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.

‘The Death of One Man is a Tragedy, the Death of Millions is a Statistic’ – Joseph Stalin

Jamal Khashoggi’s murder in the Kingdom of Saudi Arabia’s consulate in Istanbul, Turkey this past October has caused a zealous chorus of international outrage amongst governments, businesses and concerned world citizens, alike. Yet more than a month on from his ‘disappearance’ one must wonder why everyone has been so upset, as Saudi Arabia’s brutal and medieval view on human rights generally elicits not so much as a peep from anybody aside from Amnesty International and other human rights groups. Indeed, one might even question the authenticity of the collective scorn, as it has not really amounted to any tangible punishment for the Kingdom. Saudi Arabia’s track record of bloody oppression and its endorsement of a form of Islam that many religious Muslims would define as ‘extreme’ is well documented. Despite this, the death of one journalist – who was one of Saudi Crown Prince Mohammad bin Salman’s (MbS) most fierce critics – has been the proverbial straw that has broken the camel’s back and has allowed the world to see this country for what it is: a brutal and bloody autocracy. As a result some of Saudi Arabia’s closest allies like the United States of America – have expressed the gravest concerns and have threatened economic sanctions. Wall Street, leading banks and major corporations –have echoed these sentiments. Others have gone a step farther and snubbed the previously considered ‘un-missable’ investment conference the Future Investment Initiative that took place in Riyadh at the end of October 2018.

When Khashoggi was first suspected of having been murdered (allegedly ordered by MbS) President Donald Trump said that if the Saudi authorities were found responsible, America’s response would be ‘severe’.  He suggested he might impose economic sanctions, but he did not go as far to say he would halt arms sales. Yet, despite his critics saying that this did not go far enough – not to mention Trump’s interim silence on the issue – it was clearly a change from the jovial and fraternizing figure he cut in Saudi Arabia during the first official state visit to any foreign country in his presidency. Furthermore, mere talk of putting sanctions on Saudi Arabia – however abstract and unlikely – represented crossing a line that few in previous administrations would have ever considered. British Prime Minister Theresa May also took the unusual step to condemn the Kingdom over Khashoggi’s murder and added that the Saudi account that rogue operatives killed him was not credible. As a result, the United Kingdom’s government ordered that any British visas belonging to the murder suspects be immediately revoked. France, Germany and the Netherlands have also joined in by suspending political visits to Saudi Arabia until there are ‘clarifications’. Yet, like Trump, no one has seriously considered ceasing or suspending arms sales to the Kingdom.

Wall Street and the international business community were served an opportunity to express their disapproval on a silver plate, as Khashoggi’s murder happened just before the much anticipated Future Investment Initiative, or ‘Davos in the Desert’. As a result, a number of business and banking A-listers who were scheduled to attend MbS’s signature investment conference pulled out at the last moment. Among those who did not attend were Jamie Dimon, Chief Executive of JPMorgan Chase, Stephen Schwarzman, Chief Executive of Blackstone, Larry Fink, Chairman and Chief Executive of BlackRock, Dara Khosrowshahi, Chief Executive of Uber, Lynn Forester de Rothschild, Chief Executive of EL Rothschild and Bill Ford, Chairman at Ford, amongst others. United States Treasury Secretary Steven Mnuchin and International Monetary Fund Managing Director and Chairwoman Christine la Garde were also among the notable absentees, along with expected media partners the Financial Times, Bloomberg and The New York Times. Despite the Future Investment Initiative having been declared a success, the combination of such heavyweights pulling out of the event and the wide-ranging negative publicity about Saudi Arabia during the conference combined to strip off some of its gloss.

Riyadh, Saudi Arabia
Wall Street and the international business community were served an opportunity to express their disapproval to Saudi Arabia on a silver plate, as Khashoggi’s murder happened just before the much anticipated ‘‘Davos in the Desert’.

It is absolutely clear that the initial response by governments and businesses rattled Saudi Arabia. It widely believed that MbS’s reputation took a major hit, which could even deteriorate further if any evidence points to him ordering Khashoggi’s murder. Moreover, it is reported that there have been murmurs both inside and outside the Kingdom that have questioned MbS’s suitability to take over the crown from his father, King Salman. But perhaps the item that showed Saudi Arabia’s vulnerability most acutely is that King Salman re-emerged from the comfort of his retirement to help his favourite son manage Saudi Arabia out of this crisis. Yet, despite the real and palpable way in which this has affected and even damaged the Kingdom, beyond the initial outcry, governments and businesses have failed to follow up with anything meaningful or impactful.

