New article from Tatton Investment Management: Interesting times ahead

7 September 2018

It has been one of those weeks, where so much news comes across our desks that I do not quite know where to start and where to finish, but we can be sure not to get bored in the near term.

After all the Brexit drama of the past weeks, there is some evidence emerging that our rationally argued view that contrary to all the recent talk, next year’s formal Brexit, will be just that.

As leaked discussions between UK and German trade representatives this week showed, it is entirely feasible that the two parties will decide to merely aim for an agreement in principle and then kick the details into the long grass of the transition period (which could be extended). This would stabilise economic conditions, as well as preventing an entirely unpalatable and time pressured vote of parliament between two bad choices. Political instability for the UK should thereby be prevented and the Tory party may refrain from entering self-destruct mode, both of which would otherwise steer the country towards new elections which is the last thing the negotiation parties seek.

Compared to the latest Brexit news, the turmoil surrounding the Trump administration was of far higher potential impact to global near term prospects. With the stream of scandals and revelations of incompetence beginning to seriously threaten Trump’s chances to retain the majority in both chambers of Congress in November’s midterm election, a timely resolution of his trade wars appears unlikely. It lies in his nature to assume that he will win more votes while seen fighting for his electorate with foreign powers than compromising towards a deal and seeing the results picked apart by the opposition.

This does not bode well for the US as the recent locomotive of global growth. Tariffs result in higher prices for US industry and consumers and reduce rather than stimulate economic activity. The US central bank – the Fed - would be forced to raise rates faster than economically digestible to fulfil its mandate of achieving price stability, which could -just as so often before- turn the boom to bust.

The rest of the world looks somewhat less exposed in comparison. China can unleash another centrally orchestrated fiscal stimulus package toward infrastructure improvements which it could even finance by selling some of its vast USD currency reserves to pay for imported input factors. Europe and Japan are experiencing improving consumer sentiment on the back of strong jobs markets which should lead to more domestic consumption demand through lower savings rates between those two world champions of savers.

Europe may have looked unstable again because of Italy’s debt refinancing woes and Turkey’s currency crash. Here, however, Italy’s populist government assurance that it will not seek to breach EU budget deficit rules has already brought about much calmer bond markets. In Turkey the central bank has vowed to return to orthodox monetary policy measures and anyway Europe’s relative exposure to Turkey’s economy and financial assets is no longer deemed a systemic threat.

This leaves the wider emerging markets, where there has been much talk about contagion spreading from Turkey and Argentina, which could lead to a much larger stock market fall than the 20% they have already suffered since the beginning of the year. True, they have suffered from a triple onslaught of falling Chinese demand, higher costs of finance from a rising US$ and the prospect of significant curtailment of global trade, curtesy of Donald Trump.

As discussed, China’s demand may well experience fiscal stimulation while rising inflation and slowing economic activity in the US has in the past driven the US$ down. This leaves global trade and as this conflict is unlikely to be resolved quickly it is likely to continue to weigh down emerging market prospects for a while longer.

All in all a complex picture, which contains some cause for concern, although by no means at the levels we have read in some of the more sensationalist comments of the past week.

Perhaps unsurprisingly stock markets did not have the best of times, but it was notable that for the first time in a while the US tech sector suffered larger declines than the rest of the market. This, combined with the upwards jolt in £-Sterling on the prospect of a more prolonged rather than cliff edge Brexit, inform us that our portfolio positioning away from the emerging and US stock markets and towards Europe, Japan and at least a neutral allocation towards the UK is proving an adequate response to the changing, but not necessarily overall negative outlook for the remainder of the year.

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