Market Commentary – 29th March 2017
Theresa May will be ready to publish the key piece of legislation that will set Britain on the road to Brexit today. The notification will take the form of a letter addressed to Donald Tusk, President of the European Council. Downing Street however maintains that Brexit talks will be “a two-year process”, and said “we are confident that is what we will achieve”. The European Commission responded by saying “everything is ready on this side… we are waiting for notification” while Tusk tweeted that he’ll present the EU’s draft Brexit plan to member states within 48 hours of the Article being triggered.
Theresa May has told Scotland’s First Minister Nicola Sturgeon that together, the UK is an “unstoppable force”. The two politicians met in Edinburgh early this week for the first time since the SNP leader revealed her timing for a second independence referendum. Sturgeon is pressing for a referendum in the second half of 2018 or the first half of 2019, before Britain leaves the European Union, however May has told her “now is not the time”.
As the euro continues to climb against the US Dollar, further gains can be expected if the Fed and Trump continue to disappoint. As asset purchases continue to increase, Peter Praet (the ECB’s chief economist) maintains the view that the Eurozone is still missing sustainable underlying inflation, in addition to reiterating the bank’s commitment to their forward guidance.
Global Economic News
In the UK, following the retail sales figures, a further pickup in inflation in February has caused market expectations for the first interest rate hike to shift forward. But this seems to be an overreaction; inflation is evolving in line with expectations, underlying pressures remain absent and there was nothing in this week’s comments from four MPC members to suggest they are remotely close to voting for higher interest rates. Other data published this week provided further confirmation of the importance of the weaker pound in driving some rebalancing of activity. There was further strength in export orders, driven by weaker sterling, despite a better February outturn, the retail sector is on track to see the first quarterly fall in sales volumes since late-2013. For the past three successive monthly falls, February’s 1.4% increase in retail sales volumes offered some reassurance that shoppers haven’t quite lost their appetite to spend more, however February’s growth is unlikely to be enough to prevent Q1 2017 from recording the first quarterly decline in sales volumes since the end of 2013. And with shop price inflation heading up, this year remains on course to be a difficult one for the retail sector. In other updates, millions of young people may have to work until they are 70 before qualifying for a state pension, two separate reports released last week suggest. An analysis for the Department of Work and Pensions proposes raising the retirement age for those now under 30, while a report by John Cridland says those under 45 will work until they are 68. There are also calls for the state pension “triple lock” to be withdrawn in the next parliament.
In Europe, the further rise in the Eurozone composite PMI to 56.7 in March, its highest in almost six years, suggests that the region may be in the midst of a mini-boom. The available hard data suggest that Q1 GDP growth is likely to be to be lower than the 0.7% rise implied by the PMI, however the March rise in the PMI does suggest that growth prospects for Q2 are firming and that the risks to our 2017 GDP growth forecast of 1.6% now lie to the upside. The strong PMIs will increase speculation that the ECB may bring forward the start date for policy normalisation. But comments from Executive Board member Peter Praet suggest that the Bank remains in cautious mode and that the unwinding of non-standard measures will be a slow process.
In the US, markets have been left disappointed by both the Fed’s forward guidance and President Trump’s progress on delivering fiscal expansion. In the build-up to the much-anticipated rate hike in March, markets were pricing in a 20-50% chance of four rate hikes this year. The chance of having two more hikes this year is now around 50%. This disappointment has been added to by the failure of Trump to push through an overhaul of healthcare in the US last week, causing many to extrapolate this onto the ability of the administration to deliver on fiscal expansion policies, leading to a slight reversal in the Trump trade. The disappointment in US rate path comes as the ECB took a slightly less dovish tone at its last rate setting meeting amid signs of higher inflation. Last week, US PMI results came out and US composite PMI decreased to 53.2 in March of 2017 from 54.1 in February, the lowest in six months. Both services (52.9 from 53.8) and manufacturing (53.4 from 54.2) slowed due to softer business activity and lower payrolls. US manufacturing PMI fell to 53.4 in March of 2017 from 54.2 in February and well below expectations of 54.8. It is the lowest reading since October of 2016, mainly due to a slowdown in new orders and lower stocks while input cost inflation picked up. US services PMI decreased to 52.9 in March of 2017 from 53.8 in February and well below expectations of 54.2. It is the lowest value in six months, as new work was the lowest in 12 months and employment eased. Yet, job creation in March was one of the weakest reported over the past three years. Input cost inflation was relatively subdued.
