February Market Commentary

Market Overview

Despite January having been a month rife with political turmoil and economic anxieties, for many investors the panic of Christmas Eve will have likely abated considerably as markets have so far rebounded nicely in 2019. The S&P 500 – which was among the standard bearers leading 2018’s 4th quarter nose dive – enjoyed its best January since 1987 thanks to positive contributions of over 8.5% growth from the energy, industrials and financials sector. Developed Market (DM) equities followed suit by gathering a head of steam in their own right, up 6.59% as measured by the MSCI EAFE. Emerging Market equities were also lifted in the momentum, up 8.78% as measured by the MSCI EM Index after having been battered in 2018.

 Despite January market performance putting a spring back in many investors’ steps, headwinds to economic and market growth abound. Among the more notable is the United States’ inauspicious start to 2019 that saw its government in the midst of a shut down that lasted 35 days – a record, but likely not the kind with which anyone would have wanted to have been associated. Having been triggered by President Donald Trump and Congressional Democrats wrestling over the former’s polemical border wall with Mexico – the shut down is estimated by the non-partisan Congressional Budget Office (CBO) to have cost about $11bn and to have wiped 0.2% off its 2019 annual growth forecast. Of course, when the shut down ended on January 25 much of the lost money was recaptured, but it is estimated that around $3bn is gone forever and that the full effects of the shutdown may be far greater than what initial figures might suggest as over 800,000 workers were affected and federal spending on goods and services were significantly delayed. While investors can take comfort in knowing that the shut down is over, there remains palpable risk of another one on the horizon if lawmakers cannot agree on a solution for enhanced security along the US-Mexican border.

Across the pond the world’s 5th biggest economy, Britain, is a matter of weeks away from crashing out of the European Union (EU) without a deal. Aside from crippling the UK economy, mainstream pundits, policy makers and business leaders have indicated that Britain will be susceptible to widespread food and medical supply shortages. While this self-inflicted wound is bad for the UK, a no-deal Brexit would radiate shock waves throughout the rest of the world and would ravage global markets. In 2010 the world was afraid of the possible contagion from Greece’s debt crisis, and yet Britain’s economy is more than 10 times larger, which raises the stakes considerably. We believe no one would be safe in a no deal Brexit and we will be hoping that Prime Minister Theresa May will be able to acquire further concessions from the European Union (EU) and secure an orderly and structured (hopefully soft) Brexit.

Henry James International's February Market Commentary
If the US and China do not agree a new trade deal by March 2 over $200bn of Chinese goods will see their existing 10% tariff more than doubled to 25%.

While Britain and the EU scurry to work out a last minute deal, the top brass of China and US have been knuckling down to avoid their own cliff-edge: if a new trade deal is not agreed by March 2 over $200bn of Chinese goods will see their existing 10% tariff more than doubled to 25%. China has promised retaliatory measures, which would likely result in a ‘gloves-off’ trade war, which would hit both the American and Chinese economies and reverberate catastrophically throughout the rest of the world. At the heart of the deal is correcting an imbalance in trade between the nations, as well as the more serious White House accusations that US tech companies doing business in China are coerced to hand over their intellectual property, which the Chinese vehemently deny. Talks began two days after the US charged Telecoms company Huawei and its chief financial officer, Meng Wanzhou, with conspiring to violate US Iranian sanctions; US officials insisted Meng’s arrest in Canada had nothing to do with the trade talks. Despite ample scope for disaster, the Chinese hailed the talks as a great success and promised to help correct the trade imbalance through buying more American soybeans; and both parties nebulously agreed progress had been achieved on the intellectual property front. While there does appear to be a positive glow about the meeting, the clock is ticking and the stakes really could not be higher.

