Market Commentary – 18th April 2017
Theresa May calls for a snap election on 8 June!
Theresa Mays decision to request a vote for a snap general election for 8 June raises a heap of new unthought about possibilities. In her speech, she explicitly declared that this vote has been called “to shore up parliamentary support for her vision of Brexit and that the election would be, therefore, largely a second referendum on Brexit”. Assuming, as we do, that the Tories win the election, the Tories will argue for Theresa May’s “deep and special” relationship with the EU, and to strengthen her hand in negotiations with the EU. Corbyn and Labour will argue for a ‘soft’ Brexit that talks about the benefits of the UK’s existing relationship with the EU, while the Liberal Democrats will probably campaign for a second referendum on the deal itself. As we are essentially having one with an election, that will fall on deaf ears. As regards to the SNP and Nicola Sturgeon, that one is going to be very interesting to watch as it will either strengthen her position or weaken it as the electorate in Scotland will effectively be voting for a further referendum or not. It is despite the polls all to be won and lost and I for one never expected this to happen. Unlike a normal election, we see the following issues:-
- We may see a significant proportion of the electorate voting tactically, based on their preferences for Brexit. Tactical voting will apply mainly in the major cities (which typically voted to Remain during the referendum), and the fallout from this will depend on how much the urban, Tory voters care about Brexit versus other political issues.
- We may also see a very different turnout from the 2015 general election, as the referendum has stirred up political emotions among younger citizens, who historically have been less likely to vote. This is their chance to reverse or, at least, restrain Brexit.
- The behaviour of UKIP is another wildcard. Will UKIP see the election as an opportunity to bolster its parliamentary credentials, at the risk of taking pro-Brexit voters away from the government? Or could UKIP stand down its candidates, realising that a vote for the Tories is the best chance that they have of a clean break with the EU? With about 13% of the vote at the last election, UKIP voters swinging to or from the government would be significant.
- The Labour leadership is another conundrum. Given the overwhelming evidence that few voters seem to want Jeremy Corbyn as Prime Minister, the opportunity of a general election (and the opportunity for success as well as for self-destruction), could encourage Labour to get its act together. Moreover, Labour could further stir things up by changing its position on Brexit – for example, by echoing the Lib-Dems’ call for a second referendum on the outcome of Brexit negotiations. Of course, we shouldn’t forget that the government can also change its position, and so the behaviour of incumbent Conservative MPs in Remain-leaning constituencies could be another surprise element.
Brexit is a highly complex problem that was never going to be a straightforward process, but this was unexpected and we will wait and see what the impact is. Today it has benefitted sterling and been bad for the FTSE 100 as the strengthening sterling is bad for overseas earnings. One day’s movements do not though set the trade for the coming six months and nothing has changed today in the medium-term. Teresa May, is though looking to pop a few balloons and take back the advantage over the Scots and the Tory rebels. If she can at the same time get a greater majority in the Houses of Parliament which improves her negotiating position so we get a better deal, then go for it girl!
In other parts of the world the French election is giving us plenty to talk about as far-right presidential candidate Marine Le Pen has promised to “put back the borders” of her country at a rally, with just one week to go before the first round of voting. Le Pen is struggling to hold her poll lead against centrist candidate Emmanuel Macron and is facing a renewed challenge from the left-winger Jean-Luc Melenchon. There is still a third or the French electorate undecided and I would be surprised if the noise we are hearing becomes anything more than noise on the basis that when it comes down to it the French are lovers of Europe and would not want to put that at risk. Unlike our wiggly pencils that voted out I only see Macron wining and normality resuming in France. Because of these two issues and despite continuing strong economic data the European equity markets started the week lower after the long Easter weekend, following concerns ahead of the French election and continued geo-political uncertainty amongst the US, Russia and North Korea. In addition, there was the surprise political news announced in the UK.
