In her last press conference as Chair of the Federal Reserve, Janet Yellen declared that, “when we look at other indicators of financial stability risk, there’s nothing flashing red there, or even orange”. Yellen may have been somewhat demob happy by this stage but these words seemed to be tempting fate and, on the basis of the year so far, they were. Markets have been mixed at best in 2018, with the fortunes of individual markets and companies fanning-out notably. UK markets have been broadly flat at the index level, with the FTSE All Share down 0.5% year-to-date, but the 600+ companies that make up the All Share did suffer the embarrassment of being overtaken in market value by just a handful of US names in June - the infamous FAANGs (Facebook, Amazon, Apple, Netflix and Google). These FAANGs remain stock market darlings and have been the primary driver of positive US market returns in 2018. Meanwhile, in China and wider Asia and Emerging Markets it has been a tough year, as seen in that the Shanghai index has now entered bear market territory, falling over 20% since January. Investors are exiting seemingly more risky areas of the globe and looking for solace in developed markets - there is at least one flashing red light for Yellen’s successor, Jay Powell.
So why has the music changed this year? Firstly, the economy does not have the same wind in its sails that it had from mid-2016 until the end of last year. Markets tend to focus on economic momentum, rather than absolutes, and it seems that at very least the world has paused for breath after an exceptional resurgence in activity driven by China in recent quarters. China is the largest global consumer of commodities and the price movements of metals such as iron ore and copper can be good indicators of how the Chinese economy is faring - after a storming 2017, prices here have come back somewhat, indicating less positive conditions. Potentially more concerning is the fact that the Chinese currency (the renminbi) had its worst month ever in June. As with commodity prices, it should be remembered that the renminbi had previously had a strong run-up in 2017, but this must be watched carefully as China is the world’s primary growth engine at present and if it sneezes, we all are likely to catch a cold.
The second and closely related point is that central bankers globally are beginning to dial-back on the huge programme of monetary stimulus that has been in place for the last decade. Markets marched higher over recent years always safe in the knowledge that the Federal Reserve (the Fed), Bank of England, European Central Bank, etc. would be there to support asset prices with a cocktail of low interest rates and quantitative easing - “The Fed Put” as it became known. Central bankers are keen to assure us that they are in no rush to return to “normal” conditions, but there is no denying that tighter (more hawkish) monetary policy is the direction of travel. Once the tide of cheap money goes out we will see who is still wearing their trunks and, ultimately, if the economy can cope without central bank stimulus.
One thing markets could certainly cope without is an increasingly aggressive political environment. Rhetoric between Donald Trump and Chinese authorities has dominated the headlines and caused a number of spikes in volatility. If history teaches us anything, it is that companies on average outlast politicians and so long term markets can make progress in spite of politics (not because of politics). The recent spat between Harley Davidson and Trump over tariffs is a nice example of this and we hope more companies have the courage to stand up for free trade. Either way, shock and awe is clearly a favoured tactic for the President and markets will in time adapt and get on with business, as they always have done.
2017 was popularly known as the year of Goldilocks; not too hot, not too cold, but ultimately quite satisfactory for markets. At the half-year point for 2018 it seems that a hint of salt has found its way into the porridge.
Written by Fred Mahon.