Market Commentary – 26th April 2017
The UK prepares to go the polls (again)
What a week and thank you for the sensibilities of the French in voting for Macron, and for Donald Trump seemingly abandoning his border tax proposals. Not something that I say that often in thanking those two, but it has been a bit of an odd week. It kicked off a week ago when despite the denials over the weekend before, Theresa May announced that she was fed up with the wrangling and the small majority, and called an early election. In our view this is sensible play and takes a great deal of the risk off the table with Brexit, because our view was that we would have an election at some point once we had a deal, thinking it would happen in Spring 2019 and would be all about Brexit. Doing it now could be a good call and could, if played right with a solid manifesto, give her strength and also take the Scottish issue away if they come up with a strong concession position on Scotland in a manifesto. The week ended yesterday with the tax plans being leaked from Donald Trump that had no say on the border tax that no-one likes and a corporate tax rate of 15%. In between we had round 1 of the French election in which Marine Le Pen got through, but like her father no-one expects her to get any further and all are expecting Macron to win with a margin of at least 60%. It is worth noting that Chirac beat her father by over 80% of the vote in 2002, so if the French vote as they did then it will be a great change in the political landscape for France.
Today we await the tax package in full and that will dominate sentiment. Overall it was a week of volatility with the markets swinging wildly negative, then back up again so that over the week we are up and everything is positive!!!
Global Economic News
In the UK, we had the lowest public sector borrowing figures yesterday reflecting costs higher than income by £52bn, which is £20bn lower than a year ago but is still negative. OBR forecast this to be slightly higher in the coming year based on tax receipts being lower, but if we look at corporate revenue and forecast earnings we do not see that happening and we could see a figure of £30bn of net borrowing next year if revenue and profits continue the forecasted trend level. Data that came out last week was not great but does not give us a reason to worry, as not every set of data is positive. Over the coming week we are expecting consumer confidence, GDP for Q1 and PMI data next Tuesday so all in we should have some more data to review by then.
In Europe, the rise in the April PMI reflected another impressive month in France, which has now surpassed Germany’s reading for the first time since 2011. The French economy continues to show signs of strength despite the heightened uncertainty ahead of the upcoming presidential and parliamentary elections. Stepping away from the political news, consumer prices in the Euro Area rose 1.5 percent year-on-year in March 2017, easing from a 2 percent increase in the previous month and matching preliminary estimates. It is the lowest inflation rate in three months, due to a slowdown in prices of fuels for transport, oil and vegetables and a drop-in cost of package holidays.
In the US, Trump really wanted a big win in his first 100 days in office, but the repeal of Obamacare failed spectacularly in March and he refuses to let it go. He recently stunned many by saying he still wants to “do health care first,” before tackling tax reform and it is disputed that Trump wants to tackle this first, as it could generate more money for the U.S. Treasury. This week, we have heard a lot about Trump’s tax cuts and spending plans which could deliver a shot in the arm to the U.S. economy in terms of revenues, however on the positive, this could lift growth around the world, although uncertainty about his trade policies adds to the risks. As I write this, Trump has announced that he will reveal a tax proposal today. This will kick start a discussion on tax reform and will set out a timetable of discussions with congress. 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.
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:
As at 13th April 2017, the estimated earnings growth rate for the S&P 500 is 8.9% in Q1 2017. 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 beat the mean EPS estimate and 57% of S&P 500 companies have beat 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 as the expectation is worsening economic conditions.
Over the last week, we have seen bond yields in the UK and US move sharply higher with valuations falling by circa 2% in the UK and US, and rising in Europe as a result of risk reducing. 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.
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. Since Article 50 was triggered, we expect Sterling will fall as Brexit negotiations develop through the summer, however this has now stalled due to the snap election hesitation. If Sterling does fall significantly it will force us to lock in our gains and look at hedging the currency risk and becoming defensive.
