Quarterly commentary – Q3 2018

Rising share markets despite escalating trade war and divergence between the US and the rest of the world

On the economic front, Q3 continued the trend from earlier this year in the form of regional divergence with diverging growth prospects for Europe and Emerging Markets and further improvement in the US. Business and consumer confidence in the US is close to reaching an all-time high, and the number of Americans filing for unemployment benefits and the unemployment rate are at their lowest levels since 1969. In Emerging Markets and Europe, the growth level is still relatively high, but the forward-looking indicators still diverge or, in some cases, show tentative signs of stabilisation.

The US recovery are currently enjoying the effects of the tax reform and the increased public spending from earlier this year, and although the Fed hiked the key rate for the third time this year, the monetary policy remains accommodative. At the meeting in September, the Fed indicated that they will continue to normalise the monetary policy, and another rate hike in December now seems highly likely. In 2019, the Fed expects to hike the key rate another three times, while the market hesitantly follows and now factors in two rate hikes for 2019. As a result of the gradual market adjustment to the Fed's rate forecasts, the 2-year Treasury rate increased to 0.29 per cent for the quarter.

On the geopolitical front, there was plenty to worry about in Q3. Financial crisis in Turkey, increased tensioning of the trade war between the US and China and different announcements from the Italian government on the size of the expected budget deficit for 2019. On the plus side, Trump & Co. managed to land a new trade agreement (USMCA) with Mexico and Canada. The agreement does not differ significantly from the original NAFTA agreement, but given the turmoil over the agreement, the market still breathed a sigh of relief after the announcement.

Although the market had plenty of event risks to digest in the past quarter, the net result was increasing prices of high-risk assets. The best performance was seen in the share market where the world index went up 5.5 per cent in the quarter. Like on the macro front, the quarter saw major regional differences and US shares were up 7.8 per cent while Emerging Markets only went up 1.2 per cent. US High Yield bonds were up 2.5 per cent and European High Yield bonds ended the quarter up 1.6 per cent.

For several years, investors have found themselves in a regime of increasing economic growth, low inflation, low interest rates, high prices of most financial assets and abundance of liquidity. Although inflation and interest rates remain low, we are currently seeing a change of regime as the ample liquidity from the central banks is slowly rolled back. The Fed is at the forefront of this process, but in Q4, the ECB will half its monthly bond buying from EUR 30 billion to EUR 15 billion.  The ample liquidity has been instrumental in pushing the investors further up the risk scale in the hunt for returns, and an opposing movement can reasonably be expected when the tide turns. Along with the high prices, this risk means that we slowly dance towards the exit although the music so far continues in the financial markets.