River FOURcast: December 2019
Welcome to our monthly macro update, giving greater insight into our outlook for investment markets and the investment ideas that currently interest us. We are well known for our dynamic approach to investing assets, adapting our clients’ portfolios to the prevailing market conditions to manage risk and take advantage of opportunities to earn return. It’s a proven process, and we have a successful 15-year track record of applying it.
- We believe we are in the Stable phase of the market; we saw reduced equity volatility in November compared to the past few months, but the lower liquidity around the Christmas period could lead to a return of some volatility.
- Global valuations remain fair to expensive, credit conditions are still supportive and economic expectations are continuing to improve, leading to us having a positive view for on-risk markets over a 12 to 18-month horizon.
- We saw ongoing negotiations between the US and China appearing to lead to constructive talks between the two parties before Trump delivered a blow to the timing of any deal at the start of December.
- Easing trade tensions and an improvement in some leading economic indicators meant that on-risk assets generally performed well over November, with US equities leading the way.
There has been no fundamental change to our view, and we continue to believe that markets are still supported in a Stable environment:
- Valuations are fair to slightly expensive when looked through a global lens, but when you dig deeper, it is clear there are two areas at opposite ends of the spectrum. US valuations have moved into very expensive territory following a very strong period of performance in November. US large cap companies, particularly those in the newer industries such as Technology, remain the most expensive. On the other hand, valuations outside the US are more attractive and remain at a fair level, which we feel offers potential upside from here.
- Credit conditions remain supportive, although spreads and yields did increase slightly over the month. We continue to believe credit markets are healthy, with corporate fundamentals not appearing stretched.
- Our forward-looking view of Economic conditions continued to improve, and we are starting to see this feed into leading indicators around the globe. PMIs (Purchasing Managers Indices, which are good leading indicators of economic growth) appear to be at, or very near a turning point. While absolute levels are still low, the direction of travel is more important; this should be a key driver for on-risk assets to move higher over the next year.
To recap, Stable does not mean we expect the recent volatility in markets to dissipate – there are plenty of potential headwinds in the short term, but we believe there is a broadly positive fundamental backdrop which should help to deliver positive returns from here over the next year.
Trade Concerns Remain, But Reduced
Markets reacted positively in December to a reduction in trade tensions as the large threatened US tariffs on Chinese goods have been rolled back, at least for the time being. Looking ahead to 2020, trade concerns are likely to continue to drive market volatility as there is not yet an overarching deal with China or with other countries and the US that would put this issue to bed. Ramping up, or down, trade tensions looks like a preferred political tool for the current US administration, and so this lever is likely to be pulled again.
Manufacturing Cycle Starting To Turn
Manufacturing cycles tend to last about 3 years, with 18 months of weaker growth followed by 18 months of stronger growth. Global PMIs peaked in early 2018 and have seen a steady grind down since. More recent data looks to be pointing towards a potential bottoming of PMIs though. Nearly 70% of global PMIs beat expectations over the last month and c.60% trended higher than their previous values; these are positive early signs for a pickup in economic conditions. An upward trend will be supportive for on-risk assets over the coming year.
Implications For Portfolios
We continue to believe conditions are supportive for risk assets over the next 12-18 months; we see some of the risks we have spoken about in recent months starting to abate, particularly with the improvement in leading economic indicators. We still believe that the next year or so could hold a change of market leadership away from the US. We expect improvement in economic conditions and higher government bond yields, which is typically beneficial to the more cyclical areas of markets, and areas more prevalent within Europe than the US. In addition to those economic factors, valuations remain more attractive in Europe and Asia as compared to the US.
Our Recent FOURcasts
We believe we are still in the Stable phase of the market, although recognize that short term volatility is likely to occur after such a strong run in markets.
2019 turned out to be a fruitful year for equities with the S&P500 achieving record highs and delivering more than a 28% return for the year. However, 2019 returns were boosted by a low starting point at the beginning of the year following the 2018 “Christmas Crunch”.