Market Insights – November 19th, 2018

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

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Looking at the charts, the S&P 500’s decline last week is not necessarily a bad thing. The inverse head-and-shoulders pattern – a bullish indicator – is forming, which could mean that a year-end rally is on the cards. However, a rebound would have to materialise within the next few days to confirm this scenario.

After a very rough summer, emerging currencies have been gaining ground since early September. The Mexican peso, however, is a rare exception. It is being held back by the perceived anti-business comments of president-elect Obrador, who will take office on 1 December.

Germany’s GDP contracted by 0.2% in the third quarter. This is the first time in three years that the German economy has shrunk. The slowdown can no doubt be put down to the decline in car production caused by tougher emissions tests. The uptick in certain leading indicators, like new manufacturing orders, suggests that the economy should pick up again in the fourth quarter.

Will oil prices make the Fed think twice?

Energy prices fell once again last week, even though they had seemed to be stabilising. Oil prices have dropped by more than 25% since early October, when they hit their highest level since 2014. Political developments are behind this plunge – the sanctions against Iran were, for instance, less severe than expected. But the outlook on oil prices appears to have been affected even more by an abundant supply and fears that demand will soften. We think oil is oversold in the short term, and we expect Opec to try and curb the decline at its next meeting in early December.

Unsurprisingly, energy stocks have been hit by these developments. But so has the
bond market, especially its riskiest segments. In the USA, the high-yield segment is very exposed to the energy sector, which represents more than 15% of bond issues. Unconventional oil companies have used the bond market to finance the construction of oilrigs and shale gas plants. A sharp decline in oil prices could therefore weaken the profitability of these companies and even prevent them from meeting their commitments. That’s what happened when oil prices plummeted in 2015, and this segment of the bond market massively underperformed as a result. We therefore recommend taking profits and exiting the US high-yield segment. It is also worth keeping an eye on the broader corporate bond market. A widening yield spread across the board would not be good
 news at this late stage of the macro cycle.

The Fed, which has adopted a more dovish stance recently, is no doubt watching these developments closely. Fed Chair Jerome Powell appeared more cautious when he spoke at an event organised by the Dallas Fed last week. On top of the doubts that the oil-price decline raises about the robustness of global economic growth, the impact on inflation should soon be felt. In the USA, inflation has already started to slow; even core inflation, which excludes energy prices, has lost steam, coming in at just 2.1% year on year in October, compared with a peak of 2.4% in the summer. Could this prompt the Fed to slow down its monetary tightening in 2019?

Brexit – we're not quite there yet!

There are just four months to go before the UK leaves the EU. The first stumbling block has been overcome, with the UK government approving the Brexit deal. But several key ministers resigned the day after the deal was announced, weakening Prime Minister May and making it all the more difficult to get the deal through Parliament. In addition to the eurosceptics
 and Northern Ireland’s DUP, several remainers also oppose the deal. If it is rejected, things will get complicated for the UK, with the possibility of another general election and even a second referendum. But a positive outcome is still possible. If May makes some tweaks to the deal, she could still get it approved by Parliament.

In the meantime, fears that the Prime Minister might have to step down if she loses a vote of no confidence and the increased likelihood of a hard Brexit have weighed
on stock markets and caused the pound to plunge and yields on Gilts to fall. Although there is still a lot of uncertainty, we think it’s important not to react too rashly. It will be a long and winding road, but once the markets have focussed on the outcome, the uncertainties will fade and there will no doubt be a number of attractive entry points on the pound and the UK stock market, especially when it comes to domestic stocks.

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