Market Commentary – 5th April 2017
The 2016/17 tax year draws to a close today!
On the final day of the current tax year, we can look back and reflect upon a positive first quarter of the year for economic growth globally and this fuelling a reflation in risk assets, with the outlook for further interest rate rises improving and inflation picking up, making the prospects for fixed income assets less attractive. This has been against a back drop of political uncertainty in the UK, Europe and in the US with Trump taking office.
With Article 50 officially triggered, we now begin the two-year process of leaving the EU and establishing trading relations with the individual EU member states. European Council President Donald Tusk said: “Once and only once we have achieved sufficient progress on the withdrawal can we discuss the framework for our future relationship. Stating parallel talks will not happen.” This will include settling the “divorce” bill, stated to be up to €60bn (£52bn), which will be a contentious issue, and agreeing on the rights of EU nationals in the UK.
May’s letter acknowledges what Brussels and Whitehall insiders have been saying for months – agreeing on a deal within two years poses a monumental challenge. Hence the Prime Minister’s mention of “implementation periods to adjust in a smooth and orderly way”, implying that if negotiators can agree the broad principles on paper before March 2019, aspects of any deal – such as immigration and customs – could come in gradually.
The Government is also working on the Great Repeal Bill, which will legally place the entire body of existing EU law on to the UK statute books, giving parliament the power to amend and repeal them in the future, once the UK formally leaves the EU. The plan is for the Bill to be passed ahead of the UK’s exit from the EU but to become law only on the date of departure. Initially, it is thought the legislation will repeal very little.
Despite the political uncertainty in Europe, the latest economic data has been positive and continues to paint an improving picture in Europe. Commentary from the ECB continues to be dovish, which suggests there is little appetite to contemplate an early rate rise or reduction in asset purchases despite the pick-up in activity. This continues to point to a gradual normalisation of monetary policy, with a decision to taper the current rate of asset purchases deferred until the autumn. Rate rises will only come once asset purchases have concluded.
Global Economic News
In the UK, quarterly GDP growth in the last three months of the year was left unrevised at 0.7%, as was calendar-year growth of 1.8% for 2016. The latest data on services output, covering January, added to the evidence that Q1 is likely to have seen a slowdown in the pace of GDP growth. A 0.1% drop in output was the first monthly fall since last March and followed a noticeable loss of momentum through the course of Q4. March’s CIPS manufacturing PMI slipped to 54.2 from 54.5 in February, suggesting a loss of momentum. The manufacturing PMI reached a two-and-a-half-year high of 56.0 last December, but has since gradually declined. The 54.7 averaged in Q1, did however, match the previous quarter’s near-three year high. While robust growth from the production and construction sectors in Q1 seems likely, this may well be more than offset by weakness in services and cause a cooling in GDP growth. The headline seasonally adjusted Markit/CIPS Services PMI Business Activity Index rose to 55 in March 2017 from 53.3 in February and above market expectations of 53.5. It was the highest reading in three months.
In Europe, the Eurozone manufacturing PMI reading for March was confirmed at its highest level since 2011. This shows that the Eurozone (in particular Germany and Italy) continues to benefit from a pick-up in global trade. The labour market data also remains positive. The unemployment rate for the Eurozone edged down to 9.5% in February – an eight-year low – and employment expectations released last week point to a continuation of this trend. Eurozone retail sales data rose by 0.7% in February, offsetting the weakness seen in the previous three months. Germany was the largest contributor to the rise, with a labour market that continues to boost employment growth and faster wage growth than in the rest of the Eurozone. Nonetheless, the quarterly profile suggests that rising inflation will have squeezed Eurozone consumer spending in Q1 2017. Eurozone GDP growth of around 0.5% is expected in Q1, up from 0.4% in Q4 last year. However, a clearer picture about the likely pace of growth this quarter will only begin to emerge when February’s hard data begin to be published this month.
In the US, real GDP growth was revised up to 2.1% annualized in Q4 2016 from 1.9% in the second estimate.
Consumer spending was the main source of the upward revision, up 3.5% in the quarter, partially offset by downward revisions to business investment and net exports. Against this backdrop, the latest report on personal income and spending revealed that consumer spending likely slowed substantially in Q1. Real consumer spending posted a monthly decline in February, down 0.1% after a 0.2% drop in January. Much of the Q1 slowdown in real consumer spending growth is related to stronger inflationary pressures on the heels of higher energy prices, which contributed to headline PCE rising above the 2% threshold in February for the first time since 2012. The US economy is expected to expand at a softer, 1.2% pace in Q1 2017. However, activity should firm thereafter and growth is expected to average around 2.1% for the year. Against a backdrop of firmer activity and ongoing progress towards their dual mandate, the Fed is anticipated to tighten monetary policy another two times in 2017, with the next tightening most likely in June. Markets will be waiting with anticipation ahead of the Jobs Report on Friday and the latest Fed minute’s which are released this afternoon.
