Market Commentary – 18th January 2017
Teresa May – 12 Point Plan
Theresa May’s long-awaited speech on Brexit offered little in the way of new information about the Government’s plans for the negotiations. The UK will leave the European single market and plans to seek a free-trade agreement (FTA) with the EU. But the negotiations will be challenging and are far from guaranteed to succeed. The Prime Minister did make a potentially important commitment to ask both Houses of Parliament to vote on the final deal, a promise which caused sterling to spike upwards. But we do not see this as materially reducing the probability of the UK leaving the EU, it looks unlikely that ‘remaining’ will be one of the two options that Parliament will be able to vote for. It is likely also that if we go for a vote and the government lose the vote that we will have an election, or the choice will be vote for what we have agreed or leave and have a hard Brexit, which will result in parliament voting for what has been agreed. There is also a great deal of cross party agreement on this as no politician really wants to go against the will of its constituents.
The speech confirmed what we already knew in that the desire to control immigration policy means that the UK will be leaving the single market. The UK will seek to agree a FTA with the EU, with the aim of securing trading arrangements which are as close as possible to those enjoyed today, and the UK is keen to agree a transitional arrangement to give business time to adjust to the post-Brexit world. Another point was that the Prime Minister, echoed what Hammond said on Monday in that she made clear that “no deal is better than a bad deal”, which suggests that when Parliament is asked to vote, the alternative to whatever FTA the Government is able to negotiate will probably be a reversion to trading under WTO rules, rather than remaining in the EU. Secondly, legal opinion is divided upon whether Article 50 is irrevocable. If the notification cannot be taken back then a vote against the FTA would also push the UK towards WTO rules, rather than remaining. While the Government has now set out its desired post-Brexit plan, it is far from certain that the EU will agree to all of its requests. We identify the following areas where the negotiations will require some give and take between the two sides:
Overall we are clear as to what Britain wants and they have a strong negotiating position, but no one as yet knows whether the EU will be playing politics and being protectionist, also because it does not want to let the UK leave and give a blue print that the French could follow for example, so they are stuck between two points of principle and that is the danger.
Global Economic Data
Over the last week, we have continued to see strong economic data with most data points exceeding expectations especially in Europe where we saw Industrial Production YOY in November at 3.2%, which was double the expected 1.6% with MOM at 1.5% against an expected 0.5%. Overall therefore Europe and the rest of the developed world continues to show signs of reflation, which is exactly why the equity markets are going up.
As we are constantly looking at Economic data and have set a number of Barometers that test the outlook, and to give our readers some consistency we have selected the following six barometers that we will review weekly as detailed below:-
US Earnings – As of last Friday, the S&P 500 is expected to report earnings growth of 3.2% for the fourth quarter, which in English means that it should do about 6% if history repeats itself. There is mathematical evidence to suggest at this stage that the final number will be significantly higher and I will not bore you with the exact detail here, but if history repeats itself and companies report earnings higher than anticipated then we should see an additional 3% in earnings growth, so 6% is not out of the realm of reality for Q4. To back this up to date, 6% of the companies in the S&P 500 have reported actual results for Q4. In terms of earnings, 70% of those are reporting actual EPS above estimates compared to the 5 year average. In aggregate, companies are reporting earnings that are 5.9% above the estimates, which is also above the 5-year average. If the index does report growth of circa 6% in earnings for Q4 2016, it will mark the highest earnings growth reported by the S&P 500 since Q3 2014 (8.3%). We will watch, wait and report on this is as we go through the earnings seasons.
UK & Non-UK Gilt Yields; As we are expecting the Brexit Fear factor to grow as the UK tabloids start to talk down the prospects of the UK economic prospects post Article 50 being triggered, we look at UK, German and American government Bonds in particular on the basis that as and when we want to be defensive this is a traditional asset that we would use. If though the expectation is for sterling to weaken we would also use European and US government debt, as we can get a currency gain as well as an investment gain and that is the situation we find ourselves in at OCM today. If we look at the charts below, the UK and European Yields have been falling since end of September and the US yields since the end of October, despite yields falling and valuations rising over the last month. The trend with a reflection trade is that yields will continue to fall as global growth and inflation picks up globally. You can see from the charts below that the returns have been skewed significantly because of the collapse in sterling over 12 months. Despite the recent falls, we expect the trend to be negative on yields and hence valuations falling. Today therefore we do not see the asset giving us our required 5% contribution as a non-equity asset, and we are not therefore interested in investing in it as there is more downside momentum than upside potential, ignoring currency. We are also seeing far too much volatility in prices of assets that should be stable and offering very low levels of volatility moving only 1% – 2 % in either direction, making them almost impossible to invest into as safe haven strategies.
