May market review – market highs, sterling lows and political unrest
With UK markets reaching record highs, supported by sterling weakness, Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, considers what’s driving markets and where investors can find opportunities. He also takes a closer look at what’s next for US interest rates and what political uncertainty in Italy could mean for financial markets.
Sterling reaches new lows against the US dollar and euro
Once again sterling fell back against other currencies, more so against the US dollar, less against the euro throughout the month of May. This was partly related to renewed worries about the UK’s Brexit negotiations, more so due to the dollar’s rally as capital was attracted by higher US bond yields.
The important thing to remember though is that the stock market is more sensitive to currency moves than the economy. A very large part of the profits of companies in the FTSE® 100 index come from overseas, and when these are translated back into sterling the effect of currency moves is very apparent.
On the other hand, the effect which currency moves have on the economy can take several years to show. It takes time for consumers and businesses to respond to a more or less competitive currency. This is particularly true for the UK – a major provider of services to the rest of the world, which are often less price sensitive. For the time being, at Aberdeen Standard Investments we’re broadly neutral on UK equities, preferring faster growing overseas economies.
UK markets hit record highs
As I explained the recent fall back in sterling has helped UK share prices reach record highs. Where next?
As the Governor of the Bank of England has said, the UK economy is likely to recover from its weak patch in the spring, which was largely due to special factors such as poor winter weather. Where next for the dollar versus sterling will partly depend on the Bank of England’s decisions about interest rates, but more so on decisions by the US Federal Reserve (the Fed) and announcements by President Trump. Last of all, commodity prices are important for the UK market. A combination of political issues and supply disruptions in countries such as Venezuela has pushed the global oil price higher.
US earnings soar but worries about trade grow – does market stability lie ahead?
Investors are being pushed and pulled between strong company profit news and a spate of worrying political developments in different countries. As such, I’m often asked if market stability lies ahead. While I would welcome a period of calm, I think it’s quite unlikely. As one commentator on the US-China trade negotiations put it “I do not see a trade war but neither do I see a trade peace”.
It’s key to remember that President Trump’s announcements – for example his plans to examine overseas competitors to the US car industry – are intended to support his voter base in the run-up to the November mid-term elections. So there’s no reason for negotiations to proceed quickly or smoothly.
On top of that there’s a range of other issues that trouble nervous investors. Current examples include the state of Italian and Spanish politics, or how higher interest rates and a rising US dollar are putting pressure on some important emerging markets such as Turkey.
We’ve said for some months now that we see 2018 as a return to normal levels of market volatility. We still see good growth opportunities in a variety of global equity markets, but more so at a stock or sector level to avoid some of the volatility we see ahead.
US on track for interest rate rise
According to the latest set of minutes from the Fed, they’re very clearly telling us they’ll raise rates again in June and probably every three months into 2019 – as long as the upward trend in the US dollar doesn’t do its work for it.
As US growth continues and lower unemployment allows higher wages, we expect the Fed will continue to raise rates until it fears too much more will do harm. The good news is that the majority of these Fed decisions are already priced into markets.
Political instability in Italy and the global economy
The political crisis in Italy dominated headlines towards the end of the month, as did the sharp reaction in European markets. We think there’s certainly reason to worry that the political situation in Italy might possibly spill over into the global economy.
The backdrop is that Italy as one of the world’s largest economies has a very large debt burden, little improvement in living standards since 2000, and a steady rise in support for populist parties.
The likelihood of Italy leaving the EU or the euro is still very low, because of the major damage that would cause the economy. However, we’re likely to see bitter arguments between Rome and Brussels over the way forward for the Eurozone in general and Italy in particular. The European Central Bank (ECB) can only do so much to hold financial markets together when political uncertainty is rising so quickly. On balance, all this is likely to discourage global investors from raising their positions in European assets for some time.