In the United States, shutdown is beginning to have a negative impact. At first, when the U.S. federal administration closes, tourists seem to be the only ones affected, with the closure of museums and national parks. Due to security reasons, the army is not affected by this dysfunction. Social security and public health continue to operate because they have already been funded for the full year. Finally, schools remain open because their funding is not federal.
Markets closed 2018 in the worst possible way. Global stock markets turned a deep red, as did corporate bonds, convertibles, hedge funds, commodities and most currencies except the Japanese yen and the US dollar. There were not many investments to take refuge in: cash, government bonds and recently gold. While the economic slowdown is not a surprise to readers who regularly take a look at our analyses, investors are now giving it their attention.
The year 2018 might have started off with a roar, just like 2017, but the positive performances will quickly be erased afterwards (see chart 2). As the end of the year approaches and stock market indices test new lows (see chart 3), investors are trying to limit losses. There are a few ways to protect portfolios from the ongoing unrest. The bond market still offers some diversification, but the decline in bond yields and the associated positive returns are much more moderate than usual. The central banks’ limited room for manoeuvre to lower their key rates and the excessively high level of public debt are major factors.
The Chairman of the Federal Reserve (Fed) believes that the US central bank is approaching the end of its rate hikes, which are now “just below” a neutral level that neither stimulates nor hinders growth. As a reminder, the Fed has raised its rates eight times by 25 basis points since December 2015 and should decide on a new increase at the end of its next meeting on 19 December. Jerome Powell’s statements, which were considered accommodating, were mainly a shift from previous speeches. Until then, he had considered that rates were “a long way” from the neutral level and that the Fed could go even further in view of the extremely positive evolution of the American economy.
Bonds are useful in terms of portfolio construction because of their diversification power. They are also advantageous when the economic cycle, after reaching a peak, is reversing. In the coming months and quarters, as global growth slows, as equity markets seek new lows, investors are progressively shifting to fixed income assets. However, not all bonds are equal and the strategies to be implemented do not offer the same risk/reward.
Between June 2017 and October 2018, oil prices had risen sharply (see chart 2), from $43 to $76 per barrel for WTI on the Mercantile Exchange (Nymex) in New York and from $45 to $86 per barrel for North Sea on the Intercontinental Exchange (ICE) in London. As the implementation of US sanctions against Iran approached on 4 November, they had reached their highest level of the last four years. Since then, oil prices have entered a bear market, contracting by more than 25% from peak to trough. A barrel is currently trading at $57 on WTI and $67 on Brent in the North Sea.
Getting a divorce settlement through a bitterly divided Parliament was to be Theresa May’s biggest challenge for the fall of 2018 (see chart 2). Promises are made to be kept. The situation is very delicate. The British Prime Minister had to abandon the idea of convening her government today to approve a text on Brexit. Although Britain and the European Union have moved closer to an agreement that could be signed at the November summit, the momentum seems to be waning as opposition hardens in the country. Pressure is mounting for Theresa May to abandon her plan or face a catastrophic defeat in Parliament. Without any surprise, the pound dropped versus all its Group-of-10 peers (see chart 3).
October ended with a record drop in stock markets. Fortunately, over the past week, investors were able to take a break, benefiting from a welcome technical rebound. The MSCI Emerging Markets rebounded by 6.1%, the Swiss Market Index by 3.8%, the EuroStoxx by 3.0% and the S&P500 by 2.4%. Despite these excellent performances, their year to date performances remain clearly in negative territory, with the exception of the US markets.
The week begins as the previous one ended, with important political, economic and financial publications. Brazilians and Germans were called to the polls this weekend. Not surprisingly, the far-right candidate, Jair Bolsonaro, was elected President of Latin America’s leading economy with 55.1% of the vote (see WIF of 8 October 2018). During his televised speech, this former army captain promised to “defend the constitution, democracy and freedom”.