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Third quarter report: The changing macro backdrop

Discussions held at our regular Investment Committee meetings reflect a mixed global backdrop.  

Global economic growth remains positive and earnings continue to expand. Global inflation looks contained and Central Banks seem keen to manage the route to normalisation of monetary policy with care.

Yet the political environment remains challenging and financial markets are finding it difficult to price in such uncertainty.  

Rising interest rates, political uncertainty and above-average equity valuations do present a challenge to Global Equity Markets, but we believe solid underlying earnings growth and robust corporate profitability should continue to underpin equities at this point.

The global backdrop is complex, especially when up against so much uncertainty. We monitor the markets daily on your behalf to ensure your portfolios reflect your investor profile and are positioned in the best way to help you reach your goals.

If you’d like to discuss the performance of your portfolio or want to know the thinking behind the Moneyfarm investment strategy, please call your Investment Consultant on 0800 4334574.


As March 2019 fast approaches, the UK enters the final weeks of crucial negotiations with the European Union. With time running out, the fractious parties seem no closer to agreeing the final Brexit divorce bill.

It feels like little progress was made in the third quarter, yet it was anything but quiet. Internal fighting escalated within the Conservative party a leading to the shock resignations of Brexit Minister David Davis and Minister of Foreign Affairs Boris Johnson.

November was initially circled in the both the UK and EU’s diary as the deadline for an agreement on the final deal. Yet, it feels like the two sides of the negotiating table have drifted further apart and a second referendum or a hard Brexit isn’t as far from the realms of possibility as it was before the summer.

As the political stalemate continues, the whole process is characterised by uncertainty. We do know that the final outcome, whatever it is, will have a significant impact on financial assets in the UK.

Our global exposure means we should limit portfolio downside in a hard Brexit scenario, due to conservative equity and sterling exposure, although we have made the decision to avoid making an aggressive bet on Brexit.

Our portfolios haven’t been built to outperform if sterling rallies in a soft Brexit scenario, given current circumstances we feel this is prudent. We have been adjusting portfolios over time to ensure they can capture as much upside as possible.

There are still a few levers within our reach to change our positioning. The tools are all there and ready to be deployed, but it’s a question of how aggressively we want to try and predict the outcome of Brexit. Given that we should have a finalised deal in a matter of weeks, we’d prefer our risk management approach to limit downside risk.

It’s US Equity against the Rest of The World

On the face of it, global equities performed well in the third quarter, but don’t be fooled by the +5.1% recorded by the MSCI World. The US certainly retained its crown as global equity titan, but its outperformance actually masked a very different, and quite interesting, picture.

The MSCI World is an index of global companies weighted by market capitalisation. This means the US bull market has left it with a strong bias to the stars and stripes; when the US does well, so will the index.

US equities rallied in the third quarter, breaking away from its global equity peers and distancing itself at the top of the pack.

Interestingly, there was an unprecedented polarisation in the performance of the S&P 500 and the UK’s FTSE 100. The American equity index overtook the London blue-chip index by around 10%, growing 8.3% in the third quarter versus the 1.5% decline from the FTSE 100.

It’s not unusual for the performance from the two regions to diverge, but the size of the gap is abnormal – especially when you look back at performance over 1, 3, 6 and 12 months.

But what’s driving US equity growth? Some of it can be chalked up to the brute strength of US equity market and the internal policies underpinning it, but the S&P 500 has also benefited from tension and uncertainty being priced in elsewhere – the UK and Emerging Markets, for example.

Key to the momentum behind the US growth was the record buyback activity as listed companies repurchased their own shares. A record $242 billion was spent on buybacks in the first quarter, but this is already set to be eclipsed by $437 billion in the second quarter and $1 trillion for the entire calendar year.

Fiscal stimulus that allowed the repatriation of capital held abroad – similar to a tax cut on company profits – also helped the last earnings season beat rosy expectations.

After much jostling for power on the global stage, it also seems like investors have come to the conclusion – rightly or wrongly – that America will win any trade war, and this confidence is helping prop up valuations whilst sentiment still falls in Trump’s favour.

From US riches to emerging rags

Unfortunately, the US’s good fortune came at the expense of Emerging markets, which are acutely exposed to the decisions made in America. Monetary policy and threats of trade wars are key factors investors price into valuations.