US Earnings: As of 24th (with 12 companies in the S&P 500 reporting actual results for Q1 2017), 9 S&P 500 companies have beat the mean EPS estimate and 6 S&P 500 companies have beat the mean sales estimate. Earnings Growth: For Q1 2017, the estimated earnings growth rate for the S&P 500 is 9.1%. If 9.1% is the actual growth rate for the quarter, it will mark the highest (year-over-year) earnings growth for the index since Q4 2011 (11.6%).
UK & Non-UK Gilt Yields;
Over the last week, we have seen bond yields move upwards and correspondingly valuations falling in the UK and Europe. The opposite movement occurred in the US, however valuations edged up only slightly. This was due to the concerns over President Donald Trump’s ability to deliver on key campaign pledges such as tax cuts and infrastructure investment. With the Federal Reserve raising rates and inflation slowly rising in Europe, we still expect to see yields to rise. As volatility remains high in these assets, we are still not directionally investing into these assets.
GBP to USD/Euro/JPY;
We have noticed Sterling getting stronger against the dollar over the past week and is still within our expectation range. Following Article 50 being triggered today, sterling could present some volatility, but this could be purely due to investors taking a safe seat due to uncertainty. Sterling dipped to 1.24 last week, however it is gaining some strength towards the bill being submitted. This remains a key and sensitive time for the currency due to Article 50 being triggered and the possibility of a second Scottish Referendum. We are expecting to see further downside risks for sterling, associated with Brexit and softer UK economic data and will continue to keep a close eye, as a 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 1.15
GBP / JPY – Range 150 – 125 – Today 138.51
The oil price over the week is trading at $48.15 for WTI Crude and $51.15 for Brent, up approximately 1.2% for WTI and approximately 1.8% for Brent. Oil prices rose on Tuesday, supported by a weak dollar, but crude continued to be weighed down by surging U.S. production and uncertainty over whether an OPEC-led supply cut is big enough to rebalance the market. Record crude stockpiles and rebounding production in the U.S. suggest that the curbs by OPEC and Russia aren’t working fast enough. US shale production has hit back strongly. The excess- supply story, along with stable, and not so high, global demand has weakened the recent price stability that has been present in the oil market. Oil has seen a drop-in price over the month, and oil is trading slightly below our expected range of $50-60 / barrel and there does appear to be a more bearish case in the short term. As previously stated, the next OPEC meeting on 25th of May will draw attention and give some guidance on where production and inventories might be as we progress through the year.
Gold has been one of the main beneficiaries of a market correction following Donald Trump’s policy agenda running into Republican divisions in the Senate, rising by 0.9 per cent on the 27th of March to $1,259 – the highest it has been in a month. Just a week ago, gold was below $1,200 an ounce as the market priced in expectations, later vindicated, that the US Federal Reserve would increase interest rates. Gold is inversely correlated to the US Dollar and equities and considered in the markets to be a safe-haven on wider markets. If the US economy suffers, it is likely that the interest rate rises, which diminish the value of the non-yielding metal, will reduce more slowly. Overall, we are not seeing an indication of this risk-off stance, which is the purpose of this barometer.
Model Portfolios & Indices
Over the last week, we have seen majority of the indices that we track slow down.
The US indices are all down collectively. This came down after the president’s failure to make a deal on his health care reforms. Banks are the worst performers amongst the S&P 500 sectors, with the S&P 500 investment banking index down 3%. The best performers were France, Italy and Spain with the CAC, FTSE MIB and IBEX respectively, all advancing, due to strong PMI data released last week.
China also performed well due to their economic growth gaining momentum in the first two months of the year which reflects stronger investment and exports.
All portfolios have outperformed their benchmarks. 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 have seen some of the positions exceed their expected 6 month return target after only 11 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 as 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.
We feel 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. We are therefore comfortable for now that the risks in the portfolios are as balanced now as they were at the beginning of January, despite the positive momentum in the intervening period. Overall though a good week and YTD risk is being rewarded with the highest risk portfolios delivering the strongest returns over all time periods in the last 12 months, with relatively low levels of volatility.
This Day in History
In 1974, a life-sized, terracotta army was discovered near Lintong, Xian, Shaanxi, China. Buried in underground pits, the 8,000 terracotta soldiers and horses were part of the necropolis of China’s first emperor, Qin Shihuangdi, to aid him in the afterlife. While work continues excavating and preserving the terracotta army, it remains one of the most important archaeological finds of the 20th century.