Market Insights – 4th November 2019

Each week, a team of experts shares its market views with you.

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Point sur les marchés 04.11.2019

Essentials

In October, China’s manufacturing sector grew at its fastest pace in more than two years. Coming in at 51.7, the Caixin-Markit PMI beat expectations, mainly thanks to an uptick in new orders. This move back into expansion territory suggests that the main impact of the customs tariffs may be fading.

Swiss manufacturing output picked up considerably in October. Indicators are still in contraction territory but appear to have bottomed out at the end of the summer. The latest figure is in line with the improvement in the KOF indicator published last week.

US job creation figures were once again extremely robust in October, which surprised economists. With close to 130,000 new jobs and unemployment stable at 3.6%, the climate is still buoyant, especially for US consumers. Wages rose at an annualised rate of 3%, which is enough to increase purchasing power without weighing too heavily on companies’ profits.

A decline in risks

Political uncertainty is gradually fading, even though the UK hasn’t yet finished procrastinating over Brexit. We had thought that the UK parliament would approve the deal that Boris Johnson struck with the EU, but our hopes were dashed. The 31 October deadline has passed, the UK has asked Brussels for another extension, and an early election will be held in December to try and get the country out of this impasse. Boris Johnson hopes to win a comfortable majority in parliament by turning the election into a referendum on his deal. Despite all of this, we think the risk of a no-deal Brexit has decreased considerably, and the alternative to leaving with a deal could well be a long-term extension or simply no Brexit at all.

But what is weighing most on business confidence around the world is the uncertainty surrounding the US-China trade talks. We expect tensions to ease between the two countries. And for the moment, things seem to be heading in the right direction. It looks like there will be an agreement and that some of the tariff hikes brought in by the US recently will be dropped, after China agreed to increase its purchases of US goods, especially farming products. This would be a good time for political uncertainty to decline. A number of leading economic indicators  suggest that the worst of the slowdown in the manufacturing sector is behind us and that a rebound is under way. This would mean that manufacturing output bounced back even before consumer confidence had time to weaken. If these positive developments materialise, there is little chance of a recession in the short term.

What’s more, central banks are continuing with their stimulus measures and inflation is still very low. Last week, the Fed cut rates for the third time in 2019. This climate is a boon for risk assets, as the new highs reached last week on Wall Street indicate. Unless there is another surprise clash between presidents Trump and Xi, this end-of-year rally is likely to continue. At the end of last week, we increased our overweighting on equities in portfolios and upped our exposure to the US, European and Asian markets.

UK – "Get Brexit done!"

Brexit has once again been pushed off. But the political risks nevertheless decreased significantly after it was announced that London and Brussels had struck a new deal. There is of course still some uncertainty, particularly with the upcoming general election. The British people will have to choose between Boris Johnson’s hard yet orderly Brexit or staying in the EU with or without a referendum, but investors still think those options are better than the current deadlock. The Tories are leading in the polls, which increases the likelihood of a win for Boris Johnson, who would then be able to get his deal through.

This should provide a boost to the pound. Even though it has picked up recently, the pound is still undervalued and the target of significant short-selling. If it picks up, small caps should do well because they are much more exposed to the domestic economy than FTSE 100 companies. In the past, a stronger pound has pushed up small caps and pushed down the FTSE 100 index, which includes a large number of exporters. Since the Brexit referendum in June 2016, the UK market has underperformed global stock markets and British equity funds have recorded major outflows.

Until Brexit is sorted out once and for all, the risk premium on the UK market should gradually decline, making way for multiples to rise, especially since UK stocks are massively underbought and are trading at a discount. For all of these reasons, we recommend buying into the ETF iShares MSCI UK Small Cap.

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