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Markets’ big 3 issues not going anywhere soon

2 April 2019

But there are new issues on which to focus and prompting caution, says David Jane, manager of Miton’s multi asset fund range

The big worries of last year – namely QT, the China-US trade war and for the UK at least, Brexit – now appear to be continuously delayed. In the market’s mind last year, these three issues were a significant downward force. Now they’re a permanent feature, it seems they no longer matter.

It’s now conclusively proven that QE will be a part of central bankers’ armoury which is rolled out to support financial markets, and in theory at least the economy, at the earliest hint of problems. The expectation of tightening now seems a distant memory, and unlikely to return any time soon. However, the two other big concerns of last year have yet to go away.

The China-US trade talks seem stuck on the two big intractable issues, protection of intellectual property rights and the opening up of financial markets. China needs to play by the same rules as the Western world to benefit from the same treatment. It’s obvious that China has had the best of both worlds up to now, with open access to international markets while keeping its local markets protected, and protection of its own intellectual property abroad while making only the most superficial efforts to defend the rights of foreign companies operating in China. This has of course been going on for a very long time, and China is certainly not the only country to have followed the ‘invite and copy’ development path. But the US is now determined to engineer an improvement at least.

How exactly the US expects to enforce any agreement remains a big question, as the issues at stake are fundamental. China remains a centrally planned economy where the rulers are not subject to the checks and balances of the legal system, a major component of western capitalist democracies. So the US is asking China to change a key element of their economic system. While China may espouse the desire to have better intellectual property rights and a more open financial sector, these would shift a significant amount of power from the state to the people, which doesn’t seem to be part of the plan. The US and China are negotiating from tangentially opposed world views, so it’s little surprise negotiations are taking longer than expected. Inevitably, a deal will be done, but it’s likely to be less substantive than the aspirations of US regime, as it’s hard to believe Chinese regime can be forced to convert to western capitalism by the mere threat of tariffs.

Similar observations can be made regarding Brexit negotiations, with two sides coming from very different world views. The EU sees itself moving towards a financially, economically and politically integrated unit, while the UK wishes to have the benefits of economic integration and free trade, while sidestepping the other aspects. The two world views are irreconcilable, and an obvious compromise seems far off.

The market appears reconciled that all three of last year’s big issues will remain with us for the foreseeable future, with ups and downs along the way, and in a sense they seem to matter much less.

Perhaps we now need to focus on new issues, the outlook for the world economy and companies’ profitability. Both of these have continued to be under pressure, following the weakness in the leading indicators at the end of last year. New data is more often weaker than stronger, and following an exceptionally strong year, last year’s corporate earnings forecasts are being downgraded, yet markets have had a huge rally.

We remain relatively cautious, concerned that any of these issues might re-emerge and most especially the data on the economy and earnings could fail to live up to the degree to which markets have rallied. Hence, our exposure to less economically sensitive growth companies and avoidance of the areas with most downside risk.

 

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