Cracks are beginning to appear in several foreign markets and economies, prompting U.S. investors to look outward for signs that the global economy might slow down more than anticipated.
It’s a natural reaction considering how the fourth quarter 2018 slide in U.S. equities heightened fear among investors. Although equities are beginning to climb back in the first quarter of 2019, despite the clear effects of the government shutdown in January, trepidation is palpable in the markets.
“Not all of the correction fits in the economic environment that we’re in,” says Hilton Capital Management CEO Craig O’Neill. “I think what we saw in Q4 was a market reacting to a slower growth economy with little chance of near-term future stimulus. And it was exacerbated by a large percentage of assets that are in passive investment vehicles and quant strategies.
“We don’t think that’s going to change anytime soon,” continues O’Neill. “Future market moves are going to be amplified. The market structure has changed somewhat and our job as allocators going forward is to make sure we know what type of risk we have on relative to the new market structure.”
The Hilton team remains sanguine about the U.S. economy, specifically, but acknowledges the fluid situation abroad. In January, Mario Draghi, the head of the European Central Bank (ECB) made headlines, saying the European economy is weakening more than anticipated and will require continued support from the ECB. Taken alone, this might not stoke investor fears but his remarks came on the heels of realizations that the Chinese economy was also slowing more than originally believed. For its part, the Chinese government has signaled a willingness to inject capital into the system as well.
“I think what we saw in Q4 was a market reacting to a slower growth economy with little chance of near-term future stimulus. And it was exacerbated by a large percentage of assets that are in passive investment vehicles and quant strategies.”
“So much of what will transpire in 2019 and 2020 hinges on the movement of the dollar,” says Alex Oxenham, co-chief investment officer of Hilton Capital. “We are evaluating both threats and opportunities globally; and, as always, the factors that influence them are increasingly intertwined.
“You have to look at it in totality,” he continues. On the most recent Hilton investor call Oxenham pointed out that, “International markets corrected about 23% last year. U.S. markets through September were wildly outperforming, but once the U.S. data started to deteriorate, which is a very similar situation to what is happening in Europe...we had virtually the identical correction.”
Oxenham elaborated on the global markets in an interview following the call with investors.
“Draghi is highlighting some downside risks in the European economy and, as we’ve said for a while now, the U.S. economy is going to downshift in 2019,” Oxenham adds. “The good thing is we have a more consensus outlook today than we did two months ago. Eventually the Fed (Federal Reserve) might back off the rate hikes and when that happens the dollar will begin to weaken. However, we haven’t seen that yet. But once it does, the opportunity in emerging markets crystallizes. China will do massive stimulus because they get more bang for the buck when the dollar is weak, and emerging markets will do better as well.”
“In evaluating opportunities, we view emerging markets essentially the same as commodity prices,” notes Oxenham. “They need the U.S. dollar to weaken in order to have strength.”
Until now the dollar has been strong relative to global currencies. This strength, in addition to increases in U.S. crude output, is maintaining downward pressure on oil prices, though there is evidence that OPEC’s production cuts are beginning to take hold. Moreover, the Hilton investment team believes that since prices have collapsed, production levels in the U.S. are likely to fall as well in 2019. And since commodity prices, and specifically oil, tend to directly impact consumption and create inflationary pressure, it’s important to monitor.
Lastly, there is consensus that demand for crude is slowing, thus providing further evidence that the global economy is beginning to slow down in tangible ways.
“These are cycle realities that we are attuned to in balancing our portfolio. In evaluating opportunities, we view emerging markets essentially the same as commodity prices,” notes Oxenham. “They need the U.S. dollar to weaken in order to have strength.”
Oxenham believes investors have already gotten slightly ahead of the emerging market curve, but acknowledges that Hilton has also taken an emerging market debt position.
“We’re close to seeing emerging markets break out,” he adds. “The table is almost set. If the dollar weakens you’ll see global forces coalesce with Chinese and European stimulus, fewer Fed moves and slower growth overall, which should cause EM to gather momentum.”
As always, there are geopolitical risks that are worth keeping an eye on from the ongoing Brexit chaos to instability in Latin America. Argentina, for example, is still wrestling with currency instability, and the situation in Venezuela continues to degrade with sanctions further constricting the economy and hyperinflation taking hold.
It’s also worth noting that, as a whole, emerging markets are more susceptible to a weakening global economy than they are drivers of global growth. The tolls extracted on certain markets can be significant, with such consequences as mass migration from particularly hard hit areas. The longer emerging markets have to harden social, labor and health related infrastructures the more resilient they will be during economic downturns. If the weakest of the emerging markets aren’t prepared then they can further degrade negative economic situations, as we have seen with the European migrant crisis.
Political crises such as these have a way of throwing a wrench into markets but the relative strength of the U.S. economy and proactive measures from the ECB and China should be enough to prop up markets that are increasingly interdependent.