US Federal Reserve Chairman Jerome Powell is apparently feeling the heat of a less rosy outlook for the US economy, the record-breaking shutdown, trade impasses and global headwinds to growth as he has done a near complete about-face with his monetary policy in a matter of weeks. On January 30, 2019 Powell signaled a possible end to incremental interest rate increases, saying that despite neither inflation nor financial stability being particular risks, ‘cross-currents’ of slowing global growth – including China having its weakest economic output in 2018 for nearly 3 decades – and a less certain US outlook required changes to the Fed’s monetary policy. While we welcome a pausing of rate hikes, it must be said that with interest rates between 2.25% and 2.5% there will be little wiggle room to combat any future downturn with rates cutes alone.

Brazil is the clear bright spot for international investors as its Bovespa index managed to build on its stellar 15% 2018 growth by hitting its all-time high after surging up more than 8.5% in January. The benchmark stock index is clearly enthusiastic about the presidency of the far right Jair Bolsonaro who began his premiership on January 1, 2019 and comes with the promise of a range of business-friendly reforms, including changes to the Brazil’s pension system. And yet, in the midst of the Brazilian buzz the Vale Dam tragedy literally burst onto the scene, incurring for the mining giant a combined $1.7bn of blocked funds and government fines. Over 300 people are believe to have died in this ecological disaster, and Vale confirmed that it will decommission other dams similar to the one that collapsed, which will reduce its production of iron ore by as much as 10% in the next 3 years. Besides providing an element of headwinds to Brazil’s thriving equity prices, China and Vale’s mining rivals BHP Group and Rio Tinto may profit by having to pick up the slack.

Brazil’s northern neighbor Venezuela wishes it could steal even a pinch of the magic that is propelling Brazilian equities as the ‘Bolivarian Republic’ is in a particularly bad place right now. In addition to the usual poverty, mass-food shortages, unemployment, hyperinflation and ruined economy, January brought forth fresh political crisis through the emergence of the leader of the opposition Juan Guaidó. Based on the widespread view that Nicolàs Maduro won Venezuela’s 2018 General Election through fraud, on January 23 Guaidó took an oath to serve as the Interim President of Venezuela. Since then the US, EU and range of European countries including the UK, Spain, France, Germany, Sweden and Denmark all recognise Guaidó as the interim president; meanwhile, Russia, Syria, Turkey, Iran and North Korea still back Maduro. Despite fervent backing for Guaidó among Venezuelans and world leaders, Maduro remains in charge of a country on the verge of collapse, particularly after the US divvied out new punishing sanctions on its oil. While this is devastating blow for Venezuela and the Maduro’s reign, it has only had a positive effect on the price of oil which, along with OPEC-led production cuts – has helped to push US crude oil up by more than 20% to over $55 a barrel, which represents its best January on record.

Investment Outlook

Even before the US government shutdown, we predicted more tempered economic growth; and only 1 month into 2019 the CBO has already wiped 0.2% off its forecast. Of course, the full extent of the shutdown’s damage remains unclear but it is likely that it will be far greater than what initial estimates have suggested as – according to the CBO – they have yet to incorporate the indirect negative effects such as businesses not able to acquire federal permits and certifications, reduced access to federal loans and the overall uncertainty that has compelled firms to postpone important business, investment and hiring decisions. As distressing as this “own-goal” has been to the American economy and its workers, it is possible that another shutdown is imminent if Trump and House Democrats cannot come to a resolution on the budget for the Mexican border wall.

Markets are hoping for a soft-Brexit – or even a scenario in which Brexit is entirely averted – however, if nothing changes between now and March 29, 2019 Britain will leave the EU without a deal. Were this to happen, middle-of-the-road estimates suggest a 9% drop in GDP, which would make the 2009 financial crisis look insignificant by comparison. This would increase unemployment, the cost of borrowing and could crush the value of the pound which could combine to set the UK economy back a decade and would drag other economies and markets with it.

While a possible US-China trade war has hung ominously over markets for several months, we are encouraged that the January trade talks ended positively and we are hopeful that President Trump will visit Chinese President Xi Jinping this February to shore up a preliminary deal and extend the deadline to work through the thornier issues. While it will hardly be adequate for Trump and his team, it is a good sign that China agreed to increase its purchase of American soy. However, until a final deal is agreed, markets will live in fear of a Sword of Damocles in the form of a devastating trade war dangling perilously by a single thread from above.

