Market Commentary – 12th April 2017

Free movement could continue after Brexit

Theresa May has suggested that freedom of movement from the EU to the UK may continue after Brexit. Speaking during her visit to the Middle East, the Prime Minister said EU migration could still be allowed during an “implementation period” to give businesses and government time to adjust. Labour accused the PM of “broken promises” and trying to “downplay expectations”.

After the formal triggering of Article 50, both sides have made efforts to appear more conciliatory. While it is possible to envisage compromises eventually being hammered out in terms of future financial commitments or the rights of EU citizens already in the UK, the crux of the negotiations is likely to focus on trade and the degree to which the UK is prepared to limit the scope of future regulatory divergence.

UK banks and financial institutions have been given three months to present the Bank of England with details of how they would cope with a “more extreme” Brexit. A letter from the bank sets a 14th July deadline for City firms to lay out their contingency plans, should the UK drop out of the European Union earlier than expected or if Brexit happens without any trade deal in place.

Global Economic News

In the UK, things have cooled a little in 2017, with the performance of the industrial and construction sectors in February reinforcing the likelihood that Q1 saw a very slight slowdown in overall GDP growth. Industrial output dropped by 0.7% on January’s level, the second consecutive monthly fall. Almost half of this drop came from a decline in electricity and gas production, possibly reflecting mild temperatures (February 2017 was the ninth warmest February since 1910), so, there may be scope for a bounce-back in March’s numbers. Meanwhile, manufacturing output declined by a more modest 0.1%, with a contraction in the volatile pharmaceuticals sector more than accounting for this decline.

In Europe, the European Central Bank held its benchmark refinancing rate at 0% for the ninth consecutive meeting and left the pace of its bond-purchases unchanged on 9th March, as widely expected. Policymakers confirmed the monthly asset purchases will run at the current monthly pace of €80 billion until March, and from April, they are intended to continue at a monthly pace of €60 billion until the end of the year. The French economy continues to show signs of strength despite the uncertainty caused by the upcoming elections. Although business sentiment moderated slightly in March, it remains close to its highest level in six years. The final Markit France Services PMI came in at 57.5 in March of 2017, lower than a preliminary estimate of 58.5 but higher than 56.4 reported in February. The reading pointed to the strongest expansion in the service’s activity since May of 2011 as higher client demand boosted activity levels, new orders, and stocks. Payrolls rose the most since August of 2011. Manufacturing output grew at the fastest pace since January 2014 (PMI at 58.3) and service sector output expanded the most since December 2015 (PMI at 55.6). Overall therefore the data coming out of Europe is very good and we would expect equity assets to drive forward, but political instability in France is upsetting the markets as Brexit did and the US elections did.  In France, the far-left candidate Jean-Luc Melenchon is rising fast in the polls following a successful appearance in last week’s debates creating political noise in Europe that is holding markets back. That said, we still think the second round will be a contest between Macron and Le Pen.

In the US, the Fed Reserve minutes’ show that Fed officials are moving quickly to develop a comprehensive plan of how to shrink the balance sheet, with a change to its reinvestment policy coming possibly later this year. However, no final decisions have been reached. In the week, the Non-farm payrolls in the increased by only 98,000 in March, below a downwardly revised 219,000 in February and compared to market expectations of 180,000. It is the lowest payroll number since May last year as retailers cut jobs while employment went up in professional, business services and mining. US unemployment rates fell to 4.5% in March 2017 from 4.7% in the previous month, better than market expectations of 4.7%. Overall the US is doing well and as we enter the reporting seasons there is some nervousness that the expectation needs to be realised and we will therefore look closely as we progress through this period to the first Barometer below.

Barometers

The Barometers below look at some of the data we review on a day by day basis and by having these detailed it gives you, some insight into what is happening.

US Earnings are important because if the US starts to slow down then so does the rest of the world:

For Q1 2017, the estimated earnings growth rate for the S&P 500 is 8.9%. If 8.9% is the actual growth rate for the quarter, it will mark the highest (year-over-year) earnings growth for the index since Q4 2013 (8.9%). As of today (with 5% of the companies in the S&P 500 reporting actual results for Q1 2017), 74% of S&P 500 companies have beaten the mean EPS estimate and 57% of S&P 500 companies have beaten the mean sales estimate.

UK & Non-UK Gilt Yields;

UK and Non-UK Government Debt are a good measure as they indicate whether we expect the economy to improve or worsen with rising yields reflecting positive environment and reflecting positive interest rate movements as we look out. The opposite with lowering yields the expectation is worsening economic conditions.

Over the last week, we have seen bond yields move upwards and corresponding valuations falling in the US and Europe government debt market peaking on 7th April. This is because investors saw a flight to safety and safe-haven assets rallied due to geopolitical tensions in the middle east, then reassured themselves back down to similar levels from last week’s commentary. The case for UK bonds is a bit different as they are continuing to edge upwards. This will remain the case until some transparency and clarity is provided by the UK government over the next stages and negotiations after Article 50 was triggered on the 29th March. Volatility remains high in these assets as they 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;

 We monitor the GBP rate to see how much of the returns are coming from underlying equity valuation increases and movement in the currency, to see if we should be locking in the gains and hedging the risks. Now Article 50 has been triggered, we expect Sterling will fall as Brexit negotiations develop through the summer. If Sterling does fall significantly it will force us to lock in those gains and look at hedging the currency risk and becoming defensive.

