Global stock markets were strong in the third quarter with the MSCI World index providing a total return of close to 5% in US dollar terms*. This strength was not broad-based however, with the US and Japan the only major positive regions. Investors experienced negative returns in emerging markets. *Source: msci.com as at 28 September 2018
Part of the problem? The US economy steams ahead
The US economy grew at an annual rate of more than 4% in the second quarter of 2018, one of its strongest performances in years. The job market is tight with the jobless rate falling to 3.7%, its lowest level since 1969. Notably, Amazon has just announced a 50% increase of its minimum wage to $15 per hour. While the aggregate statistics show inflation is still low, the US Federal Reserve is pursuing its course of tightening with another raise in interest rates to 2.25%.
The tightening in US monetary policy is in stark contrast to many other countries around the world and it is starting to cause problems. Turkey and Argentina have been the two most visible casualties over the last three months but other emerging markets have also underperformed due to fears of contagion. Meanwhile, European markets have remained under pressure thanks to the ongoing political strife around Brexit and the populist budget from the new Italian government. European banking stocks recorded some of the worst performance in developed markets.
Beyond monetary policy, the relative strength of the US economy is contributing to global problems in other ways. A strong economy is emboldening the US government’s nationalist agenda. In Q3 there was escalation in trade tensions between the US and China as President Trump announced 10% tariffs on a further $200bn of Chinese goods, with a potential increase to 25% in January 2019. In response, China has imposed its own tariffs on $60bn of US goods.
Climate change unleashed
The rising frequency of extreme weather events is arguably more concerning than tightening monetary policy, trade tensions and populism. Thus far, 2018 has borne witness to a continuous stream of record-breaking events, such as the number of forest fires in the Arctic Circle, heatwaves in Europe and Japan, and more devastating storms and floods all across the world. The effects of climate change are no longer a future risk. They are playing out in real time and they are having a negative impact on global economic prosperity.
Trade war escalation hits IT
During the third quarter, the best-performing sectors were information technology (IT), health care and industrials. Several IT companies, however, were caught up in the trade war escalation. September bore early signs that this is causing a slowdown in the pace of investment by companies operating in the industrial, IT and automotive end markets. In healthcare, the strongest sector performance came from pharmaceutical and biotechnology. We believe that opportunities lie within the IT and industrial sectors. We see less long-term value within the energy, consumer staple and financial sectors.
In the first week of October bond yields around the world moved up sharply. This coincided with a sharp style rotation in global equity markets. On Thursday 4th October the MSCI World Value index outperformed the MSCI World Growth index by 1.3%, the largest one day outperformance since May 2009.
Stocks in the IT sector were hit particularly hard, while among the best performing sectors were energy, financials, consumer staples and utilities. Mean reversionary events are inevitable over shorter time periods and when they do happen it is important to remind ourselves of the difference between value and valuation. Many factors can cause fluctuations in near term valuations, with one of the most important being the level of interest rates. Valuation is not the same thing as value, however, and over the long term, we believe that growth will always generate the most value for investors.
We look for sustainability with reference to environmental and social trends: the low carbon energy transition and the fourth industrial revolution, characterised by rising penetration of technology into all sectors of the global economy, are two investment trends that are so powerful that we regard them as generational in nature. Both of these trends are inextricably linked to harmonising the many conflicts between environmental and social sustainability.
We believe that oil prices will start to decline again. In fact, a high oil price is self-defeating since it only serves to accelerate innovation and substitution. In ten years’ time there will be more renewable energy, many more electric cars and billions more connected devices with semi-conductors and microchips capturing and generating vast amounts of data. All of this will be stored in the cloud, requiring memory and then analysed and made useful by software, in order to create efficiencies, increase productivity and generate value for our societies. Many consumer companies are leading the way in other areas of the circular economy, within health and life insurance, healthcare services, water technology, electrical safety, architectural design, education and entertainment.
When we think about sustainability, we see a world of opportunity that combines great diversity with a clear focus.