A combination of a dovish US Federal Reserve, President Trump’s tweet “Getting VERY close to a BIG DEAL with China. They want it, and so do we!” and the UK’s ruling Conservative Party winning a decisive general election victory, propelled equity markets higher this week. As of 12pm London time on Friday, US equities rose 0.7% over the week and European equities were up 1.8%. UK equities rose 2.6%, with more domestically orientated mid cap stocks climbing 3.8%, and Sterling appreciating further, briefly touching USD $1.35 and EUR €1.20. Japanese equities rose 1.6%, Australian equities gained 0.5% and Emerging Markets were up 2.1%, with Hong Kong and South Korean equities both rising over 4% on hopes of a trade deal being signed.
Defensive assets fall but Gold bucks the trend
Developed market government bonds gave up more of their gains with yields, which move inversely to price, rising. 10-year US Treasuries are currently yielding 1.88%, UK Gilts 0.85% and German Bunds minus 0.24%. Gold, however, rose this week by 0.7%, now trading at $1,475 an ounce, as the US Federal Reserve flagged that interest rates were on hold for the foreseeable future. As well as a hedge against economic shocks, gold is also a hedge against negative real interest rates i.e. when inflation exceeds interest rates. Thus, when US interest rates are on hold, with the potential for the global economy to improve and therefore inflationary pressures to rise, it results in a positive environment for the precious metal.
US interest rates on hold as inflation remains dormant
The US Federal Reserve left rates on hold at 1.5% to 1.75% and signalled that policy was likely to be on hold for much of 2020, as inflationary pressures have failed to build. This is despite unemployment falling to 3.6%, well beneath what the Fed considers as the long-term rate of unemployment, being 4.1%. The Fed’s preferred measure of inflation, the Personal Consumption Expenditures index, excluding food and energy, is stuck at 1.6%, well beneath the 2% target.
Trump Tweet helps to stir bullishness ahead of 15th December trade talk deadline
Leaked news and a Trump Tweet regarding the US China trade talks pointed towards the two sides getting closer to a deal, as the US offered to roll back some of the existing tariffs on Chinese goods. This has been a key demand from China, as well as removing the threat of new tariffs on Chinese consumer goods which are due to be imposed this Sunday, 15th December. However, we have been here before and witnessed a collapse at the eleventh hour.
ECB interest rates on hold at Christine Lagarde’s first meeting
Christine Lagarde held her first interest rate setting meeting as president of the European Central Bank, sticking with the loose policy of her predecessor, Mario Draghi. Nonetheless she delivered a more upbeat message as to the health of the economy, citing signs of the slowdown coming to an end, with lending to companies and households having accelerated in recent months, now running above 3%.
Pocketing a journalist’s mobile phone nor hiding in a fridge fails to deter the UK electorate voting for Boris
Despite polls having narrowed markedly in a difficult last week of campaigning for Prime Minister Boris Johnson, the ruling Conservative Party won an emphatic victory in the UK’s general election. They now have a 79-seat majority which gives them the wherewithal to “get Brexit done”. UK equities and Sterling both responded positively.
Australia boosted by trade talks
The Australian market rallied late in the week on the news that Australia’s largest trading partner, China, will soon reach a trade agreement with the US. Export oriented sectors, especially miners were the main beneficiaries, with BHP Group and Rio Tinto adding 2% and 1.6% respectively on Friday alone. Gains were not entirely broad based however, as more defensive names including consumer staples fell 0.8%, and healthcare stocks were lower by 0.3% in the last session. Elsewhere, the Australian dollar, rallied to its best level since late July, jumping to a high of US $0.694.
UK equity underweight position closed
We closed our underweight position to UK equities this week, with a bias towards mid and small cap stocks, which are more exposed to the domestic economy. We have held this underweight position since before the Scottish referendum in September 2014. Although Brexit remains far from complete, UK equities are trading at a significant discount to international stocks, which we think already factors in much of the economic weakness that could arise from the Brexit process. This provides the portfolios with a modest overweight position to equities.
In order to fund this trade, we reduced the cash position in the portfolios. We have been happy to do this, as the global economic backdrop has gradually improved, with fears of recession gradually ebbing away, although we recognise that we are not completely out of the woods yet, especially given the unpredictable nature of President Trump.
Issues under discussion
Our attention has now turned to the currency hedging that we have held in the portfolios off and on since the EU referendum in 2016. Now that we have had the general election result, and Sterling has jumped as investors breath a sigh of relief that a far left Corbyn government has been avoided, we now wonder what next for the currency? Some forecasters are suggesting that Sterling could rise to over USD $1.40, however, we wonder now that the real negotiations with Europe over Brexit have to start in earnest, whether we could see some further Sterling weakness in the coming months. This has to be balanced against potential US dollar weakness, especially since the Fed has adopted a much more forthright dovish stance.