Highlights & Lowlights: what caught our eye in May 2019

The rally in equity markets stalled in May. Stock markets fell across the world with few exceptions (India bucked the trend after investors reacted positively to the re-election of Narendra Modi as Prime Minister), whilst Fixed Interest and gold rose on the back of increased demand for ‘safe haven’ assets. Hopes for a resolution to US/China trade tensions receded as US President Trump accused China of backsliding on issues agreed previously during the negotiations, imposing increased tariffs on a range of Chinese goods with more tariffs threatened. The negative sentiment was exacerbated by a widening of the battleground. Import tariffs had been the main weapon to date but, with the two sides running out of goods to tax, both moved on to how to use their own exports to exert pressure. The US administration announced that US companies would be prohibited from selling a range of technology components to certain Chinese companies, whilst China considered ways to utilise its dominant position in ‘rare earths’, elements needed for the production of multiple technologies.

Looking beneath the main headlines, we noted an interesting but related event. Donald Trump has proven to be a President that does not conform to diplomatic norms at home or abroad. He has commented on US Federal Reserve (Fed) policy in an almost unprecedented way, accusing them previously of raising interest rates overly aggressively. Whether this was a genuine attempt to influence Fed policy or simply a way to line up a scapegoat for any future economic problems remains unclear (he later blamed the Fed’s interest rate policy for a stock market fall having taken credit for the rise that preceded it). However, he was at it again in May, tweeting that it would be “game over” in the trade war if the Fed were to match the economic stimulus that he expected to be the Chinese government’s response to increased tariffs. As previously, the true motivation remains unclear, but if Trump’s intent were to prepare his excuses in response to real problems in US/Chinese negotiations, that would be a concern for investors. For now, our hope is that the political need for a settlement in advance of next year’s Presidential election focuses minds on the US side on achieving a resolution. However, risks have certainly increased.

Away from trade issues, the U.K. enjoyed its first week without using electricity generated by burning coal since it opened the world’s first public coal-fired generator in London in 1882. With the UK government planning to phase out its last coal-fired power plants by 2025 to reduce carbon emissions, such ‘coal free’ periods are expected to become increasingly common, so the event in itself may be no great surprise. However, it is hard not to see it as another (albeit small) staging post in the development of alternative energy, with all of the implications for investors in both renewables and fossil fuels. Of course, the UK economy is small in global terms and the long-term future of fossil fuels will be determined by how much (and for how long) they are used in larger economies like the US and China. Therefore, with Donald Trump advocating strongly for the US coal industry and the US Environment Protection Agency proposing to relax emissions rules for new coal-fired power stations, there may yet be opportunities within ‘old energy’. However, with Trump’s rhetoric looking increasingly out of step with the rest of the world and government figures showing US consumption of coal at a 39 year low, it would seem likely that we will see many more such milestones reached in the years ahead.

Finally, May reminded us of the old adage that history may not repeat but it often rhymes. In the run up to the Global Financial Crisis (GFC) of 2008/9, Iceland was one of several European countries that set themselves up as offshore financial centres. Whilst this was economically beneficial for a while, it made the Icelandic economy overly dependent on financial services, and banking in particular. As a result, when the GFC happened the disproportionate size of the banking sector meant that the Icelandic authorities were unable to bail out their banks, even if they had wanted to do so. The impact on the economy was dramatic, with it shrinking by 10% (as measured by Gross Domestic Product). Following help from the International Monetary Fund, the economy returned to growth in 2011, with its recovery aided by a boom in tourism. However, whilst this appeared to be a successful solution to the problems of 2008 to 2011, recent events came with a sense of déjà vu. Last month the Icelandic central bank cut its main interest rate by 0.5% to 4.0% in response to a change in their expectations for the Icelandic economy from growth in 2019 of 1.8% to a contraction of 0.4%. This dramatic and sudden change of anticipated economic performance was attributed largely to a single corporate bankruptcy, namely that of the Icelandic budget airline Wow at the end of March. This would appear to indicate that the very sector that saved the Icelandic economy, tourism, has become its latest vulnerability. Whilst not of the ‘once in a generation’ scale of the GFC, the reversal was a reminder not only that over-concentration can be a risk in an economy, just as it is within a portfolio, but that such risks may not always be easy to spot.

In summary, May was a month in which risks clearly increased but, with no major issues resolving, diversification with a focus on downside protection remains the best approach. Furthermore, with volatility having returned to a more typical level, investors may need to get used to changes in sentiment and, whilst this cycle may yet have further to run, prolonged ‘risk on’ periods may become less common.

The information provided above is for Professional Advisers: All data has been sourced from Lipper. Any investment must be made in conjunction with reading the relevant KIID or Investment Mandate. Clients should be aware that the value of investments and the income from the may fall as well as rise and they may not get back the amount originally invested. Investors should note that the views expressed and information given were current at the time of publication but may no longer be so and/or may have been acted upon by the Investment Manager already. Source SmartIM