There are three topics we are covering in this month’s market update; changes at the European Central Bank, how the US earnings season has impacted our 2020 outlook, and the upcoming UK election.
The ECB’s future under new President Christine Lagarde
We’ve seen a change recently in the leadership of the European Central Bank, with ex-IMF head Christine Lagarde replacing Mario Draghi after his eight-year term.
Draghi had quite a controversial tenure during his time at the ECB, presiding over negative interest rates and quantitative easing. But he’s generally regarded by many as having saved the euro by stating that he and the ECB would do whatever it took to protect the currency.
Lagarde and her team face a number of challenges, with increasing focus turning to how effective monetary policy actually is. Although Draghi was successful in saving the euro, he was much less successful in terms of generating stronger economic growth and reaching the 2% target inflation.
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The question for Lagarde will be whether she can develop policies that will achieve targets or will we need to see much more coordinated policy in terms of fiscal and structural reform to allow the ECB and the eurozone to generate faster growth.
Ultimately, we think it’s going to be a tough ask for the ECB to really drive stronger economic growth using monetary policy. Policymakers elsewhere will have to take on more of the burden if we are to see the sort of economic growth that the ECB would like to see.
Impact of US earnings on our 2020 outlook
We’ve had a raft of corporate earnings coming out of the US over the past few weeks, and in general the results have been quite positive. Over 70% of companies have reported better-than-expected earnings, more than we’ve seen for some time, which helped push the S&P 500 to an all time high.
The underlying growth environment has been a bit challenged, but this is still a decent result for corporates in the US and bodes well for corporate profitability and perhaps for earnings growth going into 2020.
Tailwind from interest rate cuts
You now have a tailwind from three Fed rate cuts over the course of this year that should help growth re-accelerate, albeit from a relatively low level.
The US Fed lowered interest rates by 25 bps last week – its third cut of the year. As in the recent past, the Fed walked a fine line between saying it didn’t think it would cut again (in the near future) while also saying that it would obviously lower rates if economic weakness required it.
If taken at face value, that would suggest that the Fed will only cut once it sees an imminent recession – which would be too late. That puts a heavy onus on upcoming US economic data.
The latest US employment data was a bit better than expected, with higher levels of job creation (excluding some noise around the General Motors strike), but fairly slow wage growth. That’s a good outcome for the Fed and also for risky assets. It’s another data point that suggests that the US economy has slowed, but not stalled, and maybe 75 bps of cuts will be enough.
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First, we’re in a world where “good news is good news” and positive economic data is taken well by financial markets. That’s not quite as silly as it sounds. Sometimes financial market participants fear strong economic data because it can presage a change in interest rate policy. That’s not the case currently.
Second, the most recent data on employment is positive, at least versus expectations. Third, it’s worth remembering that employment hasn’t been the issue, it’s really about output – as reflected in the ISM manufacturing survey.
Better figures from the ISM will be an important signal for markets that the US economy will continue to grow in 2020 – and that would likely provide some support for risky assets.
And finally the data confirms that inflation shouldn’t be a focus, at least for now. The US Personal Consumption Expenditure deflator, the Feds preferred measure of inflation, is sitting comfortably below the 2% target.
We’d argue that this has provided some valuable support for a bullish argument for 2020.
Decent macro data, low inflation and an easing Fed are a helpful cocktail for US equities. That’s not to say it’s all rosy – global growth still isn’t great, trade wars still loom large, and the US economy has slowed down. A lot will depend on what the incoming macro data tells us about US corporate activity – not least the ISM surveys. But if you were bullish to start with, you’re probably feeling more comfortable at the end of this week.
The UK general election
Now we have to turn to the painful question of UK politics and the upcoming General Election, more specifically. The range of outcomes, as it has done with Brexit since 2016, remains extremely broad.
Current polling suggests that the Conservatives might be able to squeeze out of majority, but faith in those polls is not particularly high.
When we think about a range of outcomes we’d argue that a Conservative majority and a deal would be taken positively by UK assets, notably equities.
A Labour majority, with all of the uncertainty around economic policy, would probably be taken negatively by risky assets in the UK.
A hung parliament depends very much on which coalition actually would form a government. A Conservative-Brexit coalition would look very different from a Labour-Lib Dems coalition.
From a portfolio construction perspective, we continue to take a cautious approach. We continue to be globally diversified in terms of our asset allocation, even though we acknowledge that UK assets, notably equities, look cheap relative to their own history.