Henry James International Management November Market Commentary

Market Overview

 Perhaps the best thing about November’s market performance is that at least it did not damage the 2019 gains that seemed a rather far-fetched prospect a year ago. The MSCI EAFE index dramatically zigzagged up and down all month, and it appears that the month coincidentally happened to end while it was up an uninspiring 1.14%. The MSCI Emerging Market index followed a similar roller-coast path, but unfortunately finished the month down by -0.13%. The MSCI World ex USA Small Cap index posted modest gains that most will gladly take given the geo-political and economic conditions with which markets have been faced, up 2.28%.

November was set to be a turning point in the United States (US) – China trade dispute until a certain President was apparently moved to announce his support for the Hong Kong protestors. On November 27, 2019 President Donald Trump signed two bills on Hong Kong human rights, one that put sanctions on Chinese and Hong Kong officials who abuse human rights and another that prohibits the sale of nonlethal munitions to Hong Kong police. Despite Trump admitting that he signed these bills out of ‘respect for (Chinese) President Xi, China and the people of Hong Kong’, his actions incurred Beijing’s ire and the summoning of the US ambassador to communicate that the move would undermine trade negotiations.

November watched the Hong Kong local elections with unprecedented interest. Generally rarely anyone outside of Hong Kong gives a hoot about them as the election winners will ultimately manage municipal tedium like bus routes and garbage collection and will have zero ability to meaningfully push Hong Kong toward the democracy the protestors (along with the West) apparently crave. Nonetheless, in light of the elections taking place during the most heated anti-Beijing protest Hong Kong has ever experienced, the elections became a proxy-referendum on the status quo and Communist China’s political stranglehold over the Special Administrative Region. The pro-democracy camp won its biggest ever victory, taking 17 of Hong Kong’s 18 district councils. While this will have severely undermined the already beleaguered Hong Kong Chief Executive Carrie Lam and her viability as head of government, the truth is that her position is as tenable as President Xi’s autocratic whims say it is. Furthermore, while the election results in themselves can and will do nothing to achieve the democracy for which so many Hongkongers are demanding, the decisiveness of the pro-democracy’s victory will have sent shock waves to Beijing. The question is which is the more likely result: President Xi listening to and fully accommodating the protestors’ wishes or bringing forth Tiananmen Square 2.0?

Henry James International Management November Market Commentary
November saw the largest anti-Beijing protest in Hong Kong’s history.

After the hubris inspired by the surprise spike in German manufacturing orders in September and the hope that this signified a bottoming out, October saw the biggest downturn in a decade. According to the Federal Statistics Office, German industrial output fell by -5.3% in October versus the same month in 2018. This is horrible news for a German economy that thought it had turned a corner, as well as for the European Union (EU) who has been dealing with the impeding effects of Brexit; of course, an economically weak Germany holds dire consequence for the global economy. Germany’s political situation does not offer any help as the junior partner in government with Angela Merkel’s Christian Democratic Union (CDU) party, the Social Democratic Party (SDP), recently elected new party leaders that are hostile to the Chancellor and will vote on whether to remain in coalition. If the SDP chooses to abandon the coalition either the CDU will form a minority government or there will be a snap election, two options that will not offer Germany the short-term economic stability it may crave.

British Prime Minister Boris Johnson’s dramatic election victory on December 12, 2019 has given a strong indication that Britain’s three and a half years of Brexit limbo will finish on January 31, 2020. Johnson’s catch phrase of ‘getting Brexit done’ apparently appealed to British voters who gave the Conservative Party the largest Parliamentary majority enjoyed by any United Kingdom political party since the 1980s. When the exit polls revealed the likely extent of Johnson’s victory, the price of Sterling shot up to its 12 month high versus USD. Moreover, despite the fact that Brexit is generally not seen as market friendly, pundits have predicted that a Conservative victory might see Britain’s economy enjoy a short-term growth spurt in Q1 of 2020, though it would seem unlikely that it would be sustained throughout the year.

Federal Reserve Chairman Jerome Powell struck and optimistic chord about the economy when he said he saw ‘the glass as much more than half full’. According to Powell, his ever-flexible monetary policy that lowered interest rates by 75 basis points since July 2019 is maintaining the strength of the US economy and is protecting it against a serious downturn; moreover, it is subduing the damaging effects of trade and tariff uncertainty. The Fed Chairman confirmed that his monetary policy is helping to improve both consumer and business sentiment and to catalyze spending in interest-rate sensitive sectors such as housing and consume durable goods. Despite the already robust US labor market adding 266,000 jobs in November – a figure that smashed expectations – along with the joblessness-rate at a 50-year low, Powell indicated that he believes there is still plenty of room for growth on these impressive gains. He suggested that elected officials can build on the momentum through implementing the policies that will support and reward the labor force to get the training and education required to meet the challenges of technological innovation and global competition.

