was that investors rotated out of defensive assets into more economically sensitive cyclical assets, with the US equity market reaching new highs. However, it was not all plain sailing. The US signed into law the Hong Kong Human Rights and Democracy Act that requires the US to revisit Hong Kong’s special trade status annually, seeming to side the US with the Hong Kong student democracy protestors and raising doubts over a trade deal being agreed between the US and China. However, in December, both countries agreed to sign an initial trade deal in January, whilst the US postponed indefinitely the introduction of new tariffs on $160bn worth of Chinese goods and halved the tariffs on a further $120bn worth, the first rollback of tariffs since the start of the trade war in July 2018.
Towards the end of the quarter, economic leading indicators surprised in China, with a broad improvement across industrial production, industrial profits and retail sales, suggesting that the trade war with the US was having less of an impact than previously thought. The Fed stated that interest rates were expected to stay on hold throughout 2020, despite improving economic indicators and evidence that the US consumer remained largely unaffected by the recession in the manufacturing sector. Equities continued to perform strongly whilst Developed Market government bonds sold off and investment grade credit, which had performed so strongly year to date, faced its first real headwind of 2019.
The icing on the cake for investors was the news that the market-friendly Conservative government had won the General Election in the UK, seemingly providing some clarity on Brexit. Despite the fears of recession earlier in the year, the strong performance in markets over Q4 made 2019 one of the best years that investors have enjoyed over the last decade.
In our lower risk models, the portfolios delivered returns from -0.2% to 0.2% over the quarter. Rising expectations of a 'phase one’ US/China trade deal and moderately better economic data supported increased risk sentiment over the quarter. As a result, ‘safe haven’ Government bonds sold off, whilst other parts of the Fixed Interest market held up better, with Investment Grade corporate bonds largely flat and High Yield (HY) generating positive returns. This was seen in the best and worst performers in the quarter. GAM Start Credit Opportunities returned 4.3%, benefitting from its HY exposure over the period, whilst exposure to government debt caused AXA Sterling Index Linked Bond to lose 10.1%, with index linked debt struggling particularly on benign central bank policy. Our Absolute Return exposure was a small negative, with such funds struggling to navigate
Our medium and higher risk models delivered strong returns from 1.7% to 3.5% over the quarter. The increased sentiment over the quarter also caused equities to rise globally. The best performer in the portfolio was MI Chelverton UK Equity Growth, which returned 15.4%, followed by Man GLG Continental European Growth and Man GLG Undervalued Assets, which rose by 9.3% and 9.2% respectively.
By contrast, ‘safe haven’ Government bonds sold off, with M&G Emerging Markets Bond falling 3.5%, whilst our Absolute Return exposure was a small negative, with such funds struggling to navigate through the volatile environment. In addition, the hedges that we had in place to protect against the possibility of a strong recovery in sterling worked well as the currency rose sharply. However, unhedged holdings faced a significant headwind, with Polar Capital Global Insurance falling 4.3% and LF Miton US Opportunities flat in spite of a rising US stock market.