Widespread geopolitical uncertainty and the nascent US-China trade war have made remaining pockets of stability compelling propositions.
Stockmarkets surged at the start of the year as they bounced back from their December lows. Progress through February has been volatile, but the upward trend continues, despite major macro concerns.
Trade wars are still a big concern as we hurtle towards the crucial 2 March deadline, when US tariff s on some Chinese imports are scheduled to rise from 10% to 25%. With no further meetings planned between Donald Trump and his Chinese counterpart, Xi Jinping, the situation has reached an impasse, with the distance between the two world powers wider than ever. China has promised to buy five million metric tonnes of US soybeans, but the US Congress is adamant that this commitment should not obscure the need for structural changes to its trading relationship with China.
Aside from the trade war, the US economy looks quite healthy, with earnings notching up a 25% increase year on year. However, Caterpillar and Nvidia both disappointed, while some earnings growth can be attributed to lower tax rates. Share buybacks rose by 44% last year, which helped support stock prices. But with valuations remaining rich, any further gains from here will be limited, while the long-awaited tightening of US monetary policy may prove a heavy drag.
The UK stockmarket almost certainly represents a pocket of value and opportunity, in the long term at least, having been ground down by Brexit uncertainty. The FTSE All-Share index lost around 11% of its value in 2018, but the UK’s underlying economic scenario is relatively robust, with earnings up and inflation down.
However, the weak pound has created a bifurcation in the market. FTSE 100 companies with large foreign currency revenue streams have done better than domestically focused companies, because weak sterling boosts the competitiveness of UK exports. Companies with predominately overseas earnings have returned around 5% over the past 18 months, while those with a high level of domestic exposure have tumbled by 12% over the period.
The pound has weakened further in recent weeks amid fears that the UK might leave the EU without a deal. Despite a flurry of stockpiling activity, businesses are ill-prepared for a no-deal outcome – so ill-prepared, in fact, that the Bank of England has slashed this year’s growth forecast to 1.2%, the lowest since the recession. The bank estimates that growth halved to 0.3% in the final quarter of last year, and will fall again to 0.2% in the first quarter of this year.
Businesses are pausing their expansion and investment plans, and consumers are delaying spending. The slowdown in the key construction sector, where employment growth has fallen to its lowest level for two years, is another indicator of a crisis in business confidence. That said, confidence will pick up very quickly if, by some miracle, there is clarity on Brexit.
Pockets of promise
BP has been one of the UK’s better performers: it recorded a 100% increase in profits last year, despite oil prices falling. There is a general sense that the oil majors have been forced to prune their operations and make efficiency improvements that will pay off when energy prices rise again.
Financials are also undervalued. US banks are trading at around a 33% discount to the S&P 500 index, and the figure is even higher for European banks, as concern over the macroeconomic backdrop remains elevated. The sector will benefit as interest rates rise, mergers and acquisitions activity increases, developments in financial technology bear fruit and regulation begins to be wound back.
An investment trust that focuses on the financial sector could be a good investment, as these are trading at a marked discount to their net asset values. For example, Polar Capital Global Financials yields 3.1% and currently trades at a 5% discount. Moreover, it is underpinned by its fixed seven-year life, which ends in May 2020 and guarantees investors their money back at net asset value.
Over the long term China will transform the business world, but the short-term risks are real, particularly risk related to huge corporate debt running at 162% of GDP, the highest of any country in the world. China’s regulators have pledged to clean up ‘zombie’ state-owned companies – 2,000 firms, typically operating in the heavy industry sectors, that persistently lose money but survive via subsidised loans – by the end of 2020. However, in the short term this will involve layoff s and social unrest, so investors should take care. The portfolio already holds the active Fidelity China Special Situations fund, which should avoid the pitfalls, but we would hesitate to invest in a China tracker in the current climate.
With so much political tension in the world, investment in countries where political risk is low has been picking up. Singapore is worth a look. It has been in the news as a result of Dyson’s decision to move its headquarters there, because of the city-state’s skilled workforce, business-friendly tax regime and geography. Corporate tax has been kept at just 17%, and while the Singapore government needs to raise various levies to support the state’s ageing population, it is also extending its corporate income tax rebate, and support for research and development.
Singapore is a member of the 11-country Trans-Pacific Partnership trade pact and has strong trading relationships. It has the highest percentage of online businesses selling globally, according to a report by technology firm Stripe. More than half of Singaporean firms that sell internationally have been expanding their export activities into new countries within their first year.
On the political front, a new party has been set up by Tan Cheng Bock, a former member of the ruling People’s Action Party, in readiness for the next election, which must be called by January 2021. However, policies on both sides of the political divide are essentially moderate.
The economy has sucked up some bad news recently, with unemployment having risen to 2.2% in the fourth quarter and annual inflation climbed to 0.5% in December from a seven-month low of 0.3% in the previous month, so now might be a time to buy on advantageous terms. One way to access the market is via the UBS MSCI Singapore ETF (OHCU), which is listed on the London Stock Exchange, or the iShares MSCI Singapore ETF (EWS), listed on NYSE Arca. Our portfolio is diverting some of its cash to buy a small stake in the latter.