Capital Markets Update: August 2018

For professional advisers only. Not to be relied upon by retail investors.

Capital Markets Update

  • Emerging markets contagion risk from Turkey’s problems
  • Markets welcome US commitment to interest rate rises
  • European concerns mount over Brexit and Italy

 

In a nutshell

August was relatively quiet on the global political front, but there will be a lot for investors to contend with as autumn approaches. The US stock market continued on its upward trajectory, breaking records in terms of the length of its bull run. It has been the strongest equity market by far. Sterling struggled over Brexit concerns, which acted as a boon to UK-based investors repatriating overseas earnings. Political and economic developments in Turkey threaten to spill over to other emerging markets.

August’s news – Turkey flirts with disaster

The Turkish lira collapsed and the country is teetering on the brink of a deep recession while also flirting with a full-blown debt crisis. The finger of blame is being firmly pointed by Turkey’s President Tayyip Erdogan at US President Donald Trump after Trump took the unusual step of using sanctions and trade tariffs as a means of seeking the release of a US pastor being detained on terrorism charges. The tariffs and sanctions certainly haven’t helped but neither have Erdogan’s own rather unorthodox economic beliefs, namely that inflation can be contained through low interest rates. This has prevented Turkey’s central bank from implementing a policy to avert disaster as the decline of the lira pushes inflation ever higher. The country’s foreign-debt-fuelled growth boom that has taken place over recent years has left it overly exposed to currency risk and a weakened domestic currency increases this debt burden significantly. At the moment, Turkey remains a risk for investors.

Contagion risk for emerging markets

There is a contagion risk if events in Turkey affect investor sentiment towards other emerging markets in similar situations. Emerging market currencies struggled this month, but not necessarily as a consequence of events in Turkey. South Africa, Argentina, Egypt and Venezuela all have their own unique issues. The key risk for all emerging markets at the moment is the threat of a global trade war slowing global growth, and a strong US dollar. There are also geopolitical consequences to take into account as Turkey moves away from the West. A European ally could be lost if Erdogan embraces the support being offered from China, Russia and even Qatar.

Markets welcome US commitment to interest rate rises

When central bankers held their annual meeting at Jackson Hole all eyes were on US Federal Reserve (Fed) Chairman, Jay Powell. His statement that he was happy with the current interest rate path trajectory was interpreted as a continuation of a policy of gradual rate hikes and was well received by equity markets. Elsewhere, the UK saw a much anticipated interest rate rise of 0.25%, from 0.5% to 0.75%. There was a strong case to leave interest rates as they were, particularly given the uncertainty around Brexit. Sterling rose on the announcement of the interest rate rise but soon fell back as Bank of England Governor Mark Carney spoke of his concerns over the possibility of a hard – or ‘cliff edge’ – Brexit.

Brexit – deal or no deal?

Prime Minister Theresa May went into the summer break with parliamentary approval to pursue the Brexit deal outlined in her Chequers white paper. There isn’t much time left before the European Union (EU) summit scheduled in October, in which the terms of Brexit are supposed to be agreed. Markets were quick to interpret the EU’s Chief Negotiator Michel Barnier’s promise to give the UK an unprecedented deal as a positive step towards avoiding a ‘no deal’ scenario and reacted accordingly. In reality, the two parties seem far apart on some key issues, most notably Ireland. Although no deal remains a risk the hope is that some form of compromise will be fudged at the last minute.

Italians add to European uncertainty

September is going to be important for the EU as it progresses Brexit negotiations, talks trade with the US and, importantly, gets its first sight of the threatened budget proposal from the new coalition government in Italy. We will see how antagonistic the Italian government is likely to be. At the moment, plans to tax less and spend more threaten to blow the budget through a complete abandonment of fiscal discipline that the EU will find wholly unpalatable. It’s a distraction the EU could well do without as it has the potential to create problems by opening up another battle line in addition to Brexit and US trade, but this time from within the EU itself.

Outlook

There is plenty of reason to remain cautious as we head into September. The US continues to grow at pace both in terms of its economy and its equity market. The Fed remains supportive of interest rate rises, while the full impact of Trump’s tax reform still has to feed through. In combination, these factors should be good for US equity prices over the coming months.

The US is picking up the slack in terms of global growth, which is showing signs of slowing elsewhere. But the strengthening US dollar and Trump’s trade war talk is weighing down on investor sentiment, particularly in emerging markets. Trump continues to impose tariffs on Chinese products and this is inviting retaliation. Europe has not yet reached a compromise on the US tariff standoff but Mexico has, showing that deals are there to be made. However, this may only serve to direct more heat from the US on China. Trade wars are not good for global growth and in turn global equities, so markets will be looking for an end to it all. At the moment, markets remain largely unaffected but that could change. The head-to-head between the US and China doesn’t look like reaching a resolution anytime soon. We continue to favour the US over other developed markets but remain wary of the sustainability of the US equity bull run. We continue to be concerned over the effect of Brexit on the UK economy but the weakened sterling is helping to boost the returns of overseas investments in our portfolios.

 
Oliver Wallin, Octopus Investments

e: owallin@octopusinvestments.com

t: +44 (0)20 7776 3153

 

Important information:

For professional advisers only. Not to be relied upon by retail investors. The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Telephone calls are recorded. Issued: September 2018. CAM07414.