Market Commentary January 2020
Here is a summary of investment markets for the month of January 2020
Global share markets fall late
Global share markets moved higher throughout much of January, driven largely by optimism surrounding US-China trade relations after the two sides finally signed their ‘phase one’ trade agreement. The deal, signed by US President Donald Trump and China’s Vice Premier Liu He, marked a welcomed truce in a dispute which had plagued global financial markets for over a year and a half. Share markets also benefited from news the US economy expanded in line with expectations in the fourth quarter and a series of positive earnings updates from the likes of JPMorgan, IBM and Microsoft. In saying that, there were some notable misses on the earnings front, including Goldman Sachs, Exxon Mobil and Chevron. Sentiment was further buoyed by evidence Asian manufacturing activity is improving and additional Chinese stimulus; the People’s Bank of China lowering the amount of reserves the country’s banks must hold with it in an effort to support growth. However, despite the positive start to the month, share markets eventually reversed direction thanks to increasing fears over the spread of coronavirus and its potential impact on the global economy. The spreading virus, which was declared a global emergency by the World Health Organisation, sent commodity prices tumbling and drove most major share markets lower as investors moved to re-evaluate the global growth outlook. Stocks were also impacted by news China’s economy slowed last year and renewed political instability in the Middle East. China’s economy grew 6.1% in 2019, well down on the 6.6% growth recorded in 2018, while uncertainty in the Middle East spiked after the US killed Iranian Revolutionary Guard commander, Qassem Soleimani, in response to what it said were plans to attack American troops and diplomats in the region.
At the country level, US stocks closed the month slightly lower despite hitting fresh record highs during the period. Share markets were also weaker in the UK, Europe, China and Japan.
In contrast, Australian shares made strong gains in January. The local market benefited from encouraging US-China trade developments, strong performances across the major banks and some positive domestic economic data, with the latest retail sales, inflation and employment figures all beating analysts’ expectations. Limiting the advance were rising coronavirus fears, a sharp decline in commodity prices and a series of mixed domestic earnings results.
Domestic interest rates on hold
The Reserve Bank of Australia (RBA) didn’t meet in January. However, the Bank’s board did come together in early February, with the RBA deciding to leave the official cash rate on hold at a record low 0.75%. In its post-meeting statement, the Bank provided a reasonably upbeat assessment of the local economy, saying it expected growth to remain around 2.75% this year and 3.00% next year. However, officials did concede that, in the short term, bushfires and the coronavirus outbreak will temporarily impact the outlook. Officials also noted that the easing of monetary policy last year – the RBA cut interest rates three times in 2019 – is supporting employment and income growth and a return of inflation to the Bank’s medium-term target range. The RBA concluded its latest meeting by saying that, “it is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target.” It also noted that, “it remains prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.”
We still expect the RBA to cut interest rates again in the first half of 2020. In deciding to keep rates on hold in February, the Bank maintained a fairly optimistic outlook on the economy, but we believe some of this optimism will need to be tempered. We remain of the view that the hurdle for lowering interest rates to 0.25% and unconventional policy remains high.
Australian dollar weakens
The Australian dollar (AUD) fell in January; the local currency impacted mainly by rising coronavirus fears, falling commodity prices and general US dollar (USD) strength. Limiting the AUD’s decline were improving US-China trade relations and some encouraging domestic economic data.
The AUD fell 4.0% against the USD, 3.9% against the British pound, 3.7% against the Japanese yen and 2.5% against the euro. The broader Australian Trade-Weighted Index1 closed the month 3.6% lower.
Global markets finished 2019 strongly, with US equities notching their best calendar year return since 2013. We believe central bank easing and US-China trade war de-escalation pushes recession risks out to late 2021. With global manufacturing showing tentative signs of ‘green shoots’, equity markets may have modest upside potential for 2020. However, any setback in US-China trade relations and uncertainty over the US presidential election outcome could accelerate the timing of the next recession.
Our view on global equities has become more optimistic. We maintain an underweight preference for US equities, driven primarily by relatively expensive valuations. Additionally, cycle conditions appear firmer outside the US, which has us favouring non-US developed equities. Both Japan and Europe should benefit from fading trade war concerns and China policy stimulus, which would help bolster export demand. We think emerging markets remain attractive from a value standpoint. Regional central banks are easing policy and Chinese stimulus will likely be beneficial, however the smaller scale of stimulus may limit the upside for emerging markets.
For fixed income assets, we continue to see government bonds as universally expensive. US Treasuries offer the most attractive relative value. However, the concern is that central banks have limited ammunition to fight a downturn. Interest rates remain at zero or negative in Japan and Europe. The Fed has more scope to ease, but it also faces the zero-lower bound constraint. A Fed ‘on hold’ and improving US economy should lead to higher Treasury yields and a steeper yield curve. In credit markets, we still view high-yield bonds as slightly expensive given the risks from slowing corporate profit growth. This is typical late in the cycle when profit growth slows and concerns over defaults rise. We believe investment-grade credit is expensive, given the spread compression versus government bonds and a decline in average rating quality.
In terms of currencies, we maintain our preference for the Japanese yen. It remains undervalued despite the 2019 rally and has attractive ‘safe haven’ properties should the US-China trade war re-escalate. A mini-cycle recovery as the trade war is resolved, at least temporarily, could see the USD weaken, given its counter-cyclical tendency. In Australia, the RBA has hinted at further rate cuts to support the economy, which is being dragged down from falling housing construction and heavily-indebted households. We expect another rate cut by the middle of 2020. The AUD is likely to continue to be impacted by monetary policy, geopolitical risks involving China and other emerging markets and commodity price movements.
Short-term recession risks have been staved off, however late-cycle risks remain. The current economic expansion could extend further thanks to additional policy stimulus from central banks and a trade truce between the US and China, even if only temporarily. However, major risks to our 2020 outlook include a re-escalation in US-China tensions, central bank policy turning hawkish if inflation pressures build, and the Democrats winning the US presidential election and triggering a policy shift which is negative for corporate profits. We remain alert to downside risks of further selloffs given uncertainty over central bank policy and changes to global trade policies. Importantly, we believe this is an environment that will favour our active management approach.
1 The trade-weighted index for the AUD is an indicator of movements in the average value of the AUD against the currencies of our trading partners.