We believe there is excellent value to be found in EM equities based on their valuations relative to profitability: they are trading at prices lower than their 10-year average but are still posting returns near 13%, which is similar to their DM counterparts. This view is fortified by the Fed’s recent decision to pause the interest rate hikes that caused so much harm to EM equities in the first place; our optimism is also based on a relative calming of geopolitical tensions, particularly on a peaceful resolution to US and Chinese trade.

February Market Commentary
While Bolsonaro has so far been hitting all the right notes with markets, his volatile disposition seems to make him a risk both to himself and to the lofty ambitions on which Brazilian equities and Brazil’s economy are counting.

We expect the Brazilian economy to remain the darling of EM equities and continue its excellent 2019 run; Brazilian stocks should also get a boost from the Fed’s slow down in interest rate hikes. However, Brazilian equities have performed so well recently not because of anything that has been done as much as the potential of President Bolsonaro’s campaign promises – chiefly pension reform. Brazil’s current pension system – that sees men retire at age 60 and women at 55 – and has led to massive government debt: more than 75% GDP according to the Brazilian central bank. Bolsonaro plans to raise retirement age to 62 for men and 57 for women as well as roll back some benefits; yet, failure to enact these changes, and to do so immediately, will push Brazil further into an unsustainable debt profile. Furthermore, while Bolsonaro has so far been hitting all the right notes with markets, his volatile disposition seems to make him a risk both to himself and to the lofty ambitions on which Brazilian equities and the Brazilian economy are counting.

2019 is undoubtedly a year in which not just economic threats abound, but extremely serious ones. If there is another US government shut down, Britain falls out of the European Union without a new trade deal and the US and China breakout into an all-out trade war, the global situation would be dire. Indeed, it would be bad news if only one of these items were to happen. And yet, beyond just blind optimism, one has to be cognizant that world leaders – no matter how seemingly brazen – are unlikely to shoot themselves in the foot in a permanently debilitating way. Both President Trump and Democrats are all too aware of the 2020 Election barrelling towards them and neither will want any part in knocking the wind out of the economy, beyond the damage that has already been inflicted. Regarding Brexit, Prime Minister May will not want to be the premier who cripples the world’s 5th largest economy and while she cannot single-handedly get the Parliament to agree to her deal or coerce the EU to accept her demands, she does have the authority to either extend or cancel Article 50, which would give the UK and EU more time to work out a mutually beneficial arrangement. It must also be said that the EU – despite its draconian stance during the negotiations – stands to be damaged by a no-deal Brexit almost as badly as Britain does, for which reason there will be plenty of incentive on their side to see that a deal is reached. To complete the trifecta, neither the US nor China will benefit from a trade war, which suggests that cooler heads shall prevail, as it seems was the case at the January summit. Therefore, despite the ample threats to markets, we believe that the global economy will make it to the other side relatively unscathed; however, while there will be growth, current conditions and looming threats will make for subdued 2019 growth at best.

Disclosures

This material is prepared by Henry James International Management and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are obtained from proprietary and nonproprietary sources believed by Henry James International Management, to be reliable, are not necessarily comprehensive and are not guaranteed as to accuracy. No warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions is accepted by Henry James International Management, its officers, employees or agents. This material is based on information as of the specified date and may be stale thereafter. We have no obligation to tell you when information herein may change. Reliance upon information in this material is at the sole discretion of the reader. Certain information contained herein may constitute forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Any indices chosen by Henry James International Management to measure performance are representative of broad asset classes. Henry James International Management retains the right to change representative indices at any time.

Henry James International Management and its’ representatives do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation.