One wonders about the incongruity of it all. The world was compelled to respond harshly to Saudi Arabia following to Khashoggi’s murder; but despite the collective condemnation it is unlikely that it will lead to any lasting deceleration of diplomatic or business relations with the Kingdom. And yet, if the final outcome was always going to be maintaining the status quo, albeit after a firm smack on Saudi Arabia’s wrist, why did the world choose to be stirred into action after the death of one journalist as opposed to resorting to it its typical inactivity and ‘looking the other way’? Indeed, Khashoggi’s murder managed to make an impact that Saudi Arabia’s history of bloody oppression, totalitarian rule and extremist Islam simply could not. Lest one forgets, Saudi Arabia frequently treats its citizens brutally and horrifically: due process and women’s rights are all but absent, the state endorses public beheadings, flogging and cross-amputation and political dissidents are imprisoned and often tortured. Moreover the Kingdom’s state-enforced denomination of Islam called Wahhabism, which many committed Muslims see as vile, is generally believed to have inspired Islamic terrorism and to have nurtured Al-Qaeda and the Islamic State into the malevolent organizations they are. Beyond overlooking these toxic attributes, the devastation caused by the Saudi-led coalition’s bombing of Yemen in the Yemeni Civil War has killed thousands of innocent civilians and millions are at risk of starving in what might become the worst famine the world has seen in a century. One hastens to add that this has been achieved through weapons purchased from the United States, Britain and other Western countries.

Desert, Saudi Arabia
The world was compelled to respond harshly to Saudi Arabia following to Khashoggi’s murder; but despite the collective condemnation it is unlikely that it will lead to any lasting deceleration of diplomatic or business relations with the Kingdom.

Has Khashoggi’s murder spurred the world to outrage because it rubs us in a different or worse way than normal bloodshed and oppression? Is it, perhaps, the case that he was ‘silenced’ on the basis that he was a journalist that had the audacity to criticize the ruling elite? Possibly, but it would seem that collectively our love of the freedom of the press is somewhat less ardent than what our superficial genuflections towards it might otherwise suggest. Are we compelled to turn a blind eye to what happens within Saudi Arabia but moved to react if and when it murders on another country’s soil? Quite possibly, as the world came to Britain’s side when Russia allegedly instigated the Novichok poisoning of the Skripal family in Salisbury, England. But perhaps the greatest clarity might be offered through the words of one of the world’s most significant standard-bearers of state-managed mass murder, Joseph Stalin: The death of one man is a tragedy, the death of millions is a statistic. Simply put, it is easy to ignore the plight of faceless persons whose tragedy and devastation is only given form through a sterile number, indeed, even if this number pushes into the thousands or, indeed, the millions. But it is nearly impossible for Western countries and its businesses and citizens not to be moved – or at least feel the need to feign having been moved – when a person wearing a kind, smiling face whose only sin is using his pen to stand up to and shed light on injustice is brutally extinguished.

Yet, despite the initial uproar of indignation, even Khashoggi’s murder has failed to move governments and businesses to set Saudi Arabia adrift from the international community. Politics and money have won the day. Aside from Saudi Arabia’s natural resources from which both governments and businesses greatly benefit, the Kingdom presents tremendous potential for new ways to earn billions through new initiatives including the ambitious Vision 2030 that will attempt to modernize Saudi Arabia and open it up to Western tourism. Politically speaking, Saudi Arabia is also the country through which the West is able to maintain its own sphere of influence and counter the perceived threat of Iran and its allies, something that will not be given up easily or capriciously. But, unless one were to argue that the response to Khashoggi’s killing was just for show, one wonders if it was ultimately an unequivocal notice to Saudi Arabia and its de facto King that these kind of headline grabbing shenanigans are simply bad for business and that any more infractions might well result in the West clandestinely locating and installing a new head of state who will work within, and for, the West’s political and business agenda.

Why is Brazil doing so well in the current geopolitical climate?

Since 1980, the Brazilian economy has consistently underperformed compared to other LatAm markets, but the end of July may be showing promise of returning to the glory days. With workers often striking and a questionably inefficient public sector – Brazil often struggles to keep afloat financially. It seems that 2018 has been the year of buoyancy for the brasileros. In the rubble of the current trade conflict – Brazil may re-establish itself as the captain of Latin American markets.

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Since Trump declared a trade war with China, Brazil has found itself in a strong position. Seeking alternatives, the Chinese have begun trading with Brazil to fill the gap left by sanctioned American supplies, which have been taxed by up to 25%. Should they continue to build this trade relationship, Latin American emerging markets could profit significantly – with Brazil at the spearhead.

Brazilian stocks have been rallying as their domestic political environment improves and they take the mantle as a primary beneficiary for the U.S.A.’s trade war with China. The Bovespa Index has since jumped 12% during the past month while the iShares MSCI Brazil Index ETF has also risen by 12%.

As exportation makes up a mere 13% of the Brazilian GDP, they are relatively unaffected by external events. However, they still remain the largest exporter of food, soft commodities, and minerals – coincidentally, the same exports that China previously bought from America. These two aspects should be seen as the reason China would turn to Brazil – a somewhat stoic economy with expertise in exports that the Chinese have been deprived of. Because of this, should the Chinese decide to continue trading with Latin America, the Brazilian GDP will most likely prosper.

Peter Donisanu, an investment strategy analyst at Wells Fargo Institution, has claimed that there is an improvement in risk sentiment across emerging markets and Brazil is piggybacking off of that. He continues arguing that recent easing of trade tensions between the U.S. and some of its key partners has improved sentiments around emerging markets, and consequently, Brazil.

While there has been an improvement in risk sentiment, as Donisanu claims, LatAms sudden boost seems to be directly correlated to recent political events, and it would be a large coincidence to say otherwise. While Brazil most definitely is piggy backing off attitudes towards emerging markets, their disproportionate boom should be attributed to the Chinese interest – not a general interest.