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June 2018 Market Commentary

Posted by First Wealth Investment Team

- Brexit talks become more stressed as deadlines approach

- European and Asian markets hit by trade war fears

- China enters a bear market

- Little net movement in major market bond yields

- Dollar strength continues to hit emerging markets

- Erdogan consolidates power in the Turkish election

- Japanese unemployment is now at 1992 levels

 

The World at a glance

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Source: Bloomberg, Trading Economics
 

World equity markets

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Source: Morningstar, FTSE National indices in Sterling

During the month, the best performing market was Mexico, +9.6%, and the worst was Ukraine, -9.5%. Investment performance was dominated by the US market and the continued strengthening of the Dollar, which led to a poor return from emerging markets and the smaller Asian nations. China officially entered bear market according to the Shanghai Composite Index. Japan managed a small gain, but this was offset by Yen weakness for UK investors. The potential threat to global growth that a full trade war would represent has not yet dented confidence in the US, where all data continues to point in the right direction.

European equity markets

3Source: Morningstar, FTSE National indices in Sterling

During the month, the best performing market was Malta, +4.7%, and the worst was Turkey, -3.8%, where Erdogan consolidated his hold on power in the recent election. European markets were once again weaker overall, as fears of a trade war with the US weighed on sentiment. Emerging European markets provided a drag on the overall performance of the Eurozone, as did the stresses  between Angela Merkel’s Christian Democrats and one of their coalition partners, the Christian Social Union (CSU), over immigration, which, at times, seemed likely to spell the end of Mrs Merkel’s leadership.

Currencies

4Source: Bloomberg

The major themes in the currency market were the strength of the Dollar, the  general weakness of Sterling and EM currencies, including China. Fears over the outlook for the Eurozone, amid German political difficulties and the prospect of a trade war between the US and China, also bringing in Europe, saw  money continue to flow into the Dollar as the reserve currency, which continued to gain against most other currencies. The continued lack of progress in Brexit talks saw further declines in the Pound, which reached 1.32 against the Dollar. This helped to mitigate losses from overseas funds for the UK investor.

Generic 10-year yields*

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Source: Bloomberg

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

Eurozone bond volatility settled down in June, with the sovereign bonds of Italy, Spain and Greece closing in against the Bund, after widening substantially in May. With little in the economic data to suggest an urgent rate rise anywhere among the major markets, and uncertainty over the effect that trade tariffs might have on economic growth, 10-year yields in the major global bond markets were mostly unchanged.

Trade Wars

The Financial Press has been awash with stories about trade “wars” between the USA and China, the EU and even Canada. Allowing for the expected media hyperbole (trade ‘disputes’ or ‘disagreements’ sounds far less alarming), what is clear is that financial markets are upset by such developments.  What started off as a US v China dispute has escalated, both in size and scope and we have now reached the stage where the retaliatory levels are at the U$200bn level. The origins lie in Trump’s successful election campaign, which tapped into fears amongst the voters about losing out from globalization. Interwoven within the dynamics of the trade agenda, are further complications associated with Chinese intellectual property theft. In Trump’s own words “China has... long been engaging in several unfair practices related to the acquisition of American intellectual property and technology. These practices... harm our economic and national security”. Once the dispute with China started (and probably smarting from the lack of support from his allies), Trump has also turned his ire towards long simmering trade disputes with other countries. For example, Canada sets domestic production quotas and imposes tariffs of up to 270% on dairy products, to keep prices stable and ensure a stability of income for Canadian farmers. In isolation, this seems an extreme form of protectionism, but domestic political considerations make it extremely difficult for the Canadians to admit this, let alone do anything about it. The EU also has high external tariffs on agricultural products and bans US GM food products on some convenient health regulation grounds. It also charges a 10% tariff on cars, verses just a 2.5% tariff in the USA. Equity markets have reacted badly to the headlines, with the Chinese equity market hitting a 2-year low during June, though the US market has held up.