January Monthly Market Report

Market Overview

December ended a rough year for investors with S&P 500 flirting with bear market territory on Christmas Eve.  The S&P 500 was up almost 9% for the year until the sell-off began in October as investors became deeply concerned over global economic weakness, increasing trade tensions, geopolitical instability and rising interest rates. The S&P 500 dropped precipitously in the 4th quarter finishing down -13.97%. Globally speaking, virtually no regional markets provided a positive return for the year.  The MSCI EAFE Index was down -16.14% for the year with most of the damage coming in during the 4th quarter when the index slid by almost 13%. Emerging markets, as measured by the MSCI EM Index, fell -7.85% during the quarter and were down -16.64% for the year. Essentially, there was no where to hide for equity investors during 2018. 

Bear Market January 2019
December ended a rough year for investors with S&P 500 flirting with bear market territory on Christmas Eve.

Investors were not in a festive spirit during the month of December, exhibiting more angst over Federal Reserve Chairman Jerome Powell controversial decision to raise interest rates by 25 basis points to 2.5%. This was the fourth time the Fed raised rates during the year and at its most recent meeting it signaled that there are likely two more rate hikes coming in 2019. President Donald Trump added his own holiday touch by attacking the Fed Chief further and deflating the markets’ Christmas spirit by failing to sign off Congress’ proposed government budget and demanding that it include the required $5bn to build his polemical wall on the US-Mexican border. As the President and House and Senate Democrats could not agree on this key aspect of the budget, the government was sent into a partial shutdown on December 21st which, when coupled with the December 19th Fed rate hike, made it a near certainty that markets would plummet as evidenced by the week before Christmas, with the Dow Jones losing 653 points on December 24th which not only capped the worst week in a decade but made for the worst ever Christmas Eve trading.
 
Unfortunately the Trump administration appeared rather ham-fisted in its efforts to quell market turmoil. Despite the fact that many investors agreed with President Trump in his palpable distaste for raising interest rates, one wonders how committing the unusual step to criticize the Fed’s Chairman – on Twitter, no less – and failing to quash speculations that Powell was on the ‘hot seat’ could have possibly helped restore investor confidence and mitigate market volatility? Furthermore, one wonders what strategy was behind Treasury Secretary Steve Mnuchin’s memo announcing that none of the six largest US banks had experienced any clearance or margin issues? Arguably, this announcement only created greater doubts in the minds of investors.

Brexit Saga
Even casual observers will admit that Brexit has snowballed into a disaster.

Looking beyond the US economy and interest rate hikes, global equity markets fell, as disappointing economic data from Japan, China and Europe ignited global growth slowdown fears, and concerns around trade frictions and European politics added to investor uncertainty. China’s November retail sales and industrial production came in lower than expected. China’s stock market suffered a nearly 25% loss in 2018.  The on-going Brexit saga remains distressingly far from a resolution. Britain’s Prime Minister, Theresa May successfully avoided a leadership challenge within the UK’s Conservative Party, ensuring she won’t face a similar no-confidence vote for another year. However, she failed to win concessions from the EU that could have made the UK Parliament more likely to pass her Brexit withdrawal-agreement proposal.  Furthermore, even casual observers will admit that Brexit has snowballed into a disaster which might end well but has caused unnecessary uncertainty for the 2nd largest economy by GDP in the EU, the world’s 5th largest economy in Great Britain and the rest of the world whose economies are faced with the direct and indirect consequences of this mammoth tussle. Brexit weighed heavily on the FTSE as it dropped by 12.5% in 2018. Somewhat unexpectedly, Brazil’s Bovespa index surged by 15% during the year, as Brazilian investors welcomed far-right candidate Jair Bolsonaro’s rise to the Brazilian presidency and made the Bovespa the best performing major index globally. Overall, the world stock markets were almost all in negative territory as evidenced by the MSCI World ex-USA index sinking by -13.12% during the 4th quarter and finishing the year down -16.40%.