Global Economic News
In the UK, the economic theme of the week was stability, evident in the latest data for inflation and the jobs market. Annual CPI inflation in March held steady at the three-and-a-half year high of 2.3% recorded in February, the first month to see no rise in the CPI measure since last October. An unchanged headline rate disguised downward pressure from a 23% year-on-year drop in airfares, reflecting the earlier timing of Easter last year. This fall was enough to compensate for rises in food and clothing prices and contributed to core inflation slowing from 2% to 1.8%. The airfares effect should reverse in April, implying, all else equal, that the month will deliver higher inflation. Barring unexpected events, past precedent suggests that CPI inflation is likely to reach a high point for this year in the summer. The labour market numbers for the three months to February delivered some positive developments. Employment continued to rise, joblessness fell and vacancies rose to a record high. This roll of impressive outturns is still failing to translate into a meaningful pick up in pay growth. On a three-month basis, the annual rise in total pay stood pat at 2.3%. Adjusted for inflation, this left real pay only 0.1% higher than a year earlier, the weakest outturn since early 2014. This is negative for consumer spending, a sector which is already showing signs of running out of steam. Granted, the apparent tightness of the jobs market may see pay growth suddenly break out significantly to the upside. But with pay remaining so unresponsive for so long, the chances of this happening look slim.
In Europe, we see a continued divergence between the soft and hard data that is being released. The European industrial sector is falling short of the expectations suggested by the Industrial production figures being slightly lower than expected. The unexpected 0.3% monthly contraction in February, combined with the sharp downward revision of January figures means that industrial output is unlikely to contribute much, if any, to growth in Q1 (industrial production would need to growth 0.5% m/m in March just to get back to 0% growth for the quarter). French, German, Spanish and Italian Inflation figures for March were in line with consensus estimates. Inflation in the these major eurozone countries was softer than the previous month’s readings, both on a month on month basis and year on year basis. Inflation data for the combined Eurozone is released tomorrow. Overall therefore the data coming out of Europe is positive 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 addition to the data we have today had the IMF increase growth projections for this year for many European countries and for the global GDP so all in we are very much continuing to watch the data.
In the US, Consumer prices fell 0.3% in March, weaker than consensus expectations and the first monthly drop since February 2016. Lower energy and core prices, down 0.3% and 0.1% respectively, were responsible for the headline decline. Consumer price inflation trends firmed markedly at the start of 2017 but, as we expected, that pressure now seems to be easing. Headline CPI was up 2.4% y/y in March, weaker than the 2.8% y/y gain recorded in February. The trend in core inflation meanwhile softened to 2.0% y/y in March from 2.2% y/y in February but it remains well supported. Looking ahead, we expect that the base effects that pushed up consumer prices in early-2017 will ease going forward. This means that the fairly high inflationary pressures that ate into consumers’ real disposable incomes in Q1 will moderate through the rest of the year, supporting stronger real consumer spending ahead. Retail sales declined 0.2% in March, following a 0.3% drop in February. Core retail sales rose 0.5%, up from a 0.2% decline in February which is encouraging for Q2 outlays after the recent lull. Unusually weak inflation distorted the March sales readings. 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 of today (with 6% of the companies in the S&P 500 reporting actual results for Q1 2017), 76% of S&P 500 companies have beaten the mean EPS estimate and 59% of S&P 500 companies have beaten the mean sales estimate. For Q1 2017, the blended earnings growth rate for the S&P 500 is 9.2%. If 9.2% 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;
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 slightly downwards and corresponding valuations slowly rising in the US, Europe and UK. Safe-haven assets have been sought due to geopolitical tensions in the middle east, and in Europe uncertainty surrounding the French election. In the UK, the 10-year gilt yield dropped below 1.00%, a level not seen since last October, ahead of Theresa May’s speech. Following the announcement of a snap general election, the 10-year gilt yield recovered to 1.05%, broadly the level a week ago. 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;
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.
Following Theresa May’ announcement regarding a snap general election in June, sterling has railed strongly against most major currencies. Against the dollar, sterling is up nearly 2% and is above of upper expectation range. Against the Euro, sterling is also up for the week and is moving towards the upper end of our expectation range. Prior to this morning’s announcement, sterling was stable against the dollar and euro for the week, due to weakness in these currencies as opposed to sterling strength. As transparency regarding the Article 50 process 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. It is also worth noting that both the Euro and the US$ have weakened over the past week because of Donald Trump openly trying to manipulate the Fed to lowering the path of interest rate rises and the concerns over the French election sit high on the concerns of currency traders. A week is a long time in politics and two to three weeks is a lifetime for currency traders so all in we expect this little rally to dissipate once we get beyond the French election and the data out of the US continues to be good.
GBP / USD – Range 1.25 – 1.10 – Today 1.27 GBP / EUR – Range 1.20 – 1.10 – Today 1.19 GBP / JPY – Range 150 – 125 – Today 138.3
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 down over the week and is trading at $52.34 for WTI Crude and $54.98 for Brent, down approximately 2.4% for WTI and approximately 2.7% for Brent. Oil prices hit their lowest in 11 days on news that U.S. shale oil output in May is expected to post the biggest monthly increase in more than two years, fuelling concerns that U.S. production growth is undermining efforts to cut oversupply. U.S. government drilling data showed shale production next month was set to rise to 5.19 million barrels per day (bpd), with output from the Permian play, the largest U.S. shale region, expected to reach a record 2.36 million bpd. Geopolitical tensions since the US air strikes on Syria will continue to fuel worries on oil supply from the Middle East, however, with stock piles still at near record levels in the US and elsewhere around the world and increasing US shale activity, the global oil glut looks set to remain.
Gold is a safe haven and a spike in price can be an indicator of increasing underlying economic concerns and as always, the opposite.
Gold price has moved higher for the week by $13 an ounce to $1,287 / troy ounce. Geo-political tensions between the US and middle east has helped to sustain the gold price at its current levels, along with a weaker US dollar. 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 and geopolitical risks 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 of the indices that we track pull back. The US indices were virtually unchanged, with European and Asia indices lower. Geopolitical tensions centred on the US and North Korea, Europe and the French Election and last but not least the US and Russia over Syria have all been impacting equity markets. The FTSE 250 has performed well over the week and hit a new high at the end of last week. As I write equity indices are down sharply in the UK, following the PM’s call for a snap election in June. European indices are also weaker, with the French CAC fairing the worst ahead of the upcoming election. The FTSE 100 is down by over 2% for the day, following sterling strengthening against the dollar by circa 1.5% and 1.0% against the euro. The inverse relationship between sterling and the FTSE 100 continues to remain in force, however, with sterling strengthening the FTSE 100 has fallen; the opposite to what we have become accustomed to as sterling tumbled in the months after the Brexit vote!
Within the portfolios, weaker global equity markets have driven the portfolios to pull back over the last week. On a positive note, we have seen the UK mid-cap positions exceed our 12 month return expectation in less than 4 months and triggered a subcommittee review. We decided to not take any profits on the positions as the earnings data we are looking at for the FTSE 250 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. Despite weaker global equity markets over the last week, the portfolios are well positioned to benefit from a rebound in equity markets, especially in the UK and Europe where momentum had been positive prior to local and geo-political concerns taking root.
What we are seeing is an increase in Noise and the data still strong and it is therefore up to the fund managers to negotiate the noise whilst we concentrate on the Macro. For now, the macro is strong and the IMF only supported that outlook today so we continue to be strong and ignore the noise.
This Day in History
On this day in 1949, Ireland becomes an independent republic. Six counties in the northern region of the island remained in the Commonwealth and a part of the United Kingdom. The Republic of Ireland Act 1948 declared that Ireland may be officially described as the Republic of Ireland, and vested in the President of Ireland the power to exercise the executive authority of the state in its external relations, on the advice of the Government of Ireland. The Act ended the remaining statutory role of the British monarchy in relation to the state, by repealing the 1936 External Relations Act, which had vested in George VI and his successors those functions which the Act now transferred to the President. The Act was signed into law on 21 December 1948 and came into force on 18 April 1949.
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