Overview
Boris Johnson became Prime Minister of the United Kingdom during July, as expected, and immediately reiterated his intention to leave the EU on the 31st October, even if no deal is reached.
Towards the end of the month the value of the Pound started to fall as investors took this outcome more seriously.
With the latest ‘Brexit’ deadline on the horizon, both the UK and Eurozone economies remained subdued.
The huge German manufacturing sector, in particular, contracted at the fastest rate for seven years.
In one of his last policy meetings, ECB President Mario Draghi announced further measures to stimulate the Euro Area.
Elsewhere, the US Federal Reserve cut interest rates for the first time since the financial crisis.
However, the Central Bank’s suggestion that this may not be the first of several rate cuts disappointed markets.
Despite continued economic weakness in several regions of the world, most equity markets had a solid month during August, and have rallied strongly over 6 months.
Over the last 6 months the FTSE 100 gained around 8.1%, whilst the Euro Stoxx 50 and S&P 500 gained around 9.3% and 11.5%, respectively (all in price terms).
The broad Emerging Markets index fared less well than its developed markets counterparts and returned 0.41% (in US$ price terms).
The Japanese Nikkei 225 gained approximately 3.53% (in price terms).
US Economic News
The US economy looked to be on a slightly fimer footing than many had expected during July.
The first estimate of growth in the second quarter of the year was 2.1%, which was better than the 1.8% many economists had forecast.
Despite the unemployment rate increasing marginally, it is still close to an all-time low, and new jobs were created at a reasonable pace in July.
However, the manufacturing sector told a different story. The ‘trade war’ with China, together with a slowing global economy, meant the sector contracted at the fastest rate since 2009; at the back end of the financial crisis.
Against this backdrop the US Federal Reserve decided to cut interest rates for the first time since the financial crisis, as had been widely telegraphed.
However, the decision was not unanimous, and the Chair of the Federal Reserve seemed to suggest that only one rate cut may be necessary.
Financial markets had convinced themselves that interest rates would be cut more than a few times over the rest of the year.
The prospect that this may be “one and done” as some have called it, saw an increase in volatility.
UK Economic News
As was widely expected, Boris Johnson became Prime Minister during July, and announced that all those who will serve in the Cabinet are signed up to leave the EU on the 31st October, even if no deal is agreed.
Initially there was little reaction in financial markets, although as the month wore on the Pound began to fall significantly.
With the EU not willing to renegotiate the deal on offer thus far, business uncertainty is likely to remain elevated.
Surveys through the month continued to point to an economy running well below potential – the manufacturing sector is estimated to be contracting.
At the same time the Bank of England cut its growth forecasts for the year, and suggested that there is a one in three chance of a recession.
However, whilst the manufacturing and construction sectors struggle under the weight of ‘Brexit’ uncertainty, the labour market still remains remarkably strong.
The unemployment rate remained at just 3.8%, which is the lowest since 1974, whilst average wages continued to grow above the rate of inflation.
The labour market is crucial in supporting consumer spending, which in turn is crucial for the UK economy’s fortunes.
Eurozone Economic News
The Eurozone economy remained weak during July, as the European Central Bank was forced to signal easier monetary policy.
The manufacturing sector, which is particularly exposed to the China-US trade dispute, contracted at the fastest rate since 2012.
The German manufacturing sector, by far the largest in Europe, deteriorated sharply.
It was confirmed during the month that Christine Largarde would take over as President of the European Central Bank in November. Some other candidates for the job were seen as being much more sceptical of interest rates remaining low.
In one of his last meetings, the current President signalled that policy would be loosened in the coming months in order to support the economy.
The Eurozone’s rate of growth slowed to 0.2% in the second quarter of the year, and is expected to remain sluggish for the rest of the year.
Wider Economic News
The Chinese manufacturing sector remained lacklustre during June as the twin effects of the US import tariffs, and the slow rebalancing of the economy toward services, remained in place.
The official rate of growth in the second quarter of the year was 6.2%; the lowest since the early-90’s.
However, as the Chinese economy develops, it is simply inevitable that it grows at a slower rate than in previous decades. Moreover, the 6.2% rate of growth is ahead of the government’s 6% target.
Meanwhile the Japanese manufacturing sector is also being affected by the trade dispute.
The latest surveys suggested that manufacturers reduced output for the seventh month in succession.
Many economists expect that Japan’s economy will have shrunk in the second quarter of the year.
Financial Markets and Corporate News
Despite economic growth faltering in many parts of the world, equity markets continue to grind higher, partly on the hope of more stimulus measures.
Since bottoming out in December, the major stock markets have rallied strongly. Over the last 6 months the FTSE 100 gained around 8.1%, whilst the Euro Stoxx 50 and S&P 500 gained around 9.3% and 11.5% respectively (all in price terms).
The broad Emerging Markets index gained approximately 0.4% over the 6 month period (in US$ price terms).
The Japanese Nikkei 225 gained around 3.53% over the 6 month period (in price terms).
Not for the first time in recent months, bond markets have risen strongly with equity market.
Over 6 months the Investment Association (IA) UK Gilts sector returned 5.5%, the IA Corporate Bond sector returned 6.1%, whilst the Sterling High Yield sector returned 5.2%.
Summary of Key News:
- Boris Johnson became Prime Minster and vowed to leave the EU without a deal if necessary.
- The Federal Reserve cut interest rates but investors were generally disappointed.
- The UK economy remains sluggish but unemployment remains low.
- The Eurozone economy remains relatively weak – the ECB signalled easier policy.
- The Chinese economy continued to feel the effects of the US import tariffs.
- The Japanese economy may have shrunk in the second quarter of the year.
Financial Markets:
- Most stock markets have rallied strongly over the last 6 months.
- Over the last 6 months the FTSE 100 gained around 8.1%, the Euro Stoxx 50 gained around 9.3%, whilst the S&P 500 gained around 11.5% (all price terms).
- The Nikkei 225 gained around 3.53% in price terms.
- The broad emerging market index returned 0.41% (in US$ price terms).
- The IA UK Gilts Sector returned 5.5%, compared to 6.1% for the IA Corporate Bond Sector, and 5.2% for the IA Sterling High Yield Sector.
Outlook
Political uncertainty has increased in the UK as Boris Johnson appears to be on a collision course with Parliament, the overwhelming majority of which is against a ‘no deal Brexit’.
As many political commentators now expect a General Election after the summer recess, the UK stock market could be quite volatile as the result of any election looks unpredictable.
In terms of the broader, global picture, there remains a disconnect between a slowing world economy and equity markets consistently grinding higher.
For now, new stimulus measures from Central Banks appear to be enough to placate equity investors.
The big question mark for investors is how the market will react if the US Federal Reserve does not cut interest rates as much as hoped for.
During the final days of July, equity markets reacted badly to the Fed Chairman’s suggestion that there may not be any further rate cuts this year.
After 10 years of strong investment gains, and with US equities more expensive than their historical average, the tiniest change of language is enough for equities to sell off.
Therefore, the language and actions of Central Banks is likely to drive markets in the short term.