Market Commentary – 10th May 2017
What to expect from Macronomics?
With Emmanuel Macron’s French election win, the prospect of France leaving the European Union – as proposed by his run-off opponent Marine Le Pen – has been all but eliminated. As a former economy minister to outgoing president Francois Hollande, his economic credentials formed a big part of his campaign. Macron’s main focuses are centralised across reforming the eurozone, help businesses, tackling Frances unemployment rates and work on allocating the French budget better to save over €60bn across his five years.
France has one of the largest public sectors in the world with public spending in 2016 was close to 56.5% of GDP. Macron also aims to reduce corporation tax and this has become one of his most urgent tasks on his agenda. His party has also pointed out that they want to make unemployment benefits available to groups currently not eligible, including the self-employed, entrepreneurs and farmers. While other European countries look to force people to work longer before being entitled to state pensions, France’s official retirement age of 62 will be unchanged. The president-elect does, however, have plans to overhaul the system to make pension pay-outs more closely tied to what individuals pay in.
What does the French election mean for the UK and Brexit? Well, Macrons win has raised a question mark over how Paris will behave towards the UK in upcoming Brexit negotiations. While his victory over the far-right Marine Le Pen led most to breathe a sigh of relief, Macron’s strong pro-EU stance will worry those politicians leading Britain’s departure from the bloc, who see him as a “tough Brexit negotiating partner”.
Global Economic News
In the UK, the economy has displayed a surprising degree of resilience since the referendum and consumers now appear to be retrenching in the face of higher inflation prospects. The preliminary estimate for Q1 2017 reported quarterly GDP growth of just 0.3%, down from 0.7% in the previous quarter. It is apparent that growth has slowed, but the most notable aspect was the weakest outturn for the services output in two years, as consumer-facing sub-sectors fared badly in the face of higher inflation. Business surveys have increasingly reported stronger results for export orders, suggesting some benefit from the weaker pound, and the official data have belatedly begun to improve. The March 2017 Budget saw the Chancellor leave fiscal policy largely unchanged. But the squeeze on welfare spending, plus previously-announced tax rises and cuts to current spending, mean that fiscal policy will exert a sizeable drag on growth over the next few years. Forecasts from the Office for Budget Responsibility imply that fiscal tightening will exert a drag of about 0.6% a year on GDP growth between 2017-18 and 2019-20. The upcoming general election appears unlikely to result in any material change to the fiscal stance.
In Europe, Emmanuel Macron’s landslide victory shows French voters acknowledged that leaving the euro will not solve the economy’s problems. Macron’s reform programme has the potential to boost economic growth in the medium term, but its implementation will largely depend on the results of the parliamentary elections in June. Stepping away from the French elections, German factory orders rose 1.0% on the month in March, beating expectations of a 0.7% increase. The March rise driven by a 4.8% surge in foreign orders, suggesting that the German economy continues to benefit from the pick-up in global trade and stronger demand for capital goods. The Sentix Index, which is a monthly survey showing the markets opinion about the current economic situation and expectations, rose to 27.4 in May, its highest in 10 years. While the Sentix is not a good gauge of the level of economic activity, however it offers valuable information which shows investor confidence levels in Europe. As such, the figure continues the run of strong results seen recently in other survey data in the Eurozone and suggests a continuation of the strong momentum in Q2.
In the US, Trump’s promise to strengthen the US manufacturing sector may fall short of expectations as a strong US dollar, up about 20% on a real, has weighed heavily on US competitiveness. Trump’s election victory energized the US manufacturing sector’s hopes of a revival after years of losing market share to international competitors. US manufacturers expect that Trump’s pro-business and protectionist policies will boost their competitiveness and underpin stronger activity as well as improving this competitive boost to manufacturing sectors in both advanced and emerging economies. US manufacturing wages remain much higher than in other advanced economies. The wage disparity is wider with emerging markets, but faster wage growth in countries like China is rapidly reducing the relative gap. Despite headwinds from a strong currency and elevated wages, US manufacturing remains globally competitive thanks to a significant absolute advantage on the productivity front. High R&D spending and a well-trained and flexible labour force are supportive of this advantage. While US productivity growth has been dull, other countries have not managed to bridge the gap.