GBP to USD/Euro/JPY;
Today we saw significant strength in Sterling following a softer Brexit and a softer yet stern approach that is more respectful of parliament, noting that if parliament does not agree, a hard Brexit is still likely or an election. In addition Donald Trump talked about getting the dollar weaker as it is strengthening at the same time as sterling weakening. The trend yesterday was reversed though noting we do not expect the sterling strengthening story to continue, but for the currency to continue softening as the rhetoric from the press starts to undermine confidence. We are still range bound for the three currencies as detailed below and asset allocation decisions will be altered if we move outside of these ranges as follows:-
- GBP / USD – Range 1.25 – 1.10 – Today 1.23
- GBP / EUR – Range 1.20 – 1.10 – Today 1.15
- GBP / JPY – Range 1.50 – 1.25 – Today 1.39
Oil continues to strengthen which as we have said is positive for global equities, partly due to OPEC cuts and partly due to an expected rise in global demand. As I write the oil price is up 84% on the year and 0.81% on the month at $52.56, and for crude up 92% on the year, 1.24% on the month and currently at $55.69. We see oil being range bound between $50 and $60 and if it breaks out above $60 and stays there, we expect the appreciation to stop and for the price to stagnate, as supply will grow as more production will come back on line in the US.
Gold has rallied YTD and has regained the losses over the six months, but is still down nearly $160 per ounce from its peak in September 2016. As an observation, the rally is a momentum trade because it was oversold and the direction of it going forward will very much be dependent on the speed at which Donald Trump alters the policy in the US. His first 100 days will be key and I expect gold in that period to at best stagnate, but if it looks like the French election is going towards the far right or we have instability in global trade, then these are reasons why we would allocate to gold as a defensive position. The UK on its own having problems over Brexit and the market reaction will not cause Gold to rise as it is more linked to global economics rather than the UK. The US will as it has a bigger impact on global trade than the UK.
Indices and Model Portfolios
Over the last week, we saw the model portfolios move forward again very positively, noting that we have only had 10 trading days this year and we are due a bit of a set back and a pause whilst we wait and see if what is being promised as a reflation trade starts to happen in reality. We have fully repositioned the portfolios and made the changes we detailed last week, and we are in a position again that all assets equity and non-equity have delivered a strong performance over the YTD analysis. The portfolios have done well against benchmarks over all time periods with lower levels of volatility as is the mandate. Most of the indices over the week closed lower than last week bar the US that was closed on Monday.
This day in History
As I said last week it is hard to find details of days that do not include war or nations attacking each other at this time of year, but despite this one being war related it is the beginning of the end not the start so it made sense.
On this day in Paris, France, some of the most powerful people in the world meet to begin the long, complicated negotiations that would officially mark the end of the First World War. Leaders of the victorious Allied powers – France, Great Britain, the United States and Italy – would make most of the crucial decisions in Paris over the next six months. For most of the conference, U.S. President Woodrow Wilson struggled to support his idea of a “peace without victory” and make sure that Germany, the leader of the Central Powers and the major loser of the war, was not treated too harshly. On the other hand, Prime Ministers Georges Clemenceau of France and David Lloyd George of Britain argued that punishing Germany adequately and ensuring its weakness was the only way to justify the immense costs of the war. In the end, Wilson compromised on the treatment of Germany in order to push through the creation of his pet project, an international peacekeeping organization called the League of Nations. Representatives from Germany were excluded from the peace conference until May, when they arrived in Paris and were presented with a draft of the Versailles Treaty. Having put great faith in Wilson’s promises, the Germans were deeply frustrated and disillusioned by the treaty, which required them to forfeit a great deal of territory and pay reparations. Even worse, the infamous Article 231 forced Germany to accept sole blame for the war. This was a bitter pill many Germans could not swallow.
As always have a great week and we will continue to watch and observe and if anything, notable happens that is beyond the scope of the fund manager that requires our intervention, we will act.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager