September was a positive month for equities, recovering some ground after a difficult August.  Total returns from fixed income were mixed, with some segments struggling to make headway.   

Backdrop

• UK Politics and Brexit: The Westminster drama continued.  Long-standing Tory MPs were amongst those expelled from the Tory party for seeking to prevent a no-deal exit.  Parliament was suspended but MPs returned after the Supreme Court judged the decision to prorogue unlawful.  Meanwhile, relations with the EU deteriorated, with the UK failing to put forward concrete proposals to amend the withdrawal agreement.
• Global Politics and Trade:  The US-China trade situation dominated investor sentiment, although there was little in the way of firm progress.  In Hong Kong, protests continued, despite the cancellation of the controversial extradition bill.  A new Italian government was formed, spurring hopes of an improved relationship with the EU.  Climate protests took place around the world.  An impeachment inquiry was launched against President Trump.
• Economics: Global economic data reflected a weakening picture, with manufacturing segments taking the brunt of the US-China trade impasse.  The OECD cut its growth forecast and Federal Reserve Chairman Powell signaled an openness to further rate cuts.
• Monetary policy: US rates were cut by 0.25%, as expected. The ECB cut rates to -0.50% and announced more stimulus in the face of opposition from core European members.  The Bank of England stood pat but remained cautious; one official called Brexit a “slow puncture”.  There was no change from the Bank of Japan.
• Currencies:  Sterling increased in value on hopes of avoiding a no-deal exit, dampening returns from overseas portfolio holdings.  The Chinese yuan moved through the significant level of 7.00 to the US dollar.

Equity markets

• Equities regained some of their poise after a volatile ride in August. They moved higher on trade optimism and anticipation of further stimulus.
• Below the surface, there was plenty of action at the sector and individual stock level.  As bond yields moved higher, equity markets rotated sharply in favour of “value” and cyclical sectors.  Stock-wise, companies that fell short of expectations were treated harshly.  It was also noteworthy that the share prices of some of the more speculative recent IPOs took a battering as investors’ appetite for loss-making companies waned.
• Most equity markets ended the month in the black, with Japan (helped by yen weakness), Europe and the UK in the vanguard.  Style-wise, value outperformed growth.

Bond markets

• Government bond yields moved up from their August lows as optimism for a trade deal grew but fell back later in the month as risk appetite ebbed away.  The broad gilt index delivered a positive return.
• With upward pressure on credit spreads, returns from corporate and high yield bonds were mixed.

Commodity markets

• A drone attack on an Aramco facility triggered a rapid rise in the oil price. It quickly fell back as the disruption to global supplies was minimised.
• The gold price fell after its strong run over the summer.

Third quarter review

Risk assets entered choppier waters in the third quarter, dogged by economic and political concerns.  The US-China trade situation was the primary concern for investors, with dribs and drabs of news, together with the usual stream of Presidential Tweets, adding to market volatility.  Further evidence of slowing global growth reinforced the sense of caution.  Protests in Hong Kong and intensifying tensions in the Middle East added to the worry list.

Despite the volatility, there were positive returns to be found in equity markets.   In base currency terms, Japan and Europe were in the vanguard, delivering positive returns.  The main US and UK markets also rose (but to a lesser extent), while the broad Asian and emerging market indices fell in value.  Overall, larger caps outperformed smaller caps and style-wise, growth indices exceeded value indices, despite the brisk rotation to value in September.

In fixed income, sovereign bonds were the stars of the show and the longer the duration, the better.  The 10-year gilt yield reached a record low in September, breaching the 0.40% level.  UK government bonds were not alone: the 10-year bund yield fell to a record low of -0.74% and the 10-year US treasury also came close to setting a new record.  Higher quality credits participated in the party but, with some upward pressure on spreads, returns from riskier bonds were less impressive.

Sterling fell versus the US dollar and the Japanese yen and therefore, related overseas allocations benefited from a currency boost.  On the other hand, the euro weakened, tempering returns from European assets.

The gold price rose, benefiting from the search for safe-haven assets.

Final thoughts

Investors have been pinning their hopes on a US-China trade deal and, as discussed above, markets have been highly sensitive to the daily news on this subject.  At the same time, macro indicators have continued to deteriorate, bringing the risk of recession for the global economy ever closer.  Much as investors have tried to ignore this threat, it is moving towards centre-stage as the slowdown spills into the US.  Equally, investors appear to be losing faith in the idea that lower rates can bring about an improvement in growth and/or a stockmarket rally.  Combine this backdrop with a full menu of geo-political issues, it comes as no surprise to see markets display increasingly skittish behaviour.  The upcoming earnings season will be more carefully watched than usual.

In our August note, “The illusion of normality and why it pays to be a cynic!”, we tackled some of the longer-range structural issues at play.  It appears that we are approaching a time of regime change, whereby monetary easing tactics are replaced by modern monetary theory (MMT), or, in other words, spending packages and supply-side policies to stimulate the economy.  A change of this nature would usher in a new regime for asset markets, one that would favour real assets with inflation sensitivity.  However, we have some way to travel between our current circumstances and this vision of the future and, as before, we remain cautious on “the bit in the middle”.  The notion of such a major shift would come with significant disruption to asset pricing and investor positioning.

Our central case is that while the monetary band plays on, bonds will be supported, although we should be prepared for increased volatility as investors sense changes ahead.  Similarly, and despite stretched valuations for many high quality/growth stocks, investors are likely to prefer the visibility that they bring.  Value strategies will have their time in the sun again, but it is too early to jump in with both feet.  Gold remains an interesting portfolio diversifier (notwithstanding its price volatility), performing well in times of strife and potentially offering inflation protection.