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 83% of the companies in the S&P 500 reporting actual results for Q1 2017), 75% of
S&P 500 companies have beat the mean EPS estimate and 66% of S&P 500 companies have beat the mean sales estimate. For Q1 2017, the blended earnings growth rate for the S&P 500 is 13.5%. If 13.5% is the actual growth rate for the quarter, it will mark the highest (year-over-year) earnings growth for the index since Q3 2011 (16.7%).
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 rise sharply again with corresponding valuations down. This could be due to positive data coming out of the UK, Eurozone and the US. 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. Following last week’s Investment Committee Meeting, we have changed our 12-month expected range for sterling across the US Dollar, Euro and Japanese Yen. This is to reflect a stronger pound and less negative risk due to the UK economic data stabilising and assumes that Theresa May gets a stronger hand, and therefore uncertainty risk is dropping off. We still expect Sterling to weaken over the coming months as negotiations set off and both sides prevaricate, then reappreciate towards year end to roughly where we are now or slightly higher.
Sterling has defied expectations and is much higher against most other currencies as we wave off the Brexit blues. Somewhere between Theresa May confirming we want a hard Brexit and calling a snap General Election, sterling has rocketed. In the main this is down to improved economic data and an increase in confidence. By calling the election and moving the next General Election until 2022 it means Theresa May has much more time to negotiate and will not be forced into accepting a poor deal to appease voters ahead of what would have been the 2020 General Election. This improves GBP expectations which is based on sentiment amongst all currencies.
GBP / USD – Range 1.32 – 1.20 – Today 1.29
GBP / EUR – Range 1.22 – 1.12 – Today 1.19
GBP / JPY – Range 150 – 130 – Today 147.22
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 a strong global economy. Opposite reflects underlying weaknesses.
The price of oil, over the past week has moved down further and is currently trading at $46.36 for WTI Crude and $49.17 for Brent, down approx. 3.5% for WTI and approx. 3.5% for Brent. Prices slumped at the end of last week as a result of US inventory data that was more bearish than expected, adding to the sense that OPEC supply cuts are not enough to rebalance the market. After a sustained rally which began when OPEC, Russia and other oil-producing nations agreed to cut production last November, oil prices are now firmly back under the psychologically significant $50-a- barrel mark. It is a far cry from June 2014, when prices reached a peak of $115 per barrel. A sustained global oversupply since then has seen oil prices plummet. Additionally, US output shows a steady upward trend, adding more oil to the oversupply.
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 further, approximately $30 an ounce to $1,222 a troy ounce. The gold price is sliding past its six-week low following the US Federal Reserve’s decision to hold US interest rates. This has sent the Dollar to a two-week high and has accelerated a gold decline which could potentially hit $1,200 a troy ounce, indicating no concerns in the global economy and 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 due to Emmanuel Macron’s French election win and the prospect of France leaving the European Union being eliminated. UK indices have done well, and will continue to do well until we hold the snap election in June. We except these indices to remain strong post-election results and will keep monitoring our positions based on the results.
The Model portfolios have done well over the week with the active models again outperforming the passive and benchmarks. Following the Investment Committee Meeting last week, we have increased our equity exposure as well as being more directional with OBI 8 and making it more aggressive than it has been. We have continued to see our UK mid-cap, European and Global equity positions exceed our 12 month return expectation in 4 months. 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 the range has moved up, which has been the case, 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 will be carrying out our full rebalance across all the model portfolios tomorrow. This has been pended as we were waiting for the results following the French election, which has caused no major shocks in the markets. We are therefore happy with our forward guidance and will be adjusting our portfolios to reflect the positive sentiment markets are feeding in.
This Day in History
On this day, in 1994, Nelson Rolihlahla Mandela was sworn in as South Africa’s first African president. He was a South African anti-apartheid revolutionary, politician, and philanthropist, who served as President of South Africa from 1994 to 1999. He was the country’s first African head of state and the first elected in a fully representative democratic election. His government focused on dismantling the legacy of apartheid by tackling institutionalised racism and fostering racial reconciliation. Ideologically an African nationalist and socialist, he served as President of the African National Congress party from 1991 to 1997.