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.

Will Labour Save Theresa May’s Brexit Bacon?

Anyone who has ever seen Prime Minister (PM) Theresa May battle Leader of the Opposition Jeremy Corbyn in the House of Commons would find it borderline impossible to imagine any kind meaningful political union between the two parties. Historically, the Tories (as Conservatives are known locally) and Labour vehemently disagree on practically everything in contemporary politics – from austerity, to corporate taxation, unions, education, and far more. And yet, as the PM nervously clings to her so-called Chequers deal – her vision for Britain’s future relationship with the European Union (EU) and the basis for her upcoming Brexit negotiations – an unholy alliance of desperation and convenience is brewing between the two parties.

Brexit Bacon
Will Labour Save Theresa May’s Brexit Bacon?

Key Brexit-supporting Tory Members of Parliament (MPs) are deeply dismayed by the Chequers deal, saying that it fails to deliver the ‘hard Brexit’ for which the people voted, and are therefore threatening to abandon their leader should it come to a vote in the House of Commons. On the other side Labour MPs have been ordered by their leader Corbyn to vote against Chequers on the basis that it fails to meet the six tests the left-leaning party have set to establish their definition of what a good Brexit deal would be. Were May’s Chequers deal to be voted down in the House of Commons, it would effectively end her time as PM and – as Corbyn hopes – will likely lead to another general election, which the Labour leader would hope to win. Given the vitriol between the two leading British political parties, one might take it as a given that Labour would only be delighted by the idea of a Tory PM battling desperately for her political life with enemies of all persuasions knocking on the gates of 10 Downing Street.

And yet, politics are not so simple these days, something that holds true for both the Tories and Labour. There are potentially over 30 Labour MPs who are strongly considering defying their leader and supporting the PM’s Chequers deal as they fear the economic consequences of a no-deal Brexit. Such is the depth of their concern that will consider betraying Corbyn even if it means inadvertently propping May up and keeping Labour out of power. On the other side, the most dogmatic Brexiteer Tory MPs – chief among whom Jacob Rees-Mogg, Boris Johnson, David Davis and Steve Baker – along with another 30 or so of their parliamentary colleagues are poised to defy May and vote down Chequers, presumably to preserve their slim hopes of a pristine hard Brexit. Of course, they must be aware that failing to support May might come back to bite them, particularly if toppling her brings forth another general election that results in Labour, not them, in the Brexit negotiation driver’s seat, a scenario which some have suggested might see Brexit called off entirely. What we have in front of us is a near perfect syllogism by which both parties are putting their Brexit concerns and aspirations over traditional party politics and ambitions.

Brexit politics
The Conservative and Labour parties are putting their Brexit concerns and aspirations over traditional party politics and ambitions.

Despite Labour MPs overwhelmingly supporting Britain’s EU membership, there are seven in their ranks, with the notable inclusion of leader Corbyn, who can be classified as Euro-skeptics or even ‘card-carrying’ Brexiteers.  Yet, even beyond this minority group there are a wide range of Labour MPs who represent Brexit-heavy constituencies, which means that many will be forced to consider abandoning their own views to pander to their voters’. Beyond this awkward dilemma, for Labour MPs a May-brokered deal is vastly preferred to a no deal Brexit. As such they will face what one shadow minister referred to as a ‘crisis of conscience’: on one side the party leader telling MPs to vote ‘no’ to Chequers and help catapult Labour into government; on the other side the wishes of Brexit-voting constituents and the havoc a no-deal Brexit might wreak on Britain’s stuttering economy.

Labour MP Kevan Jones from North Durham is among the many in this predicament and he indicated that he would be open to supporting Chequers in Parliament. He said: ‘I would not support [a] no-deal [Brexit] because that would be disastrous both for my constituents and the country.’ Jones’ Labour colleague Lisa Nandy, MP, is also worried about how a no-deal Brexit might affect her Wigan constituency, and if what May brings to parliament is deemed good enough she will feel pressure to support it. Nandy said: ‘The public wants [Brexit] over, they are fed up with this and want it done so the government can get on with other difficult decisions. There is a push from the public to just sort this out.’ Another Labour colleague anonymously added that while it will not be easy for Labour MPs to defy Corbyn and back a Tory government – far from the neat and tidy solution that Labour would merely stroll into 10 Downing Street in another general election – there is a real threat that an ideological hard Brexiter like Rees-Mogg might be the next PM who will pursue either a hard Brexit or a no-deal Brexit. Therefore, even with the false choice of two unappealing alternatives; i.e. Chequers or a no deal Brexit, May’s vision for some Labour MPs might seem the more palatable.

Parliament will vote on Brexit
Theresa May’s Brexit vision will likely seem more palatable than a no-deal Brexit for Labour MPs on the fence.

Within May’s Conservative party it is clear that those who oppose Chequers will not budge and will vote it down in Parliament if given the opportunity. One might say that this is rank and brazen stupidity (if one were a Tory and/or Brexit voter) as surely a Chequers Brexit is better than risking an even softer Brexit or even no Brexit at all under a Labour government. And yet Rees-Mogg and his eurosceptic crew are prepared to risk this and topple May’s government if it is the only remote way to achieve their perfect hard Brexit.