Henry James International Management November Market Commentary
Getting trade back on track is vital for Presidents Trump and Xi’s political survival, says O’Leary.

Investment Outlook

James O’Leary, CFA, Chief Investment Officer and Senior Portfolio Manager at Henry James International Management sees the beginning of a US-China trade truce on the horizon, the recent tension resulting from Trump’s Hong Kong protest bills, notwithstanding. ‘ Presidents Trump and Xi have mounting incentive to bury the hatchet and to work together to resolve the trade dispute. Firstly, Trump’s re-election begins and ends with a strong US economy; secondly, one of the few items that can undermine President Xi’s lifetime term in office – not to mention the Communist Party’s complete control of China – is a weakened economy.’ He continued, ‘As such, a prolonged trade conflict between the world’s two largest economies is not just something that isn’t in anyone’s interest. Getting trade back on track is vital to political survival.’ Moreover, according to O’Leary, a fair and balanced trade deal should not only go a long way to balance US imports and exports with China, it will create American jobs and mitigate Chinese intellectual property (IP) theft, something for which Beijing has already increased the penalty and on which it has promised to crack down. While O’Leary remains dubious about whether China will carry through with its efforts to mitigate IP theft given that it is widely believed that it is state-sponsored, he is encouraged that other countries – Germany, in particular – are becoming aware of the seriousness of the situation. ‘A multi-lateral approach to stopping Chinese IP theft may be the best way forward,’ says O’Leary.

O’Leary was shocked by the recent German industrial output figures as he was under the impression that its manufacturing sector was back on track. ‘German large manufacturing equities have seen their stock prices rally over that past three months and based on the fact that stock performance is generally an indicator of future GDP growth, 2020 appeared set to be a good year for Germany.’ However, not only have October’s figures thrown this in doubt, Germany’s political situation will likely only make recovery and improved business confidence even more difficult.

O’Leary agrees with Federal Reserve Chairman Powell’s assessment of the US economy is in a good place; and he believes that Powell has done a good job managing the sugar high of the Trump Tax Cuts as well as issues created through tariff and trade uncertainty. O’Leary says that the sustained economic growth is starting to benefit lower earners, but he agrees with Powell that more can be done on a policy front to invest in workers both to ensure that American prosperity benefits a wider breadth of society, but also so that the American economy is ready for the challenges of the 21st century.

In many ways, November has been a microcosm of 2019: volatile, complicated, filled with economic headwinds but also reasons for optimism. Indeed, much like the year so far, the many causes for concern, notwithstanding, markets are generally delivering positive returns for investors. While it remains difficult to be 100% optimistic about 2020, we believe that many institutional investors will be more than delighted the US and China are likely on the brink of a trade deal and that the US economy is fundamentally strong (despite inflation lower than 2% and interest rates being too low for comfort). Of course, threats to markets remain – namely a prolonged German economic downturn, a Brexit that is messy despite Johnson’s election victory and Trump continuing his policy of weaponizing tariffs. From our perspective, we see the forces for economic growth capable of subduing those of contraction and remain hopeful that 2020 will be positive for investors.

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.

Henry James International Management August Market Commentary

Market Overview

 August was not a positive month for markets. The MSCI EAFE index fell by -2.58%, the MSCI World ex USA Small Cap dipped by -2.30%; the MSCI EM index shrunk by -4.85%. Dramatic though these losses may be, they are arguably slight given the scale of market-influencing political volatility August witnessed on a global scale. The main protagonists were the United States (US) and China, whose trade conflict has escalated to dangerous heights in terms of new tariffs and fiery tweets. Worse yet, the path to a resolution is not nearly as obvious as many may have deceived themselves into believing only a matter of months ago. Brexit continues to impede both the United Kingdom (UK) and European Union’s (EU) economies and there is no end to the uncertainty on the horizon, despite new British Prime Minister (PM) Boris Johnson’s insistence that Brexit will happened, come what may, at midnight on October 31, 2019. August also presented markets with a range of worrying facts: 10 year US bonds fell below their 2 year counterparts for the first time in a decade (a telltale sign of imminent recession), the US economy is slowing, China is also in the midst of an economic slowdown as well as a serious debt crisis, Germany is in a fully-fledged manufacturing recession and Britain appears headed for their first recession since the financial crisis (July’s positive UK economic growth, notwithstanding). Despite all of this cause for genuine concern, there is some reason for optimism. Firstly, low US interest rates – despite making markets defenseless in a recession scenario – should help catalyze the US economy; furthermore, they should help Emerging Market (EM) economies who are already benefiting from Chinese supply chain disruptions. Indeed, we believe that the Federal Reserve will lower rates at least one more time in 2019, with possibly more reductions in 2020. Secondly, the World Bank is anticipating global growth of just below 3% for both 2019 and 2020, which would suggest that there is still a range of underpriced opportunities available for investors. Lastly, as we saw when Sterling surged in early September when UK PM Johnson’s bold Brexit plans were frustrated by the UK’s Parliament, in a world burdened by such troubling politics, any news that is even vaguely positive will create market optimism, however ephemeral.

