October was a torrid month for equity markets, and while November saw some pause for breath, the environment for equity investors remains quite difficult, very volatile, and intensely uncertain. The main problem for equity markets at the moment it that the euphoria created by the strong synchronised recovery in the global economy in 2017 has lost momentum in 2018 and the outlook for the year appears to be a lot more uncertain than was the case this time last year.
The majority of global economic indicators have weakened in recent times. Growth in the Euro Zone economy expanded by just 0.2% during the third quarter and by just 1.7% on an annual basis. The German economy contracted by 0.2%. Forward looking indicators in the Euro Zone are also contracting. The Purchasing Managers’ Index for manufacturing declined to 51.5 in November – this had been up at 60.6 this time last year. The services sector PMI fell to 53.1 in November, which is down from a peak of 58 at the beginning of the year. The Italian economy, its politics and its budget battles with Brussels are also justifiably giving considerable cause for concern.
The US economy is still doing well, but growth there has also eased, and the markets are now seriously questioning if the Federal Reserve will have an economic background sufficiently strong to warrant the 1% increase in official rates that is pencilled in for the coming year. A number of emerging economies are also in considerable trouble, with Turkey, Argentina, Brazil, Venezuela, and Pakistan all in varying degrees of distress. On the trade front, progress between the US and China is also not engendering confidence.
All in all, these factors are combining to create extreme nervousness and volatility for equity markets. Year to date, the Dow Jones is down 1.7%, the S&P 500 is down 1.5%, the FTSE 100 is down 8.5%, the French CAC is down 5.6%, the German DAX is down 12.3%, and the Italian market is down by 9.7%. We are not yet in bear market territory, but we are certainly in a more vulnerable place than for some time.
Looking ahead to 2019, the overall outlook looks quite uncertain from an economic and market perspective. The general expectation from official forecasters such as the IMF and OECD is that the global economy will ease modestly, but there is clearly a fear that the risks could be on the downside.
One piece of good news emanating from the more uncertain Euro Zone background is that fears of an increase in official interest rates by the ECB are abating. Earlier in the year, June to be precise, the ECB suggested that rates would remain on hold through to the end of the summer of 2019, and while it is way too early to test this view, it would appear that the ECB could actually not have to increase rates at all in 2019.
On the Brexit front, it is still hard to know where we stand. At the weekend the EU-27 agreed to the draft Withdrawal Agreement and both sides are adamant in the view that this agreement is the only one on the table and cannot be re-visited or revised. For the Prime Minister Theresa May, the hard work now really begins. It is likely that the vote on the deal in Parliament will happen in the week beginning December 10th, but based on the parliamentary arithmetic as we currently understand it, the chances of the deal coming through parliament unscathed look quite remote.
This week the Prime Minister, who has shown amazing strength and resilience in an extremely difficult situation, will begin a tour of the country to try to garner popular support for it. It remains to be seen how effective this will be in helping to sway the views of the opponents in parliament, but on balance, it does appear that the odds are stacked against her in the House of Commons.
Then what? is the big question. Following rejection, it is possible that she could go back to Brussels for some minor alterations, but the chances of this swaying parliament would be remote. It is possible that she could end up with a ‘no deal’ exit, which could be hard or soft; she could force a general election, which could end up involving another vote on Brexit; the 2-year Article 50 timeline could be extended to allow more time to reach a deal acceptable to the majority; or a Norwegian type deal could be done.
The problem with all of these options is that there will be strong opposition within the House of Commons for all of them. The hope is that amidst the chaos, sanity will eventually prevail and fear of total political and economic chaos, or of Prime Minister Corbyn, will force most of the Tory Party, the DUP and possibly a few Labour dissenters to support what May got agreement on at the weekend, with perhaps a few cosmetic alterations to save face.
One does get a strong feeling that the arch-Brexiteers just want to leave the EU for once and for all and enter a world of WTO trading relationship with the EU and set about negotiating trade agreements with other countries and possibly with the EU eventually. When it comes down to it, they don’t seem to care what damage it does to the UK economy, and the damage could be quite severe until the economy adjusts to the new world order.
One way or another, the coming weeks promise to be interesting, uncertain and difficult to comprehend on the basis of logic.
Sterling got a significant boost when the Prime Minister originally announced the deal a couple of weeks back, but this boost proved very temporary once it became apparent that the deal would run into extreme difficulty in the UK. Following the EU-27 agreement to the deal, sterling has been quite unaffected, because the markets correctly realise that there is still a distance to go and many hurdles to be overcome before we can call the all clear on this particular mess.