The first quarter of 2019 was a wild ride for capital markets — equities and government bonds rallied as US Treasury yields and German bund yields sunk. This was a clear dichotomy, indicating optimism in the stock market but pessimism about the global economy. I believe this reflected more accommodative monetary policy from the Federal Reserve and other central banks, suggesting a more supportive environment for risk assets such as equities, while weakness in some economic data suggested a slowdown in global growth, pushing yields down. In this week’s blog, I discuss six current issues that could impact capital markets in April and beyond.
1. Growing ‘Brexanity’ in the UK
On March 29, UK Prime Minister Theresa May lost a third vote on her proposal to exit the European Union even though, in an attempt to sweeten the deal, she had promised Conservative lawmakers that she would step down as prime minister if the deal was approved.
Earlier in the week, Parliament had rejected all eight options in the indicative voting process. May said of these developments: “The implications of the House’s decision are grave … I fear we are reaching the limits of this process in this House. This House has rejected no deal. It has rejected no Brexit. On Wednesday it rejected all the variations of the deal on the table. And today it has rejected approving the Withdrawal Agreement alone and continuing a process on the future.”1 May said she will press on with talks to secure support, with her political spokesman saying that the smaller margin of defeat from the prior two votes indicated that progress was being made as a number of senior Conservatives had voted with the government.
All in all, there is an enormous amount of uncertainty about Britain’s future. Dutch Prime Minister Mark Rutte said on Friday that there is a distinct possibility that Britain will leave the European Union without a deal: “The risk of a no-deal Brexit is very real. One of the two routes to an orderly Brexit seems now to be closed. This leaves only the other route, which is for the British to make clear what they want before April 12.”2 A further extension of the Brexit process beyond that date can only be granted if Britain knows what it wants, which seems to be a tall order right now.
The Brexit date has now moved from March 29 to April 12, with the possibility that it could be pushed out further. On April 1, there will be another round of indicative votes, with possibly more on April 3. Based on the first round of votes, opinion may coalesce around the idea to remain in the Customs Union only, and the idea to hold a confirmatory vote through a second public referendum. There is also a suggestion from the government that May’s Withdrawal Agreement could come back this week for a fourth vote. We could see the Withdrawal Agreement eventually coupled with something like the Customs Union idea. A general election for a new prime minister may also be an option.
The European Union (European Commission) will hold an emergency summit on April 10, at which point Britain has to tell it what it wants to do. If a vote is held between now and April 10 that finally ratifies the proposal on the table, Britain would have until May 22 to formalize the process through legislation (May 22 is a key date because the European Parliament elections are May 23-26). If it is decided that new elections will be held, this would require a long extension (if the UK were to ask for a long extension, then it would have to participate in the European Parliament vote). This is also true if Britain decides to hold a new referendum. Or, Britain could just go ahead and crash out on April 12 without an agreement — but that would be fraught with peril, as experts are suggesting this could lead to shortages of food and medicine, and other major issues.
UK equities and government bonds performed well in the first quarter, but that may not continue given that chaos has been dialed up with the events that unfolded in the last several weeks — and the potential for more uncertainty to come.
2. US Employment Situation Report for March
This report will be released by the Bureau of Labor Statistics on April 5, and the most important metric to look for, in my view, is average hourly earnings. We’ve seen a significant increase in recent months, and we want to see if that trend continues or possibly accelerates from here. Low inflation has given the Federal Reserve (Fed) the luxury to be patient. However, if inflationary pressures are starting to build, the Fed might not have that luxury much longer.
There is also heightened sensitivity around whether or not we are in an economic slowdown given lower Treasury yields and the Fed’s abrupt change in stance, so nonfarm payrolls will be important as a coincident indicator of US economic health.
If wage growth is contained and payrolls aren’t anemic (recall that February’s jobs report indicated very anemic payrolls), then I believe US stocks would continue to perform well, while investor worries would likely de-escalate, sending Treasury yields higher.
3. Chinese economic data
China’s Manufacturing Purchasing Managers’ Index for March clocked in at 50.5, which was much stronger than expected — and actually was the biggest month over month increase since 2012.3 This was the strongest reading in the past four months, and it suggests that the significant stimulus from the Chinese government is finally impacting the economy.
This is consistent with the positive speech made by Premier Li Keqiang at the Boao Forum last week, where he indicated that government stimulus is having a positive impact on economic growth. I believe that the Chinese economy has stabilized meaningfully in the first quarter due to the government’s efforts, and I expect further recovery in the second quarter. I continue to expect large capital inflows into China and for the renminbi to further stabilize and strengthen. However, I will look to upcoming data to confirm those views, including the Caixin index to be released this week.
If we see continued stabilization and even improvement in Chinese economic data, I expect Chinese equities to post positive returns and major government bonds that are perceived to be “safe harbors” to see yields rise as investor worries decrease.
4. European economic data
Given recent weakness in European data, we will want to follow eurozone unemployment and inflation releases closely. Much of the weakness has been in sentiment indicators, so we will want to see if this is impacting the actual economy.
European equities performed well in the first quarter, but I am not convinced that will continue if data remains relatively weak. In addition, such weakness would likely place downward pressure on US Treasury yields and German bund yields.
5. US-China trade talks
Talks continued in Beijing last week. Some reports suggested that China was ready to sharply expand market access for foreign banks and for securities and insurance companies, especially in its financial services sector. It was also reported (by The Wall Street Journal) that China is offering foreign technology companies better access to the country’s cloud-computing market. US National Economic Council Director Larry Kudlow suggested that if a trade deal is reached, the US may keep some tariffs in place to ensure Beijing’s compliance. “We’re not going to give up our leverage,”4 Kudlow explained. Kudlow also said he expected negotiations to take some time — at least a few more weeks, if not months. “This is not time-dependent. This is policy- and enforcement-dependent.”4 The two sides are reportedly working on written agreements in six areas: forced technology transfer and cyber theft, intellectual property rights, services, currency, agriculture and non-tariff barriers to trade.
Despite what seems like significant progress, I am always cautious when I read news reports, as I don’t know who is providing the information and what their motive is. It seems that China’s economy is improving, which is a critical reason why I believe China is unlikely to make any major concessions to the US — despite all the positive fervor around trade negotiations. Last week Li sounded a bit more ominous, although I believe his comments were overlooked: “We need to prevent a trust deficit from occurring — otherwise the damage it could do to US-China relations is incalculable.”5
Talks will resume this coming week, so we should be prepared for news flow from those negotiations to potentially impact markets.
6. Political pressure on the Fed
Following Stephen Moore’s nomination for the Fed the previous week, Kudlow called for the Fed to cut rates 50 basis points “immediately.”6 In my view, while this would be a strong positive for stocks in the shorter term, it would be dangerous for two reasons: it further politicizes the Fed, and it takes away some of the little dry powder the Fed has at its disposal to handle the next crisis. I wouldn’t be surprised to see continued pressure going forward; we will want to follow the situation closely.
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1 Source: Reuters, “May’s statement following Brexit defeat,” March 29, 2019
2 Source: Reuters, “Risk of no-deal Brexit ‘very real’: Dutch PM Rutte,” March 29, 2019
3 Source: Bloomberg News, “China factory gauge rebounds as business confidence improves,” March 30, 2019
4 Source: Bloomberg News, “Kudlow says US ready to extend China talks by weeks or months,” March 28, 2019
5 Source: Reuters, “China pledges to expand financial market opening as US trade delegation arrives,” March 27, 2019
6 Source: CNBC, “White House advisor Larry Kudlow says Fed should ‘immediately’ cut rates,” March 29, 2019
Important information
Blog header image: Billion Photos/Shutterstock.com
Equities defined by the S&P 500 Index and the MSCI EAFE Index, UK equities by the MSCI United Kingdom Index, and European equities by the MSCI Europe Index. Government bond information from Bloomberg, L.P.
The S&P 500® Index is an unmanaged index considered representative of the US stock market.
The MSCI EAFE Index is an unmanaged index designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the US and Canada.
The MSCI United Kingdom Index is designed to measure the performance of the large- and mid-cap segments of the UK market.
The MSCI Europe Index is an unmanaged index considered representative of European stocks. The index is computed using the net return, which withholds applicable taxes for non-resident investors.
In a “no-deal” Brexit, the UK would leave the EU with no formal agreement outlining the terms of their relationship.
The China Manufacturing Purchasing Managers’ Index is compiled by the Chinese government and is a monthly indicator of economic activity in the Chinese manufacturing sector.
The Caixin/Markit Purchasing Managers’ Index (PMI) for China is considered an indicator of economic health for the Chinese manufacturing sector. It is based on survey responses from senior purchasing executives.
Safe havens or safe harbors are investments that are expected to hold or increase their value in volatile markets.
A basis point is one hundredth of a percentage point.
All investing involves risk, including risk of loss.
The value of inflation-linked securities will fluctuate in response to changes in real interest rates, generally decreasing when real interest rates rise and increasing when real interest rates fall. Interest payments on such securities generally vary up or down along with the rate of inflation. Real interest rates represent nominal (or stated) interest rates reduced by the expected impact of inflation.
The opinions referenced above are those of Kristina Hooper as of April 1, 2019. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
Kristina Hooper
Chief Global Market Strategist
Kristina Hooper is the Chief Global Market Strategist at Invesco. She has 21 years of investment industry experience.
Prior to joining Invesco, Ms. Hooper was the US investment strategist at Allianz Global Investors. Prior to Allianz, she held positions at PIMCO Funds, UBS (formerly PaineWebber) and MetLife. She has regularly been quoted in The Wall Street Journal, The New York Times, Reuters and other financial news publications. She was featured on the cover of the January 2015 issue of Kiplinger’s magazine, and has appeared regularly on CNBC and Reuters TV.
Ms. Hooper earned a BA degree, cum laude, from Wellesley College; a J.D. from Pace University School of Law, where she was a Trustees’ Merit Scholar; an MBA in finance from New York University, Leonard N. Stern School of Business, where she was a teaching fellow in macroeconomics and organizational behavior; and a master’s degree from the Cornell University School of Industrial and Labor Relations, where she focused on labor economics.
Ms. Hooper holds the Certified Financial Planner, Chartered Alternative Investment Analyst, Certified Investment Management Analyst and Chartered Financial Consultant designations. She serves on the board of trustees of the Foundation for Financial Planning, which is the pro bono arm of the financial planning industry, and Hour Children.
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