Despite the projected growth that cushions markets from international recession, we believe we are experiencing a global growth slowdown. The US enjoyed tremendous short-term benefit in 2018 (GDP growing 2.9%) through the Trump tax cuts, which flooded the economy with corporate and consumer capital. However, it came at a big cost of adding more than a Trillion USD to the fiscal deficit, which a cynic might think is not necessarily symptomatic of the fiscal prudence for which Republicans are famous. Beyond that, a range of non-political voices, including that of the International Monetary Fund, were transparent in their view at the tax cuts’ inception that 2018’s turbo-charged economy would not only lead to an economic slow-down and recession, it would in fact hasten it. We believe we are experiencing this today, which has become even more problematic given the way in which the Fed was effectively coerced to keep up with 2018’s economy by raising interest rates to combat inflation. Today, with American growth stalling and further impeded by the US-China trade war, the Fed is really only able to stimulate growth by lowering the interest rates it – we think – unnaturally hiked up only last year which will leave it without any tools to combat the recession which many believe is on the horizon.

China and Germany – and certainly the two nations combined – corroborate our view that we are in the midst of a global slowdown. China has arguably been the main driver of global growth since the financial crash of 2008 and any reduction in its GDP is felt throughout the world. Part of China’s economic overdrive in the past decade has been heavy borrowing and loans that stand little chance of ever being repaid. Moreover, Chinese consumer debt is also worryingly deep. China has tried to rein in corporate and consumer lending, but each instance has led to a global economic stumble, which compelled Beijing to loosen lending again. China is currently at a 30-year industrial production growth low (4.8%), which may be part and parcel of its desire to shift its economy from manufacturing to services, but this will be a painful transition not only for China, itself, but for a world economy that is dependent on Chinese growth.

Henry James International Management August Market Commentary
Despite the projected growth that cushions markets from international recession, we believe we are experiencing a global growth slowdown.

Germany, meanwhile, saw its economy shrink by -0.1% in the second quarter of 2019 and a deeper drop is predicted in the third quarter. Its fate is largely in the hands of China as Germany exports nearly $100bn of goods to the Communist state and a slowing of Chinese consumer and corporate spending will hit hard. The Chinese buying fewer German products – chiefly cars, machines tools and manufacturing equipment – will continue to damage Germany’s manufacturing which is currently at seven consecutive months of decline. It must also be said that Germany imports more than $100bn of Chinese goods, and an economically declining Germany spells bad news for China, particularly given its trade war with the United States.

Brexit is not just bad for Britain, whose best-case scenario appears to be recession – it is also dangerous for Germany. Germany exports nearly $100bn of goods to Britain and a Brexit that imposes any element of trade friction and uncertainty will make this number fall; and possible tariffs will make the cost of business significantly higher. Indeed the uncertainly and chaos caused by Brexit are likely partially to blame for Germany’s recent poor GDP and manufacturing figures. With the October 31st Brexit deadline quickly approaching, the projections of economic Armageddon as well as food and medicine shortages are becoming less abstract and more tangible (particularly since the release of information pertaining to Operation Yellowhammer). Markets reacted positively to the news that Parliament managed to thwart a ‘No-Deal’ Brexit (for now) as well as possibly extending the deadline beyond Halloween. But when markets wake-up, they will realize that an end to the deadlock remains illusive and until a market-friendly resolution is achieved the British, European and World economies will continue to suffer.

Of course, among the largest contributors to US and Chinese market woes is their trade war, the stakes of which rose considerably this past month. August kicked off with Trump announcing a 10% tariff on over $300bn of Chinese goods, citing a lack of progress in trade negotiations. A couple weeks later, the US President did a partial about-face, saying that he would delay the tariff on cell phones, video games and apparel until December 15 to mitigate the damage it would have on US consumers in the run-up to Christmas. Trump hoped this gesture would impress Chinese counterpart President Xi Jinping and make him more dovish. This was not realized as the Chinese increased their hostility by ordering all companies to stop buying US agricultural goods (worth up to $20bn) and new tariffs on $75bn of US goods, which went into effect on September 1st along with the new US tariffs. Trump’s response was ordering US companies to no longer do business in and with China (an order that does not command legal weight) and set the preexisting 25% tariffs on $250bn of Chinese goods to go to 30% on October 1, 2019 and the newly introduced 10% tariff to rise to 15% on December 15, 2019. As of September 2019 we are at the high water mark of this trade war and markets will hope that hostilities begin cooling immediately.