With daggers pointed at May from all directions, will she accept re-enforcements from her sworn enemy? One would imagine that reaching across the aisle, as it were, would be among the bigger ‘no brainers’ in the PM’s career… That is, if she’s given the opportunity. Yes, despite the borderline impossible situation May is facing domestically, there is a tangible threat that she many never be able to give her Labour colleagues the chance to save her Brexit bacon. Upon hearing the details of Chequers EU leaders, chief among whom President of the European Council Donald Tusk, German Chancellor Angela Merkel and French President Emmanuel Macron, rejected it out of hand based on its solution for avoiding a hard border between Northern Ireland and the Republic of Ireland; i.e. what will be the only land border between the EU and UK. Chequers sets out a vision whereby the whole of the UK would remain in the EU custom union for a limited time while a reasonable trade solution is worked out. EU leaders have said such a concept is unacceptable, which means that as things currently stand, there is serious doubt as to whether the EU will even consider entertaining Chequers in its current form. If the EU rejects Chequers, it will never ever be put to a vote in the House of Commons, making May’s unlikely Labour allies irrelevant.

Theresa May's vision for Brexit
If Theresa May’s political shrewdness out-maneuvers her European counterparts and she brings a Chequers-inspired Brexit deal back to Parliament, will Labour’s support even be enough?

And yet, in the event that May’s political shrewdness out-maneuvers her European counterparts and she manages to bring a Chequers-inspired Brexit deal back to Parliament, will Labour’s support even be enough? Not only have there been estimates of up to 80 Tory MPs who view Chequers suspiciously, on a good day May’s government only has a majority – albeit a slim one – in the House of Commons only because she is propped up by the 10 Democratic Unionist Party (DUP) MPs from Northern Ireland. Depending on the agreement May makes regarding the Irish border, the DUP’s support may be called into question. In a scenario in which she is coerced to accept a version of the EU’s solution for the Irish border – their so-called ‘backstop’ that would see Northern Ireland remain in the EU customs union and single market on a temporary basis while the rest of the UK existed on the outside – the DUP would withdraw its support from Chequers. In the words of Arlene Foster – leader of the DUP – her party’s only ‘red line’ is a situation in which Northern Ireland is treated differently in customs or constitutionally than the rest of the UK. She said: ‘We don’t know what will happen in five or 10 years’ time. We don’t want Northern Ireland going off in a different direction from the rest of the UK.’ To say that the PM is in a tight spot is an understatement, as it is clear a sleight of hand or some other magic trick will be necessary to resolve the conflicting needs of the EU and the DUP just to give willing Labour MPs a hope and a prayer at turning her Brexit vision into law.

Just What Is Happening with Brexit?

Since the Brexit vote of 2016, British politics has been tumultuous with inter- and intraparty disagreements causing investors to treat FTSE and UK market investments as high-risk. So far, the most damaging aspect of Brexit seems to be uncertainty. Beyond the ramifications of leaving the EU, analysts are struggling to predict what a post-Brexit Britain will be like. It is difficult to predict how red tape around the Customs Union, which greatly benefits the British economy, will affect British trade, market capitalisation, and deciphering whether the market is undervalued or not.

The constant battles and disputes surrounding the legitimacy of Brexit and how Britain should go about it are frequently voiced in the House of Commons, appropriately reflecting the nations division over Brexit. Despite disunion being apparent between the two main British parties, Conservatives pushing for Brexit and Labour for a second referendum, there is a glaring divide notable within the Labour party – the left-wing alternative in the British parliamentary system.

Although individual Members of the Labour Shadow Government Parliament are for the most part Remainers, the party is a life-long Eurosceptic which is an obvious conflict of interest. Voters are very aware of this, and it is making Labour’s position on Brexit unappealing and creates more confusion among the electorate. Ex-British Labour Prime Minister Tony Blair has come out of the woodwork and criticised the current shadow government leader Jeremy Corbyn’s policies as being “the worst of both worlds”.

Following from this glaring division, an unforeseen issue has arisen in Ireland as talks of a hard border are discussed. Northern Ireland will follow Britain out of the EU, but Ireland will not. This issue was made more prominent when Theresa May stated recently that Britain is leaving the EU and will not softly exit the customs union.

This debate could reopen a healing wound with Northern Ireland by raising the issues of borders between the Ireland and Northern Ireland causing more political instability. Four political parties have backed Northern Ireland staying in the single market – stating that there should be no hard border between Ireland and Northern Ireland – and Ireland and the rest of the UK. This is also being supported by the DUP who propped Theresa May into power during the last election.

These political conditions reflect peoples’ uncertainty as to what will happen. Since the referendum, there have been market crashes, volatility, and stagnation in house prices all related to the vote.

Theresa May has opened the Conservative sails to the wind with her firm Leave stance when addressing the EU last week, stating that Britain will not be “climbing down” and will leave the Customs Union. Hopefully, Britain will decide soon how it will tackle leaving the EU so that it can begin reshaping itself according as currently no one seems to know what is going on, making it tricky for investors to trust British markets.