Market Commentary – 8th March 2017
Budget day and the Lords weigh on the Brexit bill.
Over the past week, we have seen markets edge off the highs seen last Wednesday, but not by much with sterling weaken. Despite this lack of upward momentum, we have seen positive economic data come out of Europe and the US. UK PMI data suggested a slowing of the economic momentum that was seen at the end of last year, however, we will not read into this too much until Q1 GDP figures are released, as translating PMI figures to quarterly GDP growth can sometimes be misleading. As far as noise is concerned there have again been some contentious issues in international relations over the last week. As Trump, has started making noises again as he signed a revised version of his controversial executive order on travel at the start of this week. In less sobering news, North Korea fired four ballistic missiles on Monday morning, three of which fell in Japan’s territorial waters. Japanese Prime Minister Shinzo Abe called it a “dangerous action”. The launches, which violate UN rules, come as South Korea and the US run an annual joint military exercise in the South.
With UK unemployment at an 11-year low of 4.8%, analysis based on Office for National Statistics reports show that more people than ever are employed on zero-hours contracts. ONS figures show there are now 910,000 people on the controversial contracts. There has been a nine-fold increase in the numbers of zero-hours contracts since 2005. Connor D’Arcy, policy analyst at the think-tank Resolution Foundation, said “with the employment rate at a record high and the first inklings that firms may think the supply of labour from the EU could be limited after Brexit, employers may be finding it harder to fill roles without guaranteeing hours of work”.
Theresa May also suffered a second Brexit defeat in the House of Lords as peers backed, by 366 votes to 268, calls for a “meaningful” parliamentary vote on the final terms of withdrawal. The amendment would require the final terms of the UK’s withdrawal from the EU to be put to separate votes in the Commons and the Lords. Some peers believe this would amount to a veto but ministers insist the UK would leave the EU anyway irrespective of whether it was approved or not. Ministers said it was disappointing and they would seek to overturn the move when the bill returns to the Commons. We are now likely to see so called political ping-pong, where the Article 50 bill is passed back and forth between the two respective Houses. Today is Budget Day in the UK. We will be analysing this closely and will issue our Budget Report later today.
Global Economic News
In the UK, the CIPS manufacturing survey reported a drop in the headline PMI from 55.7 in January to 54.6 in February. The mini-surge in output growth around the turn of the year appears to have cooled and, while the survey points to a better manufacturing performance than much of the past few years, the relatively small size of the sector means that it is unlikely to be sufficient to offset the drag from weaker growth in consumer-facing sectors. A dip in the headline activity balance of February’s CIPS services survey to 53.3 from 54.5 in January tallies with other evidence that UK economic activity has lost momentum since the start of the year. In January’s Money & Credit release, net unsecured lending recovered from December’s nineteen-month low of £1.0bn, but lending of £1.4bn fell someway short of the £1.6bn averaged over the past six months. This chimes in with the evidence of a step down in sales on the high street in recent months and raises questions over the MPC’s view that consumers will continue borrowing to offset the pressures from higher inflation.
In Europe, the final Eurozone manufacturing PMI for February was confirmed at 56.0. This is the highest in six years and adds to a stream of positive survey data in the opening months of the year, which suggests that the Eurozone economy is gaining momentum in Q1. At 55.2, the January-February average is firmly above 53.9 in Q4, and is consistent with quarterly GDP growth of 0.6% in Q1. Retail sales in the Eurozone declined for a third straight month in January. Sales dropped by 0.1% over the previous month (but were up 1.2% in annual terms). The sluggishness seen in retail trade in recent months highlight concerns about a slowdown in consumer spending, as households are being increasingly squeezed in an environment of rising consumer prices and low wage growth. February’s flash Eurozone CPI estimate revealed that headline annual inflation increased from 1.8% to 2%, in line with the consensus estimate. The rise leaves the annual rate above the ECB’s inflation target of “below, but close to 2%” for the first time since January 2013. The rise in headline inflation was driven by higher energy and food inflation. Core inflation edged down slightly in February, however, this seems to mask the trend of core inflation edging upwards as we move through the year.
In the US, The ISM manufacturing index rose 1.7 points to 57.7 in February, increasing the pace of expansion for a sixth month in a row. This was also the highest pace of expansion since 57.9 in August 2014. The ISM manufacturing index ended 2016 with a mild firming trend that looks to have strengthened in early 2017. The improvement is likely in part due to businesses finally restocking lean inventories and improved confidence for the future. The ISM composite index for non-manufacturing business (NMI) rose to 57.6 in February from 56.5 January and the highest reading since October 2015. Solid gains in the components for business activity and new orders powered the gain and pointed to robust conditions in the service sector. The January income and consumption report was one of contrasts; despite a solid increase in nominal income, real disposable personal income declined. PCE inflation moved up to 1.9% year on year while core inflation was up 1.7% year on year. Inflation is moving towards the Fed’s 2.0% target, with comments from the Fed and the wider market seemingly indicating that a rate rise next week is now likely.