Investment Outlook

Despite the raising interest rates punching the mirth out of investors’ Christmas spirit and the effects of the partial government shutdown, the fact remains that on balance, 2018 was a good year for the US economy outside of stock market performance. In the Fed Chairman’s own words: ‘Over the past year, the economy has been growing at a strong pace, the unemployment rate has been near record lows and inflation has been low and stable. All of those things remain true today.’We share the Fed’s view that both the US and certain global economies have strong fundamentals and with the prospect for another positive year of expanding. While there remains cause for optimism in 2019, we view the risk of further market underperformance as significant. We believe The U.S. remains a relatively strong anchor for the global economy, and we see emerging market equities potentially offering exceptionally positive returns after being beaten down to attractive prices given the associated risk. Emerging market (EM) assets have cheapened dramatically this past year offering better compensation for risk in 2019 compared to the more developed markets. Country-specific risks, such as a series of EM elections and currency crises in Turkey and Argentina are mostly behind us. China is easing policy to stabilize its economy, marking a sea change from 2018’s clampdown on credit growth. EMs are set to maintain double-digit earnings growth, led by China as its tech sector recovers and a pivot toward economic stimulus supports its economy. Ultimately, investors will focus on earnings growth as a positive indicator while remaining guarded against macro-economic headwinds. U.S. earnings growth estimates look set to normalize from an impressive 24% in 2018 to 9% in 2019, consensus estimates from Thomson Reuters data show. This is still above the global average. EMs are set to maintain double-digit earnings growth, led by China as its tech sector recovers and pivots toward economic stimulus to support its economy.  Globally, dramatically slowing earnings growth and the impact of tariffs make for more cautious market expectations.

President Donald Trump
President Donald Trump added his own holiday touch by attacking the Fed Chief further and deflating the markets’ Christmas spirit by failing to sign off Congress’ proposed government budget and demanding that it include the required $5bn to build his polemical wall on the US-Mexican border.

While we believe recession is unlikely (and Trump’s impeachment even less likely than that), it is more likely now than it was a year ago. US-China trade frictions ominously hang over markets and it does not appear that they will go away anytime soon while these two economic behemoths duke it out for tech supremacy. And despite our faith in the Fed’s wisdom, it is absolutely the case that 5 straight quarters of interest rate hikes have created economic volatility, which have had perilous effects on developed world economies and most notably on emerging market economies.

Despite this somewhat bleak picture, one should be reminded that 2018’s growth was assailed by a range of threats – indeed, many of the same with which 2019 is faced, and it still exhibited solid economic fundamentals.

To sum up our 2019 outlook, we are cautiously optimistic that we will see modest positive returns for both the US and many global economies; however, we expect continued market volatility, geopolitical risks, increasing costs of capital and trade tensions to continue to weigh down expectations. We also believe that while 2019 will see additional rate increases, we will expect to see the Fed slow down its cycle to assess the effects of abating economic growth and tighter financial conditions, which should result in easing the pressure on asset valuations.

Disclosures

This material is prepared by Henry James International Management and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are obtained from proprietary and nonproprietary sources believed by Henry James International Management, to be reliable, are not necessarily comprehensive and are not guaranteed as to accuracy. No warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions is accepted by Henry James International Management, its officers, employees or agents. This material is based on information as of the specified date and may be stale thereafter. We have no obligation to tell you when information herein may change. Reliance upon information in this material is at the sole discretion of the reader. Certain information contained herein may constitute forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Any indices chosen by Henry James International Management to measure performance are representative of broad asset classes. Henry James International Management retains the right to change representative indices at any time.

Henry James International Management and its’ representatives do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation.

Who Will Be Affected by China’s Trade War?

After sitting on the cusp of a financial war with China, the U.S.A. has finally unleashed their tariffs on Chinese goods after accusing them of stealing intellectual property in March. This back-and-forth disrepute of imposing tariffs on certain items will have a backlash on the citizens of both countries as China seek to reprimand the U.S. The Chinese have since stated has since stated that although they did not start this conflict, they will fight back.

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Chinese technology is receiving a 25% tariff due to accusations by the Trump administration that the Chinese stole intellectual property which optimizes semi-conductor chips. These chips are found in most electronics, ranging from televisions, personal computers, iPhones, and cars. Unfortunately, it seems that the U.S. consumer will most likely be footing the bill as China’s production pricing will remain the same, but the cost to American citizens will increase by 25%, and the Chinese will not be covering these expenses.

