Market Bulletin (10/12/2018)
Over the long term, China can lay claim to pioneering some of the world’s most significant inventions. Gunpowder, paper, the compass and printing may be the famous four that Chinese schoolchildren memorise in school, but there are many more; among them football (just not the ‘association’ kind), umbrellas, wheelbarrows, kites, and fermented drinks.
These days, China’s relationship with innovation (the technological kind) is more controversial – and its impact on markets significant. Last week, leading stock indices opened the week positive, following a 90-day trade truce between the US and China. Yet the initial rise was more than reversed midweek, as Donald Trump tweeted “I am a Tariff Man” and appointed a renowned China hawk to head the US team in trade negotiations with China. Perhaps more unnerving was news that the Canadian authorities had arrested the chief financial officer of Huawei during an Ottawa layover. She now faces an extradition hearing over whether she should be handed over to US authorities.
The world’s largest telecoms equipment manufacturer and second-largest smartphone manufacturer faces scrutiny over reportedly breaking the rules of US sanctions on Iran. The move is a bold one, and redolent of Cold War manoeuvring. US and Chinese stocks took a dive in response, with the former falling into negative territory for the year. The MSCI World Index had a bad week, while the FTSE 100 struck a two-year low, driven down by the automated selling of tracker funds.
Technology stocks were in the eye of the storm last week. The sector is now vulnerable not merely to worries over consumer protection and intellectual property, but also to trade tensions and competition between the great powers. The US, New Zealand and Australia have all banned Huawei from their future 5G networks and the head of MI6 said this week that the UK must now make some choices of its own. BT announced on Wednesday that it will remove Huawei technology from its core 3G and 4G networks within two years – BT’s share price had a jumpy week.
Such moves reflect both privacy and security concerns. In recent years, Beijing has taken a far more assertive line in international relations while, back at home, it stipulated that “all organizations and citizens shall… support, cooperate and collaborate in the national intelligence work”. A media report last week detailed how the Chinese state invested $200 million in a Boeing satellite facility in California, raising fears of technology transfer to Beijing. Moreover, China’s technology champions show increasing signs of state control in some of their financial decisions, such as acquisition policy.
The most prominent of those is Alibaba, the Chinese internet giant, which boasts better operating margins than Amazon, and saw the same choppy trading last week as other tech stocks. “Jack Ma has been hugely successful in building Alibaba but has now stepped back from running it, as the company’s priorities have changed,” said Glen Finegan of Janus Henderson Investors, manager of the St. James’s Place Global Emerging Markets fund. “In China, monopolies are used [by Beijing] to fund government projects. We prefer family businesses where the processes and aims are aligned with those of shareholders. There’s a reason that Gazprom and Lukoil in Russia trade at such low multiples.”
Western technology majors are facing their own, related pressures. Google will be grilled by the US Congress this week. One likely question is why the company is working on a censored search engine for China. Last week, a UK parliamentary committee released documents showing that Facebook had considered offering fuller consumer data access to companies that advertise on its platform. The S&P 500 Information Technology Index had a bad week.
There was a short-lived market bounce on reports that the Federal Reserve is softening its rate-rise outlook for 2019. Some of that softening relates to concerns over the outlook for the US economy. Last week, the US yield curve edged still closer to inversion; in an inverted yield curve, short-term bond yields are higher than long-term bond yields. Historically, an inversion has augured recession, albeit with a 21-month average time lag.
It was not all bad. The ISM non-manufacturing index for the US came in very strong; IHS Markit’s services sector index was also positive; and the US jobs market is now the best it has ever been for American workers who lack a high school degree. Moreover, profit margins for S&P 500 companies remain sharply up in 2018. The US trade deficit rose too, but this actually represents the positive state of the US economy – the dollar is rising and US consumers are in spending mode. Nevertheless, investor nerves are apparent even in the US, and not just over politics.
“We expect global GDP to slow quite sharply over the next year or so,” said a Capital Economics report released last week. “There has been a slowdown in the eurozone already and the US is likely to lose steam as monetary tightening starts to bite and the fiscal boost fades. The slowdown in the US should prompt the Fed to end its tightening cycle in mid-2019 and begin cutting rates in 2020.”
If markets are sensitive to rate policy, they may be more vulnerable to quantitative tightening (QT), as central banks sell back bonds they previously bought up. QT only began on an aggregate global scale this year but is set to continue through next year.
The European Central Bank can find its own reasons to stall on QT for a while longer, among them disappointing growth and febrile politics across several EU economies.
Germany posted negative growth in the third quarter. Both manufacturing and banking are facing significant headwinds. Last week, the head of Volkswagen warned that 2019 would be the “most difficult year ever”, with court cases (over emissions cheating) slated in 50 countries worldwide. VW also faces a threat from technology, as cars become smart products and are increasingly ranked by the quality of their software, not hardware. Meanwhile, the finance minister said Deutsche Bank and Commerzbank could potentially merge.
France has suffered street protests that almost forced the government to declare a state of emergency and did persuade it – last week – to cancel a fuel tax rise and place its October wealth tax cut under review. In neighbouring Belgium, the government lost its parliamentary majority over a UN migration pact. The EURO STOXX 50 fell significantly over the five-day period.
More positively, eurozone finance ministers agreed measures to improve the eurozone’s crisis-fighting capacity: notably a stronger banking union and moves towards ensuring bondholders aren’t so easily bailed out in future downturns. Moreover, Rome hinted at softening its budgetary plans; the yield on Italian 10-year debt hovered around 3% – not low, but hardly in crisis territory.
Across the Channel, meanwhile, the political maelstrom continued, as Theresa May lost three parliamentary votes in a day – hers is now the first UK government to be deemed in contempt of parliament (for failing to publish the full Brexit legal advice). A vote forcing the Brexit issue to go back to MPs if she loses her key vote this Tuesday may yet prove decisive (although at time of writing, there are reports it will be postponed or cancelled). The latest polls suggest 86% of Labour members want to remain in the EU, while most Tory members still want Brexit – just not the one Theresa May has been touting.
“The withdrawal agreement is less a carefully crafted diplomatic compromise and more the result of incompetence of a high order,” said Mervyn King, former Bank of England governor and a prominent Brexiteer. “It is time to think again, and the first step is to reject a deal that is the worst of all worlds.”
Despite the momentous matters under discussion, the normal business of government continued. Last week, it was reported that a forthcoming Department of Health green paper will trail the idea of introducing automatic enrolment for later-life care costs. The proposal reflects the reality that people are living much longer after retirement; that the population is ageing, making it harder for the state to provide financial backing; and that the cost of care itself is rising.
Last week should also have concentrated the minds of anyone born after 5 December 1953, as their State Pension age rose as part of reforms which aim to reduce the burden on the state to fund retirement. Amid such buck-passing by central government, personal retirement planning is becoming ever more important.
Janus Henderson Investors is a fund manager for St. James’s Place.
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