The Tilney Investment Podcast – Measuring the impact of global events on markets

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Highlights of this episode

You can use the links below to navigate to a section of the transcript.

01:17 – The round-up of markets in January is “far from boring”

03:00 – Asset managers and sustainability: is climate risk investment risk?

07:29 – Coronavirus and US-Iran tensions are heavily impacting the economy

11:31 – Will the Bank of England cut interest rates?

15:06 – UK’s farewell to Europe: pressure to get the deal done before the end of the year

The following is a transcript of the podcast which has been edited for clarity.

It is important to remember that investments fluctuate in value and you may not get back the amount invested. Nothing in this article is intended to constitute advice or a recommendation, and you should not take any investment decision based on its content. The opinions expressed may change without notice. If you are unsure about the suitability of an investment, or if you need advice on your specific requirements, you should seek professional financial advice.

Q1: The round-up of markets in January is “far from boring”

Justin 01:17

So, Ben. Just to start us off, could you give us a quick roundup and review of what's happened in January in the markets after a pretty good December rally?

Ben 1:30

Absolutely. It's been far from boring. We started the year with the momentum that we saw at the end of 2019 continuing in January. We started off with risk assets, particularly equities, rallying quite nicely. Most other risk-off assets held relatively firm.

All of that change mid-month went into reverse, particularly some of the concerns around the Coronavirus really impacted a lot of sentiment and we saw market stocks sell off quite notably. Equities, as we stand today at the end of January, wiped out all of their gains; not a huge shift but certainly taking all of the air out of the movement, thus far. We saw a big bid up for ‘safe haven’ assets, particularly government bonds and gold.

So, overall equities are largely flat and government bonds have particularly benefited from this. For example, if we look at the 10-year UK government bond, the yield – which obviously moves inversely to the price – has fallen from 0.8 [%] to 0.5 [%]. That doesn't sound like a lot, but in price terms that's around a 2.5% move and, again, to many of our listeners that might sound quite mundane, but believe me that's pretty racy for what is a perceived ‘safe haven’.

Gold is up 3.5% in the month now comfortably above the 1,500 mark, but interestingly oil has fallen back.

Brent is now back around about the US$60 mark which we last saw back in October. So really, a round trip for risk assets and a pretty solid month, overall, for those risk-off assets.

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Q2: Asset managers and sustainability: is climate risk investment risk?

Justin 3:04

Okay, there's always a lot to talk about. One of the main stories over the last month has been the annual shindig, the get together of world leaders in the mountains in Davos. The big theme there was, of course, sustainability and climate change. How does that and other things that came out of Davos really feed into our thinking these days?

Ben 3:24

It's always a good opportunity to watch the output from Davos; you have a lot of key thinkers and world leaders all giving their view of the world and particularly of some of the longer-term themes.

Climate change was front and centre and obviously it's something that we think about a lot here at Tilney. It's in the public psyche overall: extinction rebellion became very active last year but more broadly we're seeing this theme, I think, extend.

It's interesting from my point of view, sitting on the investment side, that the Bank of England – and Mark Carney in particular – has been very vocal about these issues, particularly getting a lot of these externalities brought onto the balance sheets. That has a big ramification for companies such as oil and gas producers if suddenly they start to have some sort of responsibility. It's worth remembering Mark Carney has a much more global role in some of the financial stability elements, so he is obviously a big player. As in the next couple of months we see Mark Carney leave the Bank of England and Andrew Bailey come in – who was previously head of the FCA – it'll be interesting to see if Andrew Bailey continues that theme or really where his heart is on the matter.

More broadly, I think it's interesting if you look at BlackRock. BlackRock is the world's largest asset manager globally. It runs in the order of US$7 trillion, a huge amount of money. The CEO, Larry Fink, has been very vocal about these issues. He came out at the start of this year around the time of Davos announcing a whole raft of initiatives and adjustments at BlackRock, talking around divestment from bad companies or those that aren't particularly sustainable and really looking to embed a lot more of those sustainability-minded elements in their investment process and launch a lot of products around that.

So there's definitely the shift: BlackRock are now talking about ‘climate risk is investment risk’, which is something that I think is very true and something to pay close attention to.

It's interesting that if you're particularly cynical you might say they're just looking to exploit public feelings, but it's certainly something that Larry Fink has been talking about for a long time, and when one big asset manager moves, the others can't help but move in line. So that's a real key theme throughout the year.

What I would say though, one of the risks I'm cognisant of is that we're at risk particularly here in the UK of being in something of an echo chamber. I think it's been very front and centre and public perception has definitely shifted. This shift to sustainability areas is much embedded in the UK and more broadly in Europe. It is worth remembering that at a global level I think it's fair to say the US and some of the developing countries are some way behind that thinking. So whilst it might feel like a done deal and we're definitely going to see shifts here in Europe, we do need to remember a lot of the press and a lot of the people we talk to might not be reflective of some of the larger economies. There's some very interesting discussions to be had, particularly around the politics and the morality.

