Market Outlook Q3 2019: What about the risks?
Is it ever plain sailing? Can investors ever be certain which investments will generate the returns that they are seeking? Alas, no. A risk-free environment where returns are guaranteed is not the reality that we live in and risks are an inherent characteristic of investing, no matter where you choose to allocate your assets. However, the external risks in the current environment do seem to be plentiful and bear considering.
Among the most significant current risks are the trade conflicts between the US and some of its main trading partners. In particular, the future trade relationship between the world’s two largest economic players, the US and China, is still uncertain. The regular updates on the ongoing negotiations, sometimes reporting progress but sometimes much more negative developments, are serving to unsettle some investors. This is because the failure to come to an amicable agreement could ultimately have an impact on global growth, when adjustments in supply chains, as a result of the imposition of tariffs, start to weigh on productivity.
The escalating trade conflict has made China’s stabilisation look fragile, while also increasing the risk of lower than expected growth in the US and even a recession. Lower US growth would likely have knock-on effects on economic growth across the world. Furthermore, in response to the increasing risk of both souring sentiment and a weakening outlook for global growth, the US Federal Reserve has indicated its willingness to halt its gradual tightening of monetary policy. In fact, at the Federal Open Market Committee (FOMC) meeting on 19 June, the Federal Reserve (Fed) Chairman Jerome Powell reiterated that the Fed is open to reduce rates if necessary and even a 50 basis point cut was not ruled out. The signs from Asian and European central banks have also been dovish. Nevertheless, these are only signs and the future monetary policy of the key central banks is another unknown currently on the minds of investors.
President Trump has also been instrumental in creating one of the key risks in the area of commodities. Last year, the US withdrew from the Iran nuclear deal and re-introduced sanctions on Iran’s oil industry. Then in May this year, the US terminated all sanction waivers. The obvious consequence of the US sanctions is diminishing oil exports from Iran, which is of course having an impact on Iran’s economy, as revenues from sales of oil are critical for the nation. In a sign of the tensions in the region, two oil tankers in the Strait of Hormuz were attacked in early June. Given the clear discontent and rising tensions between the US and Iran, investors might be wary of how events will unfold from here and what the subsequent impact on oil prices may be. However, in the past, geopolitically driven spikes in oil prices have been short-lived and, with the exception of the oil crisis in 1979/80, have not altered fundamentals and the market regime.
The United States’ domestic politics is also a source of risk. Senate Republicans and the Trump administration are grappling to find an agreement regarding critical budget and spending matters. Funding legislation must be passed by Congress and signed by President Trump by 1 October, if a government shutdown is to be avoided. The threat of another shutdown of the US government is a risk worthy of consideration as the country’s credit rating, economy and financial markets may all be negatively impacted as a result, and the effects may well then spread.
Meanwhile in the UK, Theresa May, try as she might, was not able to get the Brexit withdrawal deal through Parliament. She subsequently resigned and the race for the leadership of the Tory party and thus the role of UK Prime Minister is now on. So the political muddle at home goes on and a resolution in terms of how to actually achieve Brexit is not yet in sight. With deep divisions in the House of Commons, both between and within political parties, a clearer vision of when Brexit will happen, what form it will take and what the consequences will be for businesses, trade relations and ultimately the economy, is still on the wish list of many.
Hence, there is certainly enough to think about and there are plenty of risks to take into consideration when investing in the current environment. Nevertheless, we do not believe that these risks individually pose a significant threat to the global economy, although if all (or some of) these risk scenarios were to materialise together, the combination may trigger a downward spiral. Overall, however, we believe that the global economy is set to gather momentum in the second half of 2019 and that the opportunities outweigh the risks.