Investment Outlook

James O’Leary, CFA, Chief Investment Officer and Senior Portfolio Manager at Henry James International Management, believes we are starting to experience a global growth slowdown. ‘Germany is the bellwether of global manufacturing and their manufacturing sector has slipped into recession,’ he said. Due to uncertainty that has negatively affected the Chinese economy on the back of the trade war and their debt crisis, says O’Leary, China simply has neither the need nor the money for German manufacturing machines and luxury cars. According to O’Leary the German and Chinese economies are co-dependents and their respective woes and uncertainty will drag the other down. Closer to home, German trade with the UK has slowed down simply because the British economy is shrinking, which will likely continue to be the case until a market friendly Brexit is achieved, says O’Leary.

Henry James International Management August Marketing Commentary
‘The German and Chinese economies are co-dependents and their respective woes and uncertainty will drag the other down.’

Regarding Brexit, ‘Who could possibly consider investing in the UK right now? It is not even clear whether they will be able to import food in a few weeks,’ said O’Leary. He continued, ‘Uncertainty breeds consumer anxiety, and this inevitably results in consumers tightening their belts and spending less money.’ While the likelihood of a No-Deal Brexit will have gone down considerably after Parliament wrested control from PM Johnson, the longer Britain and the EU kick the can down the road, market pessimism will persists and people will choose to save and not spend their money. The result: further economic slow down in Britain, Europe and the rest of the world.

O’Leary is not averse to the concept of playing hardball with China, particularly in relation to their recent history of intellectual property theft; indeed, he is even open to some element of ‘necessary’ market pain that may result. However, in his view IP theft is not a uniquely American problem. ‘Multilateral action against China that incorporated the likes of Germany, Britain and Japan would have worked far better in terms of actually getting China onside and limiting market volatility.’ What is more, says O’Leary, while the Obama administration’s Trans-Pacific Partnership (TPP) was not an effective way to subdue China, there is no reason why the US could not have remained within the robust trading block and still go after China in a multi-lateral fashion. The US-China trade dispute has put uncertainty into both countries manufacturing, says O’Leary, because tariffs automatically reduce the number of people on either side of the divide who will be open to buying the other’s products. ‘If one is going to produce goods, better be sure there will be somebody who will buy them,’ says O’Leary. Of course, a positive side-effect of the trade war has been disrupting Chinese supply chains, which makes the world economy less reliant on Chinese manufacturing and also gives Asian EM economies like Vietnam a big boost.

According to O’Leary, one of the most worrying elements of the global slow down from a US perspective is that the Trump Tax Cuts, despite boosting the economy in 2018, added significantly to its public debt. Indeed, much of this debt is foreign, which means that it actually has to be paid back, he says. Of the US’s $6.2tn foreign debt, $1.18tn is owned by China and $1.03tn is by Japan. O’Leary also laments the way in which Trump’s Tax Cuts effectively coerced Fed Chairman Jerome Powell to combat inflation through raising interest rates through gritted teeth.

At Henry James International Management our investment strategy bears the full range of these market issues in mind while it ‘quantamentally’ locates opportunities while minimizing risk. ‘We use a very disciplined country-weighted system that is based on equally weighted equities in each country based on their 52-Week Sharp Ratio,’ says O’Leary. He continued: ‘So when a country’s relative strength decreases the weighting in our portfolios for that country also decreases.’ He points to the UK, Germany and China, whose equities have decreased proportionally in our portfolios. Conversely, our portfolios are over-weighted in India, which has seen excellent growth during the past several years, and Russia, which is exhibiting growth in several sectors. Sector-wise, our ‘quantamental’ strategy has seen our funds naturally reduce investment in iron ore and, of course, manufacturing, while we have increased investment in biotech, internet retail and pharmaceuticals.

As we head into 2019’s homestretch, we are grateful that the year has mostly defied analyst predictions from back in 2018, in so far as markets have delivered for investors thus far. And yet, far from the political volatility abating, it has only increased. We would like to see world economies turn away from the tit-for-tat that has seen countries use tariffs to exploit others’ vulnerabilities. Moreover, we would like to see a world of inclusive economic relations for everyone’s mutual benefit, as using trade as a substitute for war is reminiscent of the politics of the Smoot-Hawley Tariff Act that arguably made the Great Depression both deeper and longer. As O’Leary puts it, ‘Let’s hope wiser heads prevail!’ Thankfully for investors in the medium term there is some global growth and lower US interest rates should help impede the global slowdown.

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.