US Earnings: As of 31st March (with 17 companies in the S&P 500 reporting actual results for Q1 2017), 13 S&P 500 companies have beat the mean EPS estimate and 9 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 downwards and correspondingly valuations rising. This was the common theme across the UK, Europe and the US. The yield gap between French and German two-year debt has widen to its highest level since the eurozone crisis, ahead of France’s presidential elections in three weeks’ time. The two-year spread – a measure of the premium to hold French over German debt – has hit 47 basis points, surpassing the 42bps reached during the height of jitters about Marine Le Pen’s chance of victory in France’s presidential elections and the widest since the bloc’s debt crisis in 2012. Whilst this week’s movements are contrary to our view of further strengthening of bond yields and a corresponding fall in valuations, we still expect to see yields rising based on rising inflation and interest rate rises ahead, accepting that political uncertainty can see a flight to the ‘perceived’ safety of bonds which is positive for valuations. As volatility remains high in these assets, we are still not directionally investing into these assets.
GBP to USD/Euro/JPY;
We have seen sterling flat against the dollar over the past week and is narrowly within our expectation range. Sterling had been weaker over the weak, following Article 50 being triggered and a broadly stronger dollar, however, following the release of today’s positive Services PMI data, sterling strengthened by around 0.3% against the dollar. Sterling initially strengthened against the euro following the triggering of Article 50 and has maintained most of this strength since, staying in the 1.17 region. 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 1.17
GBP / JPY – Range 150 – 125 – Today 138.33
The oil price has moved up over the week and is trading at $51.46 for WTI Crude and $54.60 for Brent, up approximately 6.9% for WTI and approximately 6.7% for Brent. Oil prices rose for the sixth time in seven sessions on Wednesday, propelled higher by signs that U.S. supplies are finally dwindling and helping rebalance the market. The gains come after data from the American Petroleum Institute late Tuesday showed U.S. crude oil inventories fell by 1.8 million barrels last week, sparking hopes the official report from the Energy Information Administration later today will show the same trend. Oil prices have risen in recent weeks on hopes that OPEC and prominent producers such as Russia agree to roll over a production-cut agreement, which is currently set to end in June. The group is due to decide on May 25. Following an increase over the last month, oil is back trading within our expected range of $50-60 / barrel and it does appear that some of the downwards pressure on the oil price has lifted, however, this may be short-lived as it is very dependent on the balance of supply from US shale producers and OPEC’s decision regarding their production cut agreement.
Gold is virtually unchanged over the week at $1,253 / troy ounce, following the leg up to $1,259 an ounce on 27th March after Donald Trump’s policy agenda ran into Republican divisions in the Senate. Just three weeks ago, gold was below $1,200 an ounce as the market priced in expectations, that the US Federal Reserve would increase interest rates more quickly than previously thought. 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
Over the last week, we have seen most the indices that we track moving upwards.
The three main US indices are all up, following the pullback that was seen last week after President Trump had problems getting his health care reforms passed by congress. The best performance, however, was in Europe. The broad Euro STOXX 600 index ticked up, as the DAX in Germany and the CAC in France both advanced strongly. This followed strong PMI data and positive retail sales data. This was positive for the portfolios where we are overweight Europe, based upon our views of improving economic data and relative value.
All portfolios performed positively over the week, with OBI 5 and 6.5 exceeding their benchmark and the remaining portfolios generally keeping pace with their benchmark.
Within the portfolios, we still have positions exceeding their expected 6 month return target after just over three months and 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.
Overall it has been a good week and year to date risk is being rewarded with the highest risk portfolios delivering the strongest returns over the last 12 months, with relatively low levels of volatility.
This Day in History
For most, this day is remembered as being the final day of the tax year. But also on this day in 1976, Harold Wilson resigned and James Callaghan became Prime Minister of the United Kingdom. Harold Wilson was not the only UK Prime Minister to be succeeded on 5 April. In 1955, Anthony Eden succeed Winston Churchill as Prime Minister of the UK. Also on this date in 1908, British Prime Minister Herbert Henry Asquith succeeded Henry Campbell-Bannerman.
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