After a stellar 2019, risk markets began the new decade in a good mood, before volatility picked up towards the end of the month. Concerns over the coronavirus outbreak checked the stock market optimism that followed the signing of a phase one trade deal between the US and China.
Markets were less perturbed by the brief flare-up in tensions between the US and Iran, which de-escalated swiftly. Economic data across regions continued to show signs of improvement and, with major central banks set to remain accommodative in the coming year, near-term recession fears appear to be subsiding.
With the turn in sentiment, safe havens performed well in January. The US dollar and Japanese yen both appreciated and government bonds outperformed equity markets – US Treasuries and euro government bonds returned 2.4% and 2.5% respectively. In a month where equities were down, the S&P 500 continued its leadership of major stock markets and was flat over the month. Emerging market equities were most affected by the coronavirus outbreak and fell 4.7%.
Exhibit 1: Asset class and style returns
Source: Bloomberg Barclays, FTSE, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. DM Equities: MSCI World; REITs: FTSE NAREIT Global Real Estate Investment Trusts; Cmdty: Bloomberg Commodity Index; Global Agg: Barclays Global Aggregate; Growth: MSCI World Growth; Value: MSCI World Value; Small cap: MSCI World Small Cap. All indices are total return in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 January 2020.
Exhibit 2: Fixed income government bond returns
Source: Bloomberg Barclays, Refinitiv Datatsream, J.P. Morgan Asset Management. All indices are Bloomberg Barclays benchmark government indices. All indices are total return in local currency, except for global, which is in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 January 2020.
January saw the outbreak of the latest coronavirus, originating in Wuhan, China. At the time of writing, more than 17,000 people have contracted the disease, with 362 confirmed fatalities. In comparison, the SARS outbreak of 2003 infected over 8,000 people, with 774 deaths. Increased travel over the Lunar New Year celebrations is likely to have aided the spread of the disease, and 26 countries outside of China have now reported cases.
As we are still in the early stages of the outbreak, and given the incubation period of up to 14 days (before symptoms present), it is hard to gauge exactly how the situation will develop and the subsequent economic impact. It is likely that this will be a near-term drag on growth in China and its neighbours, as infrastructure networks shut down and more people remain at home. A concerted policy response from the Chinese authorities seems likely, which may assist a recovery in the coming quarters. The prospect of a weaker global economy in the near term and associated weaker demand for oil led to an 11.9% fall in the price of Brent crude oil over the month.
The outbreak comes at a time when economic data suggests that the Chinese economy is stabilising in response to accommodative monetary and fiscal policy. China grew at 6.0% year on year (y/y) in the fourth quarter of 2019. December retail sales continued to grow at 8.0% y/y, while industrial production picked up 0.7 percentage points to 6.9% y/y.
Exhibit 3: Fixed income sector returns
Source: Bloomberg Barclays, BofA/Merrill Lynch, J.P. Morgan Economic Research, Refinitiv Datastream, J.P. Morgan Asset Management. Global IL: Barclays Global Inflation-Linked; Euro Gov.: Barclays Euro Aggregate Government; US Treas: Barclays US Aggregate Government - Treasury; Global IG: Barclays Global Aggregate - Corporates; US HY: BofA/Merrill Lynch US HY Constrained; Euro HY: BofA/Merrill Lynch Euro Non-Financial HY Constrained; EM Debt: J.P. Morgan EMBIG. All indices are total return in local currency, except for EM and global indices, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 January 2020.
The signing of a phase one trade deal between the US and China on 15 January was welcome news, representing a thawing in tensions, but it is important to remember that significant tariffs will remain in place and that the structural issues to be tackled in the next phase are not likely to be resolved easily. The agreement means the US will suspend its next planned round of tariffs, as well as cutting the existing tariff rates on around USD 110 billion of Chinese imports from 15% to 7.5%. In exchange, China has committed to boost its imports from the US by around USD 200 billion over the next two years; allow greater access to its markets for financial services companies; enforce intellectual property protections; and be more transparent in its currency management practices.