US Earnings – As of 2nd March, (with 98% of the companies in the S&P 500 reporting actual results for Q4 2016), 65% of S&P 500 companies have beaten the mean EPS estimate and 53% of S&P 500 companies have beaten the mean sales estimate. Earnings Growth: For Q4 2016, the blended earnings growth rate for the S&P 500 is 4.9%. The fourth quarter will mark the first time the index has seen year-over-year growth in earnings for two consecutive quarters since Q4 2014 and Q1 2015.
UK & Non-UK Gilt Yields; Over the last week we have seen bond yields moving upwards and correspondingly valuations falling in the UK. The opposite movement occurred in Europe and the US, however, valuations edged up only slightly. The yield spread of French 2 year bonds against German bonds continues to remain wide, amongst the fears of a potential Le Penn victory in the French elections. Whilst this week’s movements in Europe and the US are contrary to our view of further strengthening of bond yields and a corresponding fall in valuations, with US rate rises on the horizon and inflation slowly rising in Europe, we still expect to see yields rising, accepting that political uncertainty can see a flight to the ‘perceived’ safety of bonds, which would be positive for valuations. Volatility remains high in these assets that should not be functioning like this, which is a further example of why we are still not directionally investing into these assets.
GBP to USD/Euro/JPY;
Sterling has weakened against the dollar over the last week, and is now comfortably within our expectation range. We have also seen sterling weaken against the euro, falling back to 1.15, continuing the weakening that was seen in the week previous. As always there is a variety of factors affecting the exchange rates, however, sterling weakened following the release of softer services PMI data and the Lords voting for a “meaningful” parliamentary vote on the final terms of withdrawal from the EU. This was perceived by some as compromising the Governments negotiating position. We are beginning to see further downside risks for sterling, associated with Brexit and softer UK economic data.
- GBP / USD – Range 1.25 – 1.10 – Today 1.21
- GBP / EUR – Range 1.20 – 1.10 – Today 1.15
- GBP / JPY – Range 150 – 125 – Today 138.6
Oil is lower over the week and is trading at $52.54 for WTI Crude and $55.32 for Brent, down approximately 2.8% for WTI and 1.3% for Brent. The story is much unchanged with oil. High levels of compliance with OPEC’s agreement to cut output, which is limiting supply on one side of the equation and providing a floor to oil prices, however, US shale oil production is increasing which has an offsetting effect. The supply story, along with stable global demand has provided some much-welcomed price stability in the oil market, even at a significantly lower price by historical standards. Oil is still trading within our expected range of $50-60 / barrel and we do not expect any significant changes in the short term.
Gold is down by $30 / troy ounce and is currently trading at $1,213 / troy ounce. This movement downwards follows the risk on stance that was seen last Wednesday and the expectation that US rates may rise quicker than the market anticipated, with comments suggesting a rate rise could be likely at next week’s Fed meeting. This has been longest losing streak for gold since November 2016. We do not expect much upside potential in the current risk on environment, and although it is a good diversifier, unless we see risks of a soft Brexit decrease and sterling falling substantially, there is no gain to be made accepting it is a safe asset. Overall, we are not seeing an indication of a risk off stance, which is the purpose of this barometer.
Model Portfolios & Indices
Excluding today’s movements, almost all market indices that we track were slightly higher for the week. This includes the rally from last Wednesday. The strongest performance was in Europe and was broad based amongst the major EU countries. Japan’s Nikkei 225 also performed well. This strong performance in equities has helped the model portfolios all to perform exceptionally well. Contributors to portfolio performance were broad based, with global equity and European equity funds performing the best and the weakness of sterling also helping to boost the value of overseas assets. All portfolios, bar OBI 5 which was only 0.05% behind, outperformed their benchmark. Performance over all time horizons detailed below has been strong, with each portfolio delivering positive performance at each of the horizons. The portfolios remain well positioned to capture the benefits of the reflation trade.
Within the portfolios, we are now starting to see some of the positions hit their expected 6 month return target after only 10 weeks and this has therefore triggered a subcommittee at which we will review the economic data and see if we are at a point where risks have increased or the whole data set as moved up. As always, if we expect 10% upside and 10% downside if we get 8% upside we must evaluate whether we now have 18% downside or the range has shifted upwards. This is what we call analysing value at risk and will be reported on in next week’s market commentary if we continue at the elevated levels. These are nice problems to have and we continue to monitor and evaluate and watch the economic data.
We will continue to monitor the economic data and should things change that require our action, we will step in to act in your interests.
This day in History
On this day in 1817, the New York Stock Exchange was formally established. The NYSE at 11 Wall Street in New York City is the world’s largest stock exchange by market capitalization, with listed companies at US$19.3 trillion as of June 2016. As always have a great week and we will continue to watch and evaluate and if anything changes we will let you know.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager