Global equity markets have notched up a sixth consecutive week of rising share prices as investors continue to focus on a cocktail of positives in the run up to Christmas.
With the S&P 500 rising above 3,100 - 3,122 at last night’s close in New York - a rise of nearly 25% since January and 14% over one year, 2019 look like being one of the best years since the financial crisis. Other markets have risen on Wall Street’s coat-tails with the underperformers like the UK and Hong Kong lagging only thanks to home-grown problems - Brexit here and the escalating pro-democracy protests in the former colony.
The principal drivers of market optimism remain: easing trade tensions; falling interest rates; better than expected corporate earnings and a resilient jobs market. Recession fears, which caused the market’s mid-year pause, have been put to bed for now.
On the trade front, the White House is sending out progressively brighter signals and markets are betting on a deal being signed before Christmas. We should get some clearer indications of the direction of travel at the coming weekend’s G20 summit in Japan.
With easier trade pointing to an improving backdrop for the global economy, it is unsurprising that the main beneficiaries in market terms have been the more cyclical, value stocks that have played second fiddle to growth shares for much of the past decade.
Value shares are the out of favour stocks that trade cheaply against their own history and when compared with more popular growth shares. They have enjoyed a big rebound in recent weeks as the economic outlook has improved. There are a few reasons for this. Business surveys point to a bottoming out of the growth cycle, corporate earnings forecasts are improving after a marked slowdown this year, the Fed has gifted investors three quarter point interest rate cuts and Donald Trump is clearly eyeing next year’s election and looking to play the statesman in the ongoing stand-off with China.
Sectors in favour over the past six weeks include industrials, financials and materials all parts of the market that respond well to a buoyant economy, in contrast to the more defensive areas like consumer staples and utilities that are steady performers whatever the broader outlook.
Defensive growth shares have attracted investment flows during the years since the financial crisis precisely because economic growth has been so hard to find. In that sluggish environment, companies that can deliver reliable earnings growth appeal to investors and they have been driven to relatively high valuations as a consequence.
It is the yawning gap between the valuations of value and growth shares, as much as the improving backdrop, that has triggered the rotation in the markets since September. Nothing goes on for ever in the markets and the pendulum always swings back in due course, usually overshooting in the opposite direction before reverting to the mean again.
The question mark hanging over the recent market rally, therefore, is whether the fundamentals will be delivered in 2020 to justify the remarkable rise in shares in 2019. With valuations having extended as far as they have, it is the outlook for profit margins that will determine the future direction of the market.
Meanwhile, the Federal Reserve now looks to be less of an influence on markets than it clearly has been during the past three months in which US interest rates have fallen at three consecutive Fed rate-setting meetings. Last week Fed chair Jay Powell restated his more cautious stance in testimony to Congress, saying that the current approach to monetary policy was appropriate as long as the incoming data remains consistent with the Fed’s outlook of moderate economic growth and inflation close to the central bank’s target.
Investors have pretty much dismissed the possibility of another rate cut before the end of the year with expectations of another quarter point cut in December put at just 8%, according to prices in the futures market.
Hopes and fears on the trade front are not just impacting the equity market. They are also having a significant influence on the oil price, with traders watching for signs that a reduction in tariffs could boost economic activity. The price of Brent crude is tracking trade war sentiment closely, with a rise of 1.5% to $62.60 early last week reflecting signs of a thawing in relations only for the oil price to retreat after the US President warned of further negative actions if a deal could not be reached.
Supply and demand continue to be the principal drivers in the oil market, however, with speculation about further production cuts by OPEC putting a floor under the price. Under current plans, the oil producers’ cartel will limit production by 1.2m barrels a day until next March but some analysts think that even deeper cuts may be agreed at OPEC’s December meeting on the 5th and 6th of the month.
The need for further production cuts was highlighted by the International Energy Agency this week. It said that OPEC and its allies face a ‘major challenge’ in 2020 as demand for its oil falls in the face of increasing production from elsewhere, notably US Shale.
The oil price is of particular interest to Saudi Arabia, which is in the middle of selling off a stake in the kingdom’s giant oil and gas producer Aramco. Over the weekend, the scale of the proposed sell-off was reined in after a lukewarm response to the flotation by international investors.
The kingdom said on Sunday that it will raise around $25bn from the listing, about a quarter of the $100bn it had originally hoped for. Aramco will sell off just 1.5% of its total shares at a price that will value the whole at between $1.6trn and $1.7trn. That would still make the company the biggest listed business in the world, ahead of Apple, but it is well shy of the $2trn that Crown Prince Mohammed bin Salman is reported to have been seeking.
This week, in a further blow to the IPO, Saudi Arabia called off the European leg of its sales roadshow, effectively limiting the flotation to local investors in the Gulf region after plans to tour the US and Asia had also been shelved.
On the corporate front, this week’s focus - appropriately in the run-up to Black Friday next week and then Christmas - will be retail, with a string of results from Target, Macy’s, Home Depot, Foot Locker, Gap and Lowe’s in the US and Kingfisher over here. Retail sales have been a bright spot in the economy, rebounding more than expected in October. Walmart last week increased its profit forecast after a strong third quarter.
There is not so much corporate activity on this side of the pond, although attention will likely focus on what a handful of utilities reporting this week have to say about the nationalisation proposals of the Labour party. United Utilities, Centrica and Severn Trent are all due to announce results, as is another nationalisation target Royal Mail.
Labour upped the ante on the economic front last Friday when it unexpectedly extended the list of potential nationalisations to include the part of BT responsible for the country’s broadband network. Taking Openreach into public ownership would allow a notional Labour government to offer free broadband to companies and individuals, no doubt a popular measure with consumers but a proposal that was roundly criticised by the other political parties and many business figures too. As well as the cost of the plan, the impact on competition in the telecoms market and BT’s pension were highlighted as potential problems.
More generally, all the main parties are busy trying to outspend each other in a rejection of the austerity politics of the past ten years, although the reality of actually finding the money appeared to be starting to bite yesterday. Boris Johnson told the Confederation of British Industry that plans to cut corporation tax from 19% to 17% have been postponed in order to prioritise public spending.
Later this week we should start to see actual manifestos which will put some meat on the bones of the political promises that have peppered the opening salvos of the election campaign. Public finance experts are in broad agreement that if the Tory party is to meet its recently announced new fiscal rules, which seek to balance the current budget by 2022-23, there will be little scope for meaningful tax cuts.
During the Conservative party leadership contest in the summer, Boris Johnson proposed raising the annual earnings threshold for higher rate income tax from £50,000 to £80,000. It is now thought unlikely that this measure will find its way into the Conservative manifesto. At the same time, there is widespread scepticism about Labour’s ambitious plans for the UK economy.
In terms of market reaction to the unfolding election news, the pound is close to its highest level since May on the back of a widening poll lead for the Conservatives. Despite considerable Brexit uncertainty in the case of a Tory win, the radical economic proposals from Labour, including expropriation of company shares, higher taxes and heavy spending, make a win by the incumbent Government the more market-friendly option. Or if you prefer, the lesser of two evils.