The key now will be to watch upcoming economic data releases to see whether global businesses feel empowered by the deal to restore investment plans that were postponed in 2019. We do not expect a vigorous bounce back in activity, since ongoing trade concerns, coupled with the uncertainty caused by the presidential election in November, are likely to keep firms hesitant (see our On the Minds of Investors – How will the 2020 US presidential election affect markets?).
The US economy grew at an annualised pace of 2.1% in the final quarter of 2019 and broadly remains on solid footing. Manufacturing remains weak, with the December release of the Institute for Supply Management’s (ISM) manufacturing survey showing that the sector continues to contract. However, the services side of the economy remains resilient, and the ISM non-manufacturing survey picked up 1.1 points to 55.0 in December. And the consumer, the bedrock of the US economy, is still in good shape, with confidence rising significantly in January.
Growth in jobs (non-farm payrolls) moderated in December. The three-month average pace of job growth now sits at 184,000 per month. This is well above the 100,000 that we would generally regard as concerning however, the number of job openings warrants monitoring since it fell significantly in November.
With the economy evolving broadly in line with the Federal Reserve’s outlook of moderate economic growth and a strong labour market, the decision to keep the key interest rate unchanged at the January meeting came as no surprise to markets.
The US earnings season for the fourth quarter of last year is well underway, with companies so far doing better than expected. Earnings per share and sales are growing at 6% and 2% year on year, respectively for the S&P 500.
Exhibit 4: World stock market returns
Source: FTSE, MSCI, Refinitiv Datastream, Standard & Poor’s, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency, except for MSCI Asia ex-Japan and MSCI EM, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 January 2020.
Growth in the eurozone remains positive but tepid, at 0.1% in the final quarter of 2019. The consumer remains supported by a healthy labour market – unemployment in the region fell 0.1 percentage point in December to 7.4%.
More encouragingly, the manufacturing side of the economy showed a significant rebound. Should international trade improve on the back of the phase one trade deal, then the manufacturing hubs of Germany and Italy, which both have about a fifth of their employment in manufacturing, stand to benefit.
Christine Lagarde’s second meeting in charge of the European Central Bank (ECB) was a low-key affair. Policy rates were left unchanged, but, more significantly, a comprehensive review of monetary policy strategy was announced. The review will include an assessment of the monetary policy toolkit, including its effectiveness and potential side effects, how the ECB approaches price stability, and environmental sustainability. Importantly, we do not believe the review will conclude that negative interest rates should be reversed.
Lagarde also reiterated her call for more fiscal stimulus, in particular to countries more able to borrow than others, saying a good fiscal support would give much more effect to our monetary policy.
The UK officially exited the EU on 31 January 2020. But those hoping that this marks the curtain call for this long Brexit performance will surely be left disappointed. The UK and EU will now need to negotiate a new free trade agreement during the 11 months of transition. As a result, talk and risk of a hard Brexit will persist to some degree, and may intensify by mid-year.
Economic data deteriorated notably ahead of the December election, but there has been some rebound in the subsequent data. Employment grew by 208,000 in the three months to November. The flash purchasing managers’ index releases for January, the first major data points since the election, pointed to a sharp improvement in both manufacturing and services, with the composite rising from 49.3 to 52.4.
This was sufficient for the Bank of England to judge that interest rates should be kept on hold. We believe interest rates will be held at 0.75% as the downside risks to global growth fade and the domestic economy is supported by a sizeable fiscal tailwind.
We think that the UK stock market may be poised for a comeback, especially given the attractive yield UK stocks offer in an income-starved world (see our On the Minds of Investors – Three reasons investors could return to UK stocks post Brexit).
The outbreak of a coronavirus and a brief flare-up in US-Iranian tensions in January have served as a timely reminder that as well as positioning for the risks on the horizon – the known unknowns – investors also need to prepare their portfolios to be able to weather the unknown unknowns. This is best achieved through a broad approach to portfolio diversification across and within fixed income, equities and alternative assets (see our Investment outlook 2020 for a more detailed discussion on portfolio construction).
Exhibit 5: Index returns for January 2020 (%)
Source: Bloomberg Barclays, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as of 31 January 2020.