Strong economic growth during the first stages of US monetary policy tightening has increased interest rate expectations for the near future, increasing the cost of borrowing for emerging market economies.

Trade wars are also risky business for earnings from EM economies. Trade is an important driver of economic growth, so restricting this could have clear knock-on effects for risky assets like equities,  especially in emerging markets.

But risks to emerging markets can’t all be blamed on America. Individual economies have seen their currencies, equities and government bonds put under heavy stress due to heightened geopolitical tensions.

In Brazil, the wholly unpredictable upcoming election is polarising voters, with one of the country’s most popular politicians in jail and the front-runner recovering from a near-fatal stabbing. Turkish assets have been left bruised after US sanctions and the dictatorial shift of President Recep Tayyip Erdoğan.

Argentina has a minimal impact on global markets, but there is a big focus on public debt, and South Africa has technically slipped into a recession.

Next we look to the economy nipping at America’s heels as global economic powerhouse; China.

China officially entered a bear market as the third quarter began, with the Shanghai Stock Exchange down 20% from the January highs by the end of June.

The slump was driven by weakness in the technology sector (Alibaba, Tencent), and Trump’s war on intellectual property and tariffs would have done nothing to alleviate investor nerves. The usual questions over the economic imbalances within China also still remain.

Concerns of contagion rumbled through the markets in August – although nerves seemed to ease in September.

A brave new world in the ancient regime

Within the European Union, the Italian government’s maiden budget put pressure on Italian bond markets. Fresh bouts of volatility surfaced on the FTSE MIB and BTP (government bonds) in August as the gulf between Italy and Brussels widened.

A pledge by Deputy Prime Minister Matteo Salvini to stick by the 3% debt/GDP rule improved sentiment temporarily in August, although fears of fiscal indiscipline returned in the final days of September.

As Europe gets ready for the next round of European elections in May 2019, we prepare to see whether populism is still a growing threat to the establishment.

As the UK leaves the EU, the extreme right continues to grow in popularity in Germany, Macron’s consensus seems to be collapsing, and with the election of the Northern League to Italian government, we’re reminded that we can’t underestimate the impact of regional elections.

After all, the picture emerging from the EU political stage threatens to overturn the institutional landscape.  

Fixed Income

Even the bond market seemed to be polarised in the second quarter. Bond market heavyweights like the US and Germany were relatively stable throughout July and August, whilst emerging markets, Italian government bonds and British gilts were left exposed to political risk and experienced greater volatility.

The Federal Reserve raised rates in September, as expected, and the market has priced in a further hike in December. The direction of the Fed’s monetary policy in 2019 and 2020 appears to be more contentious, however.

Interestingly, the Fed’s own expectations aren’t being reflected in financial markets. Investors are pricing in a less aggressive monetary policy schedule, as if the Fed may be required to roll-out expansive monetary policy to counteract a slowdown in the economy or in US public finances.

A valuable September

September was an important month for assets in the third quarter.

Bund and Treasury yields steadily rose in September, underpinned by an increase in real rates rather than a particular inflationary push. The US 10-year yield rose above 3% for the second time this year after the Fed hiked its benchmark short-term interest rate and pencilled in two further rate rises.  

Value assets also staged a comeback, with the main European, Emerging Market and Japanese stock markets outperforming the US behemoth.

Japanese markets merit a special mention, after Prime Minister Shinzo Abe won his third straight three-year term as head of the ruling Liberal Democratic Party, taking him a step closer to becoming the country’s longest-serving premier.

The victory clears the way for Abe to extend the ultra-loose monetary policy that has helped Japan achieve its strongest period of economic growth since the 1990s.

However, almost six years into Shinzo Abe’s premiership, we suspect investors are yet to fully buy into his ‘Abenomics’ programme.

The Topix, an index tracking the top domestic companies on the Tokyo stock exchange, has outperformed the S&P 500 since November 2012 – when investors started to price in an Abe election win. But this uplift pales in comparison to the earnings growth, which has almost quadrupled over the same period.

As a result, the price/earnings (PE) ratio of the Japanese benchmark dropped to a seven-year low this year, as it traded at a record discount to the S&P 500.

To understand how the complexities of the global backdrop impacted Moneyfarm model portfolios in the third quarter, or to speak to one of our investment consultants about our investment strategy, book a call and one of the team will be in touch soon.