Major stock markets gained between 2% and 4% in April. Better than expected economic news and first quarter corporate results helped Wall Street to a new all-time high. Returns for sterling-based investors were boosted by the dollar strengthening to $1.29 as the delayed Brexit timetable prompted speculators to close short positions. The FTSE 100 rose 139 points to 7,418, lagging global markets as well as small and mid-sized UK stocks. The oil price was squeezed higher as the US ended sanction waivers on eight major purchasers of Iranian oil.
Economic growth in the advanced economies appears stable – albeit marginally lower than last year – and a long way from fears of a US recession that were circulating a few months ago. US interest rates are on hold for the time being, financial conditions have eased and the drag from the government shutdown is passing. While first quarter 2019 GDP may have been boosted by “one-offs” such as companies building up their stockpiles, housing is showing signs of improvement and consumer spending – still the main driver of domestic growth – is well supported by the strong employment market and rising wages. The pick-up in orders for capital goods suggests business investment will accelerate in the second half of the year. Higher oil prices are likely to lead to a small rise in headline inflation but core inflation (inflation excluding the more volatile food and energy components) will remain subdued with wage pressures offset by weaker housing rents. Financial markets are pricing in a 50% chance of an interest rate cut during the second half of the year, but this may be premature given GDP is expected to be around 2.7%. US Treasury yields have risen to 2.4% reflecting better economic data and the yield curve is still broadly flat.
By comparison, GDP growth in other advanced economies remains pedestrian. The latest Japanese business survey suggests manufacturers still face headwinds from the global trade slowdown so, while investment to increase efficiency and counter ageing demographics continues, exports have contracted year-on-year with little evidence that the upturn in China has improved the position. The benefit from preparations for the Tokyo Olympics will fade and the government has yet to postpone or renege on the consumption tax rise scheduled for October. Although 2019 GDP estimates have not been downgraded, growth is likely to remain anaemic at around 0.6%. The eurozone also faces GDP growth of 1% this year and, while sentiment has been boosted by the Brexit delay, US tariff wars could escalate and German exports may not benefit as much as anticipated from the improving position in China. However, the eurozone’s 8% unemployment rate continues to fall and higher wages are supporting consumer spending. Inflation dipped below 1% in March and it remains to be seen whether the oil price rise will impact growth or be passed through.
China has engineered a mild economic acceleration with industrial production, retail sales and exports all up sharply in March. Further policy stimulus is unlikely before the Politburo meeting in July when the leadership will reassess the economic outlook and re-calibrate policy. The current priority is to channel liquidity towards the real economy, particularly small and medium sized enterprises, in order to boost domestic demand. Markets were convinced that a US/China trade deal was imminent and the latest setback may simply represent negotiating rhetoric by a President who is keen to secure a second term. The US was always likely to push for structural change to exchange rate policy as well as greater visibility on intellectual capital violation – both issues where China would prefer to move more gradually. The data has been mixed elsewhere in Asia. India continues to grow at around 7%, Malaysia is one economy benefiting from supply chain shifts away from China, and Taiwan is re-shoring some Chinese production. Business surveys from economies that are sensitive to the global manufacturing cycle have surprised on the downside this year, reflecting the domestic/infrastructure bias of the pick-up in China. There are signs of exports stabilising in countries such as South Korea however!
The UK exit from the EU has been delayed again which should provide some relief for the economy. However, with the government and Parliament still incapable of agreeing a way forward, the impasse could continue until 31 October. Despite the EU spelling out the choices, it is not clear that another referendum would produce a decisive outcome. Meanwhile, stockpiling, high employment and real wage growth have boosted consumer confidence and retail sales. The Brexit delay means business investment is unlikely to pick up but improved government finances should see spending increase so, despite the obvious uncertainties, GDP growth is likely to be 1.4%, similar to last year and higher than the major eurozone economies.
With first quarter corporate reporting nearly complete, it is encouraging to note that earnings exceeded estimates, even if these had been significantly reduced. While earnings have contracted year-on-year in absolute terms – around 1% in the US and 5% in Europe – comparatives should now become easier and revisions year-to-date have improved. Consumer discretionary and healthcare results were better than anticipated but energy disappointed. Few companies reported higher than expected sales and margins were broadly in line with reduced estimates. Given the economic backdrop, year-to-date returns of around 15% reflect improved sentiment rather than material changes to the GDP or earnings outlook. As valuations in most markets have risen towards the top of their twelve month range, this suggests a period of consolidation is likely. The good news is that, apart from balance sheet leverage, there are few signs of typical end of cycle indicators and the significant downgrades to profit estimates in late 2018 mean companies could surprise on the upside. With US interest rates on hold, global trade and US tariffs remain the major uncertainties.