As you look at developed economies, really a lot of that development has come on the back of fossil fuels with combustion engines. We look at elements such as ‘what will happen with emerging markets?’. If we perhaps say they can't benefit from those same changes, where does the onus on driving the shift to sustainability investing really lie? Those are big political issues that I don't think there is a clear cut answer to, so I think we're definitely heading in the right direction and that's the theme from Davos. But there are a lot of question marks.

Also, on the back of that there is this question about global economic growth: in order to achieve these outcomes, particularly around sustainability, you need a backdrop of solid sustainable economic growth. The big risk, even though climate change is very high on many investors’ agenda at the moment, is that if we do start to see growth stall… we've had a 10-year bull run and if that goes into reverse, I think you can find in aggregate that concern drops down in investors’ list of concerns quite quickly. So you do really need to see a solid economic backdrop to achieve these outcomes.

Back to highlights

Q3: Coronavirus and US-Iran tensions are heavily impacting the economy

Justin 7:30

Well very much like you said, the agenda seems to be changing quite rapidly at the moment. There always seems to be something for us as investment professionals to think about.

Recent news, of course, in the last week or so has been dominated by the Coronavirus in China, but we also saw another important news story come out of the Middle East in January. Perhaps you could just touch on that and the implications of those two subjects in particular.

Ben 7:55

Yeah, absolutely. I think it just shows how quickly the news agenda changes. In the last podcast, there was a lot of focus on Iran and the potential flaring up of that conflict. We do still keep a watching brief on that area; it does seem like both the US and Iran are stepping back from the brink. Unfortunately, one of the main catalysts for that does seem to be the accidental downing of this aircraft by the Iranian authorities and really the question marks and internal divisions that caused the whole situation really seem to simmer down.

I think, as we touched on last time, the key flashpoint really could be what happens in Iraq, which is acting as something of a proxy battle area for the two economies. There is the risk those two countries could be dragged into a conflict there, if there isn't a political resolution. That’s a great example of something that's still in our watch list, and even as it disappears from many of the front pages of mainstream newspapers, it's something that hasn't gone away; we'll keep a watching brief on, but certainly the imminence of that challenge seems to have dissipated.

But against that, what's replaced it is Coronavirus coming out of China. It's all over the news and, as I said at the top, it’s really heavily impacted markets. That's something to keep a careful eye on, as it is easy to see some level of overreaction. But I think that's potentially warranted, given the hugely unknown nature of the virus. Obviously, any fatalities are unfortunate and not something that anyone wants. To put in context, though, as we had with previous outbreaks, it's about the response: the Chinese authorities have been very open, very quick about the virus compared to SARS back in the early 2000s, and also its fatality rate is still very low, so hopefully it will stay that way.

Unfortunately, hundreds of thousands of people die every year from seasonal flu and so, even though the numbers are unfortunate, we have yet to see that fatality rate necessarily spike. So far it's a watching brief. The early indications are that it's unlikely, we think, to be a global catastrophe. Obviously that could mutate but we hope it doesn't.

From an economic point of view, the impact is more around activity production. We've seen a large number of Chinese cities become locked down; we see, most recently, flights in and out of China being blocked by certain airlines and that will have a knock-on effect both to industrial activity and consumption. So, if it goes the same path of previous viruses – which is a sort of sharp uptick – a peak with a relatively low fatality vaccines in control was brought in to bring it under control, which is sort of the base case, I think, you have to start with. With all of these, you could see an impact in terms of Q1 GDP both from China itself but also through supply chains, and you'd expect a bounce back into Q2 and beyond. And really, if you look at markets, it should be about long-term cash flows and earnings and the discount you apply; one or two quarters of poor growth don't really affect the valuations you should place on assets. That's something we saw in 2019 as economic growth faulted. Markets look through that because of its monetary policy stimulus; they said, ‘you know what, we think the future is bright’. So obviously it's something to watch carefully. There's a lot of unknowns there, but based on that sort of model, I think you can see a short-term hit. We would hope and expect that to normalise going forward.

Back to highlights

Q4: Will the Bank of England cut interest rates?

Justin 11:33

Okay, so, a watching brief on that, as so often is the case. It's a bit unfair this one, but the Bank of England is due to publish its interest rate decision tomorrow. Have we got any thoughts on the likely outcome based on recent data? What do we think is going to happen and what are the potential implications of the decision?

Ben 11:55

Sure. Well, it is difficult because it is tomorrow, but I'll give you my view – and that's oddly that I don't know. I say it's odd because I think, as we've talked about on the podcast before, mostly interest rate cuts are on the day. It's the weeks and months leading up that we see that the changes come through. Typically, at this stage, compared to the meeting the day before, you know, we can go online, we can use our data providers to see what the market is pricing in and normally there's 80 or 90% chance of a cut or hike or no change. So normally there's a great deal of confidence.

But that's changed in the last few days. The day before, as we sit today, the probability [of a cut] in the market is around 44%; that's very close to a 50:50 ‘don't know’ point of view. And the reason for that is some disappointing data. Earlier in the year we saw UK industrial production deteriorate, so it fell from minus 1.3% to 1.6% year on year, and no change was expected. And I think particularly inflation surprised to the downside. The headline CPI inflation fell from 1.5% to 1.3%, and that's really when I think markets started to price in the need for the Bank of England to cut, and we saw the probabilities push up to 60-70%.

Since then, though, we've had some pretty reasonable wage data, but also we talked a lot on the podcast about purchasing manager indices and UK had some good numbers, both surprising to the upside. Manufacturing PMI picked up from 47.5 to 49.8, so basically at the breakeven level, and services went from bang-on 50 to 52.9. Very strong numbers, much stronger than expected, and I think that's helped soothe some of the moves.

If you were to commit me to an answer, I don't think the Bank of England is going to move tomorrow. I do think they're going to move this year and there is a strong likelihood by the summer we'll have had another quarter point cut. The reason I'd hold back, even though I can see the rationale, just for a little bit more stimulus, is that as you look at the changing of the guard, this is Mark Carney's last meeting. The new governor, Andrew Bailey, comes in mid-March; the next meeting is the end of March and I think if all of the data this month was negative, then Mark Carney would have to act. As it stands, you're about to hand over, and I think Mark Carney is likely to see it's unfair to enact a policy change and someone else has to deal with the consequences. I think it's much more defensible to say, ‘okay, the data is mixed but deteriorating, but I don't think there's an urgency’, so he could hand over to the new governor, who can then establish himself on the committee, and then make the change.

So I think a cut is coming, but just because of those dynamics, it's unlikely to be at the January meeting.

Back to highlights

Q5: UK’s farewell to Europe: pressure to get the deal done before the end of the year

Justin 15:08

Okay, finally – and I'm sure you'll be very happy that this is potentially the final time that we discuss this on the Tilney podcast – we are approaching the end of January. At the time of recording we are still in the European Union. By the time that our listeners might be listening to this, we may be out of the European Union, after the end of January. Is there anything in particular that you would like to bring up, just with that deadline approaching in the next couple of days?

Ben 15:41

Well, I think it's wishful thinking to hope that we won't be talking about it ad infinitum for months and years to come.

The good news is I don't think at least some people are going to be talking about Brexit after the 31st of January, certainly not if you're a minister; mostly because the Prime Minister has sent around an edict saying people aren't allowed to talk about Brexit.

Functionally, nothing really is going to change as we go into the transition period. And I think there are lots of interesting points to look at this year, particularly around the relative hardening and softening no longer of the exit itself, but around the trading relationships. That's what everyone is talking about now. There is a lot of pressure to get a deal done by the end of the year, and the challenges we had last year were these cliff-edge negotiations which are good for politicians, possibly good for your negotiating strategy, but not good for business.

The most important thing is to see whether or not the government then tries to engineer another cliff edge at the end of the year; that's probably not going to be positive. Instead, what we'd hope for is a much more positive approach to negotiation and the idea of inclusion and how the government manages to run these different negotiations in parallel.

I think the mood music has soured since the start of the year marginally. Again, we always look at the relative value of sterling compared to the US dollar: that's dipped from US$1.325 at the start of the month and it's now around bang-on US$1.30, which implies back to middle ground but down from some optimism earlier.

And just to give us some idea of the challenges that we do face, it's not a done deal. There are pressures with Europe, but a lot of people have been looking to the US and what sort of deals can be done there, and we already have at least two points of friction. Firstly, the point around the digital tax that the US has indicated they would respond quite harshly to if that's imposed to the likes of Google and others that generate a lot of revenue, but maybe don't pay some tax. So that's already a point of friction. But also, the government's acquiescence in allowing Huawei to take part in the 5G network in spite of protestations from the US. So we're already seeing some friction in what is likely to be our biggest non-EU trading partner and I think that really is going to be the theme of the year.

What we do have coming up in March though is the next Budget, and I think that's going to be interesting. We're already expecting a significant fiscal boost. This is what we talked about last year and one of the reasons we're reasonably positive on UK assets, going into 2020, is that we're likely to see more fiscal stimulus infrastructure. A lot of that going not necessarily to London and the Southeast, but toward some of these new areas that the Conservatives have taken over, so it'll be interesting to see what developments they have in there.

So there's definitely a lot to watch out for and I don't think it's going to be plain sailing. I'm sure we're going to be talking about it at many points over the coming years and months.

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