Since Article 50 was triggered, we have noticed that sterling has been relatively flat against the dollar over the past week and it is narrowly within our expectation range. As no clarity, or timescales, have been provided by the UK government with regards to what the next steps will be after triggering article 50, we expect sterling to remain flat against the dollar. However, as transparency over Brexit is made clearer, we are expecting to see further downside risks for sterling, and we will continue to keep a closer eye on softer UK economic data, as weaker sterling is positive for our overseas assets.

GBP / USD – Range 1.25 – 1.10 – Today 1.25

GBP / EUR – Range 1.20 – 1.10 – Today 1.18

GBP / JPY – Range 150 – 125 – Today 137.10

Oil Price;

We monitor the oil price as it is strong indicator of global consumption when balancing the output and storage data. Strong supply and usage denotes strong global economy. Opposite reflects underlying weaknesses.

The oil price has moved up over the week and is trading at $53.65 for WTI Crude and $56.48 for Brent, up approximately 4.3% for WTI and approximately 3.4% for Brent. Brent crude, the international oil price benchmark, rose above $56 for the first time since 6th March. Trading has been boosted after one of the biggest oilfields in Libya, itself one of the more productive OPEC member states, was disrupted once more. In addition, geopolitical tensions since the US air strikes on Syria are continuing to fuel worries on oil supply from the Middle East, prompting a wave of buying. Despite these output reductions – and the 1.8 million barrels a day of cuts promised by OPEC, Russia and other producers – stocks are still near record levels in the US and elsewhere around the world. In addition, US shale activity is bouncing back, which could keep the supply glut going. As such, traders expect the oil price rally to remain contained.

Gold Price;

Gold is a safe haven and a spike in price can be an indicator of increasing underlying economic concerns and as always, the opposite.

This week the gold price has touched its highest level since Donald Trump won the US presidential elections in November. Spot gold had gone as high as $1,270 an ounce, and is currently trading above $1,274 / troy ounce. The gold price has been rising on the back of market unrest following the US air strikes launched on a Syrian government military target on Thursday evening, amid fears the conflict could escalate. Gold is inversely correlated to the US Dollar and equities, and considered in the markets to be a safe-haven on wider markets. With some political uncertainty ahead, we could see periods where the gold price spikes, however, we do not expect much sustained upside potential for gold in the current environment, and although it is a good diversifier, we do not feel there is gain to be made accepting it is a safe asset. Overall, we are not seeing an indication of a significant risk-off stance, which is the purpose of this barometer.

 Model Portfolios & Indices

We have currently introduced new products onto our client range. These include new Passive and Ethical portfolios and within the detail below you will now se we have included the passive portfolios so apologies if it looks a bit busy. As a bit of background, it has not been possible historically to develop passive portfolios that deliver the level of diversification required to gain exposure to the assets across the whole universe without using ETF’s and these come with additional risks and charges. However, in recent years we have seen the growth of multi asset passive portfolios that are cyclically adjusted in relation to the assets they are tracking and these new products with others can be built together today to give us portfolios that are very similar in the underlying assets allocation to the active variants.

We built these portfolios on the 1st October and they have been running in the background since and as we have some six months of performance the observations are interesting in that despite the lower charges the performance is lower than the active and we are experiencing higher levels of volatility. It is too short a timeline for any long-term conclusions to be drawn, but the passive portfolios will be overlaid with the same OBI principles and will settle once and for all the argument over active and passive at OCM.  We expect to have clients who invest in both and even blend both strategies but we would look for them to have 12 months’ performance before any fixed conclusions can be set.

Over the last week, we have seen most the indices that we track slow down. The US indices are all down collectively. This is due to the geopolitical tensions with the middle-east, however these are gaining some momentum as these issues settle. European indices are relatively strong as we have seen PMI results throughout the Eurozone. As the French elections near closer, we expect European indices to remain vigilant and flat. Chinese indices are performing well due to the positive results of President Trump meeting with President Xi Jinping last week. This could reflect stronger investments and trade between the two countries, which has improved investors’ confidence. Within the portfolios, we are seeing more of our positions exceeding their expected 6 month return target after only 14 weeks and this has triggered a subcommittee meeting, where we reviewed the economic data and determined whether we are at a point where risks have increased or the whole data set has moved up. We have decided to not take any profits on these positions as the economic data we are looking at has improved since we set the forward guidance in January. Thus, we feel that risk has not increased and instead the range has moved up, so the value at risk on the positions has not become higher than we originally set in January despite the growth in asset values since.

This Day in History

 On the 12th of April 1961, Russian cosmonaut Yuri Gagarin became the first human in space when he orbited the Earth once during a 108 minute flight. In 1960 Gagarin, a fighter pilot, was shortlisted for the Vostok 1 programme, which built on the success of Sputnik 1 just three years earlier. German Titov was Gagarin’s closest rival for selection – both men tried to impress space programme director Sergei Korolev.

Gagarin became an instant worldwide celebrity and visited several countries including Britain in 1961.