China will not take a hit to its economy lightly and have already planned their retaliation by focusing their own tariffs on a wide variety of U.S. exports. This ranges from plastics, to nuclear reactors, to even dairy making equipment. China must be vigilant and handle these tariffs sensibly as Chinese brokerages are sitting on more than £240 billion of loans that grow riskier by the day as China’s equity market tumbles. Losses on the debt could wipe out 11pc of the industry’s net capital, the U.S. bank reported in July; and we suspect this is something U.S. Administration is aware of.

The reality could be more than fist wagging as this tariff war is the biggest economic attack in history. Although undoubtedly better than boots on the ground, this conflict still poses a threat to Americans and Chinese citizens. Firstly, American citizens have a lot to lose beginning with the aforementioned 25% tax they are going to need to pay on certain goods. Further issues include a shrinking market from Chinese buyers, and even rotting livestock due to smaller demand which will heavily affect farmers in the red Mid-West as they lose access to China’s market and are left with excess goods.

It seems likely that the war will not take place in the open, and the real battle will be “on the flanks in the form of unnecessary inspections, product quarantines, and heightened regulatory scrutiny” says James Zimmerman, a partner in the Beijing Office of International Law.

But in reality, this war affects everyone across the globe. With reduced access to the U.S. market, China’s growth may come to a halt which would have a knock-on effect to all world economies. Increased caution and confidence for business will cause uncertainty within China’s market and puts expansion plans on ice. With the two biggest economies grinding themselves against each other, could there be space for a third party to intervene?

Italy’s Harlequin Performance

The laughable situation in Italy in which the traditional political parties struggle for majority votes at the behest of the populist movement “5 Star” (MS5) is somewhat remnant of the Renaissance theatre style commedia dell’arte. MS5, the ambiguous and enigmatic harlequin-esque populist movement, has danced its way into mainstream politics taking a large slice of votes from the Right-Wing parties, who are now screaming “encore” as they attempt to scramble enough power to encourage a second election. But why have these events had a tumultuous effect on the rest of the world?

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The political drama began when the MS5 seized power through their refusal to bow down to political elites. This is not the typical Left vs. Right epidemic we see in most Western countries, but more of a working class vs. elite struggle like the Catalonians against Franco or British Labour reforms in the 60s. At this stage, MS5’s aim seems drastic – this is not just about a reform, this is about a revolution with a focus on domestic empowerment, immigration issues and the European Union alongside a strong hatred of the mafia. But nothing is set in stone, and due to this, Italy are currently proving real tricksters to label which is a massive turn-off for international investors.

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Geo-political issues and rapid social change tend to not bolster share prices, and since the beginning of this new chapter, Italy’s stocks have gone on sale. Rocky prices like we have seen it Italy do however tend to draw in the braver investors who hedge their bets on the dangerous side. Unfortunately, the sale prices don’t match the level of volatility in political stability, and therefore don’t seem to be a great bargain. This of course puts off even the high-risk investors. JP Morgan strategist Mislav Matejka noted recently that there is a poor risk-reward going forward giving the strong run and the political overhang.” It seems that nearby German equities have been the preferred route for most investors after taking profits on Italian stocks.

This mass sell-off of Italian stocks was originally triggered by fears of a second election and investors fear of Italy ditching the Euro, which currently seems highly likely. Investors have decided to keep their money in their pockets for now until the situation cools down with SocGen trio warning that buying could remain weak for several months.

Italy’s performance hasn’t just affected Europe, it managed to dance its way across to the Atlantic and cause the Dow Jones Industrial Average to drop 391 points. Although the Dow Jones made a huge recovery, making back most of the May dip, it is still undeniable that Italy’s Euroscepticism and quick social change managed to scare even the Americans.

No one can predict the ending of this drama, and although for now it seems that Italy have put forward a government, we don’t know if we are at the beginning or end of this unbridled saga which will likely continue to tighten the strings on investors’ wallets.