Sterling has maintained a strong position against the US Dollar since the decision of a snap election was decided just after the Easter break. Sterling faces strong resistance around $1.30, however the direction is up and importers, who have struggled since Brexit, will benefit from this. Contrary to the Euro, Sterling gained some ground before the first round of the French election, however fell back down and has remained stable at around €1.17 following the strengthened results in Europe and a possibility of Emmanuel Macron winning the French election. As the Japanese Yen continues to be one of the havens of choice for investors concerned about Syria, North Korea and French elections, Sterling is one of the many currencies which will weaken against it.
GBP / USD – Range 1.25 – 1.10 – Today 1.28 – we will resist the range at next IC on 3rd May 2017.
GBP / EUR – Range 1.20 – 1.10 – Today 1.17
GBP / JPY – Range 150 – 125 – Today 142.6
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 price of oil, over the past week has moved down further and is current trading at $49.51 for WTI Crude and $52.08 for Brent, down approximately 5.7% for WTI and approximately 5.6% for Brent. Oil prices inched up slightly on Tuesday but markets have continued to remain under pressure following six consecutive sessions of declines. Traders have seemed to lose their confidence after speculation showing that output cuts by major producers will continue to inject in a world oversupplied with fuel. Geopolitical tensions since the US air strikes on Syria have continued to fuel worries on oil supply from the Middle East, which has resulted in high demand. US shale activity has bounced back, which could keep the supply glut going. The oil price movement has nothing to do with consumption, it is down to debating whether or not the supply cuts agreed previously will be continued or not.
Gold is a safe haven and a spike in price can be an indicator of increasing underlying economic concerns and as always, the opposite.
Over the past week, we have seen gold prices drop approximately $22 an ounce to $1,266 a troy ounce. The price has dropped as investors risk appetite weakened following haven demand for Eurozone Treasury bonds which drove yields slightly higher, following the signs of strength despite the heightened uncertainty ahead of the upcoming presidential and parliamentary elections in May. 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.
Model Portfolios & Indices
Over the last week, we have seen most of the indices that we track strengthen. European indices have done particularly well following the positive results from the first round of the French election and the UK indices have done well since the Prime Minister’s decision to hold a snap election in June. We expect these indices to remain strong post-election results and will keep monitoring our positions based on the results. However, our portfolios performed strongly over the last week and we have seen the equity positions strengthen following the strength driven by the indices. We have continued to see the UK mid-cap positions exceed our 12 month return expectation in less than 4 months and as stated last week, this triggered a subcommittee review. We have further decided to not take any profits on the positions as the earnings data we are looking at has improved since we set the forward guidance in January. Consequently, we feel that risk has not increased and instead it has been the case that 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.
Our European and global equity positions have also exceeded their expected 6 month return target after less than 4 months and following our review of the economic data 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 and 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 aligns with our view for our UK mid-cap positions outlined above.
The active portfolios are all delivering more than benchmarks over all time periods now and that is good as our overweight position on Europe finally starts to pay dividends. The passive portfolios continue to underperform the active, but with greater volatility so that observation continues noting until we have over 12 months performance, no real observations can be drawn. There will always be periods when active will outperform passive and vice versa. Today what is happening is expected in that active is outperforming with less volatility. All in this is good data and long may it continue.
This Day in History
On this day in 1929, the first non-stop England to India flight lands. The aeroplane had been built at a cost of £15,000 and was specifically designed for long-distance work. It was meant to be flown by two pilots and there was even a bed for members of the crew to relax and gain a few hours’ sleep. The two pilots in question were Squadron Leader Arthur Jones-Williams and his co-pilot Flight Lieutenant Norman Jenkins. Flying a Fairey Long-Range Monoplane – one of two built specifically for the RAF Long Range Development Unit – they set off from the RAF base at Cranwell. 50 hours (and 38 minutes) later they arrived at Karachi in the sub-continent.
As always have a great week and we will continue to watch and evaluate and if anything changes we will let you know.