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Chinese threats to impose tariffs on agricultural imports are already impacting US agricultural commodities. The price of US Soybean futures has fallen sharply, which puts pressure on US rural communities, which have been staunch Trump supporters (which is why the Chinese have done this). Germany has long been the industrial powerhouse of Europe, deriving over 50% of its GDP from exports and is the world’s third largest exporter of merchandise. Unsurprisingly therefore its main equity index (DAX) sold off heavily on the additional tariff announcements. Germany is also in the firing line for the US over their failure to honour NATO defence spending pledges, their 10% tariffs on car imports and its large current account surplus with the United States. It is also important to consider the differentiation of company size in the US (and indeed globally). Those towards the mid and lower end of the market capitalisation scale, will be much more influenced by domestic economics (fiscal reform, deregulation etc) when compared to their large-cap, Dow Jones cousins. For these smaller companies, by many measures, the outlook remains optimistic and performance year-to-date has been strong.

The challenge here is how to reconcile the Trump approach with international trade negotiations and the attitude of the Chinese and Europeans. Trump thinks bi-laterally, not internationally. He wants immediate actions and solutions, not endless rounds of negotiations. He expects the other side to accept his proposals to eliminate what he regards as obvious tariff inconsistencies and he has little regard for their domestic political considerations, or the historical (and very slow) protocols for resolving these kinds of issues. The media has so far tended to focus more on his tactics and less on the actual tariffs that have so stoked his fire.


So what happens next?

Chinese imports from the US are only a quarter of the value of their exports to the US, but there is more than one way to skin a cat. We could see state-organized boycotts of US products – a tactic the Chinese have employed previously with Japan. They could stop buying US treasuries, or even start selling some of the U$.118tn that they currently own. Alternatively, the Chinese government may decide simply to flex their significant political muscle to leverage influence in key geopolitical issues of major US interest, such as N Korea or Taiwan. Domestic  considerations make compromise from the likes of Canada or Mexico difficult, whilst the EU’s approach to tricky decisions has always been to kick the can down the road. Even if the EU was minded to amend some of its protectionist trade policies, getting all 27 EU counties to agree is a very time consuming operation. With the US economy performing strongly and the rest of the world less so, Trump will feel that he has timed his rhetoric well. Markets don’t like uncertainty, disruption or change to long held agreements and perceptions of how the world works and the perceived wisdom is that raised tariffs (1930 Smoot-Hawley Act) was a key factor in turning the 1930's recession into the Great Depression. US tariffs have been very modest for several decades, particularly when compared with the rest of the developed world. This is most striking when we compare tariffs on agricultural products between the USA and the EU.

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Trump represents a challenge to all these beliefs, which is his intention. Many of the tariffs and trade practices that he has highlighted are hard to justify, but that is no guarantee that they will be negotiated away. A summer of adverse headlines about trade and tariff disputes seems inevitable. Some of the investment trends that we have seen in recent months seem, therefore, likely to continue. The US, particularly small and mid-cap companies, seem well placed. Trade worries can be added to an ever-growing list of challenges for Europe and many of the positive long term structural trends that underpin Asian consumer growth remain in place.

This article does not constitute advice. Anyone considering any form of financial planning should seek independent financial advice. First Wealth LLP is an appointed representative of Best Practice which is authorised and regulated by the Financial Conduct Authority (FCA). You should note that the FCA does not regulate tax advice.

Past performance is not indicative of future results. The value of your investment may go down as well as up.

 

 

 

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This article does not constitute advice. Anyone considering any form of financial planning should seek independent financial advice. First Wealth (London) Limited is an appointed representative of Best Practice which is authorised and regulated by the Financial Conduct Authority (FCA). You should note that the FCA does not regulate tax advice.

Past performance is not indicative of future results. The value of your investment may go down as well as up.

Posted by First Wealth Investment Team

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