Henry James International Management September Market Commentary

Market Overview

As 2019’s third quarter came to an end, the salient thought in our mind at Henry James International Management was ‘growth’, despite raging political, economic and market volatility. The trend evident across markets is that while 2019’s 3rd quarter was a downer, positive September growth partially offset the quarter’s losses. Despite this disappointing quarter, Year-to-Date (YTD) markets are up significantly. MSCI EAFE was +2.92% in September, -1.00% in the 3rd Quarter and +13.35% YTD; MSCI Emerging Markets +1.94% in September, -4.11% in the 3rd Quarter and +6.23% YTD; MSCI World ex USA Small Cap was +2.6% in September, -0.19% in the 3rd Quarter and +13.01% YTD.

Just keeping up with the news has presented enough turbulence to make even those with strongest constitutions feel motion sickness. Some of the prominent market influencing headlines continue to be the US-China trade conflict and a range of other tariff scrums between nations, Brexit, Iran’s provocation of the West and United States (US) President Trump’s subsequent saber rattling. The pro-democracy riots in Hong Kong show no sign of abating and one assumes it is only a matter of time before we see a version of Tiananmen Square again with China’s using its military to put the Special Administrative Region firmly under its thumb. Staying in Asia, North Korea is getting antsy and has resumed missile testing again at the expense of the Sea of Japan. Domestically any chance of short-term political stability was derailed when US Congressional Democrats launched an impeachment inquiry on the back of accusations that Trump encouraged the Ukrainian president to interfere on his behalf in the 2020 US General Election.  Germany, the bellwether of global manufacturing, has seen its output continue to drop; American and Chinese manufacturing has followed suit.

Henry James International Management September Market Commentary
Global Manufacturing is slowing.

And yet, somehow markets – despite personifying the before-mentioned volatility – have pressed forward in a mostly unperturbed fashion. Of course, there is some reason for optimism. The Fed lowered interest rates again by 25 basis points to between 1.75% and 2.00%, which should give domestic and global markets (particularly emerging markets) an excellent spark of positive momentum. Also noteworthy is a new US-Japan trade deal that is set to take effect on January 1, 2020; while it will technically have to be approved by Japanese lawmakers before it is official, it is expected to be ratified without difficulty.

Investment Outlook

James O’Leary, CFA, Chief Investment Officer and Senior Portfolio Manager at Henry James International Management, sees self-inflicted political turmoil as the main factor impeding global economic growth: ‘It seems that politicians globally cannot sit back and enjoy a stable and slowly expanding global economy,’ he said. According to O’Leary, the economic slow down, that we discussed at length in our August Market Commentary, will continue as long as Brexit is uncertain and continues to pull both the United Kingdom and European Union down, the US is mired in political turmoil, the US and China fail to achieve a mutually beneficial trade resolution and Iran continues to destabilize the Middle East and threaten oil through its support of regional terrorism.

Henry James International Management September Market Commentary
Markets have so far push through Iran’s destabilizing influence.

Despite the volatility, O’Leary sees markets as resilient, but to a point. ‘Markets took Iran’s bombing of the Saudi oil processing facility in stride, and were unaffected by Trump’s United Nation’s speech where he lambasted Iran and China,’ said O’Leary. Of course, the world remains awash with oil despite the actions with which Iran has been accused and, in spite of the US President’s bellicose rhetoric, shooting-from-the-hip style, and apparently being ‘locked and loaded’, he has made it very clear that he does not seek war.

At this point – around mid-September – O’Leary believed that markets were cautiously hoping to find some element of terra firma at their feet to use as a sturdy platform to reverse the global slowdown. What they were greeted with was what O’Leary views as Congressional Democrats who could not leave well enough alone and took impeachment action against Trump. Not only does this tremendously damage US-China trade war negotiations before the 2020 General Election – as a distracted, politically impeded President will not be able to negotiate from a position of strength in the face of Chinese Premier Xi Jinping’s absolute rule – it will also push the required robust domestic economic agenda to help stimulate the US economy to the back burner. When combined with the Chinese debt crisis, Hong Kong riots and Brexit taking yet another turn for the worst and paralyzing British business, one wonders how much more markets can take before the global slowdown becomes a global recession. Thankfully, the global economy is still expanding and is projected to grow just below 3% in 2020, though new International Monetary Fund Chief Kristalina Georgieva’s October 8th speech could certainly erode some optimism.

O’Leary is hopeful that the international economy will shake off the political uncertainty and that we will see a globally coordinated fiscal and monetary response. The ray of good news for the US and global economy is this: as pressure turns coal into diamonds, so may Trump’s ardent desire to get re-elected drive him to achieve a trade deal with China and get his own economy back on track with the help of falling Fed interest rates.

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.