Market Commentary – 31st May 2017

Polls? Only one that matters is on the 08th of June…

 

The Times today reported a YouGov poll which suggested that the conservatives could fail to win an outright majority in the election on the 08th of June which could result in a “Hung Parliament”. This is the first poll of its kind to suggest a fall in the seats for the Tories and is creating a bit of a stir in the media this morning. But, polls can go up as well as down and we believe that the only one that actually matters is the one next week, as projecting results on the basis of polls can be a tricky business.

 

It’s been suggested that Jeremy Corbyn and Scottish Labour leader Kezia Dugdale aren’t on the same page over the issue of a second independence referendum. It’s been suggested that Jeremy Corbyn and Scottish Labour leader Kezia Dugdale aren’t on the same page over the issue of a second independence referendum. It’s been suggested that Jeremy Corbyn and Scottish Labour leader Kezia Dugdale aren’t on the same page over the issue of a second independence referendum.Global Economic News

 

In the UK, quarterly GDP growth was downgraded from 0.3% to 0.2% in Q1, even though it is suspected that the noise in the data is exaggerating the extent of the slowdown between Q4 2016 and Q1 2017. A stronger outturn for services in March suggests the economy carried greater momentum into Q2 than previously thought. But while we could see a modest bounce in Q2, the bigger picture remains one of weaker growth in 2017. However, it’s not all bad news, in particular, services output rose by 0.2% in March, well ahead of the flat reading that the ONS had pencilled in for the first estimate. This suggests that the economy carried greater momentum into Q2 than previously thought and, along with April’s stronger CIPS surveys and retail sales data, indicates that we could see a modest pickup in growth in Q2. Overall, the noise in the data is probably overstating the degree to which the economy has slowed, with Q4 not being as strong as the data suggests and Q1 not being as weak. But while we anticipate a modest bounce in Q2, the bigger picture remains one of 2017 seeing a weaker pace of growth, with the remainder of the economy unable to offset the drag from a weaker consumer.

 

In Europe, the EC’s Economic Sentiment Indicator (ESI) remained close to its highest level in a decade in May, suggesting that economic growth will remain strong in Q2. The ESI adds to other buoyant survey data in suggesting that the Eurozone economy is experiencing a mini-boom, and it is expected that the activity numbers will start catching up soon, closing the gap between soft and hard data. In France, we saw a triple batch of data released yesterday. GDP growth in Q1 was revised up from a previous 0.3% to a 0.4% in Q1 due to stronger investment, which grew a robust 1.2% over the previous quarter. The strength of capital spending was enough to offset a weak performance in household spending and exports. The upward revision is in line with other positive data for the French economy, which has seen solid economic activity despite the increased political uncertainty of recent months. France also reported monthly data for consumer spending, which saw consumption increasing 0.5% in April after contracting 0.1% in March. Also, consumer confidence rose to 102 in May (April: 100), the highest level since 2007. While it is too early to draw definite conclusions, French households are now more confident in their future financial situation, in what seems a vote of confidence in the economic policies proposed by Emmanuel Macron. Yesterday’s inflation numbers for Germany and Spain showed that, as expected, inflation moderated in May after spiking in April due to seasonal effects related to the timing of Easter. In Spain, preliminary data show inflation fell from 2.6% in April to 1.9% in May, slightly below market expectations and the lowest in five months. A sharp decline in the price of package holidays after the end of Easter was the main driver behind the decline, so core inflation is likely to have moderated following the temporary bounce seen in April.

 

In the US, the trillion-dollar question is whether President Trump’s administration will be successful in passing its promised tax reform and infrastructure package through Congress. In its first budget blueprint, the administration promises to balance the federal budget over the next 10 years via a mixture of severe spending cuts, totalling $3.6 trillion, and a very optimistic growth outlook. These proposals are generally nothing more than an indication of presidential priorities, this budget stands out for its questionable timing, growth expectations and budgetary assumptions. President Trump has argued that the best way to push economic growth above its current moderate 2% pace is to reform the tax code and lower rates for households and businesses. Treasury Secretary Mnuchin noted at the annual Milken Institute Conference that the administration favoured an “economic plan that focuses on tax reform, proper regulation reform, and fair trade.” On the household front, the proposal suggests: (1) reducing the number of tax brackets from seven to three, at 10%, 25% and 35%; (2) doubling standard deductions; (3) reducing most deductions other than mortgage interest and charitable donations; (4) eliminating the alternative minimum tax (AMT); and (5) reducing the top capital gains tax rate to 20%. A childcare tax credit was discussed, but no details were provided. Only time will tell how successful these proposals will be.

 

Barometers

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 98% 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 64% 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 13.9%. If 13.9% 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 go lower with corresponding valuations rising. Volatility remains high in these assets which should not be functioning like this. This 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 movements in the currency, to see if we should be locking in the gains and hedging the risks. 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, following Brexit, and less negative risk due to the UK economic data stabilising, and therefore uncertainty risk is dropping off. As the Brexit mature, we 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 remains a sensitive topic as we edge closer to the general election next week. All over the news this morning we have seen that Sterling is under pressure as a new poll showed that there is a possibility of a “Hung Parliament” when the YouGov poll suggested the Conservatives could fail to win an outright majority. The pound has been volatile since the UK voted to leave the European Union in a referendum last year, however we believe that it is now fairly priced at 1.28 against the Dollar. We will continue to see volatility in the currency over the next week, and indeed during the Brexit negotiation talks, however we do not see it changing drastically and it should sit quite comfortably within our ranges, which were extended in this month’s Investment Committee Meeting.

GBP / USD – Range 1.32 – 1.20 – Today at 1.28
GBP / EUR – Range 1.22 – 1.12 – Today at 1.14
GBP / JPY – Range 150 – 130 – Today at 142.03

Oil Price;

We monitor the oil price as it is a 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 decreased, despite the agreement between OPEC and non-OPEC nations to extend output cuts. WTI Crude is currently trading at $49.16 and $51.70 for Brent, down approx. 5% for WTI and approx. 5% for Brent. Despite the surprise fall in oil prices following last Thursday’s key meeting, there is optimism that the deal will achieve its objective in the near future and will help motivate the balance of the market.

Gold Price;

Gold is a safe haven and a spike in price can be an indicator of increasing underlying economic concerns and as always, the opposite.

Despite the price of oil reducing over the past week, we have seen the price of gold increase only approx. $12 an ounce to $1263 a troy ounce, which would indicate that markets are relatively strong and investor confidence remains relatively high.

Model Portfolios & Indices

 

Over the last week, we have seen most of the indices that we track strengthen. The US indices continue to climb up and so have the UK indices, which have been their strongest in their record. With regards to the FTSE 100, the increase had been expected following the fall in sterling. The FTSE 100 is dominated by companies dependent on exports and therefore they could expect to benefit from a weaker pound.

 

Given the above, we have seen our model portfolios perform well over the past week with the active models again outperforming the passive comparative models (OBI Active 8 compared to OBI Passive 8) and benchmarks. Since inception (around 4 months ago), we have seen the following positions exceed our 6 and 12 month targets:

 

  1. Our UK Mid-Cap, European and Global equity positions have exceeded our 12-month targets.
  2. Our Property position has exceeded our 12-month target.
  3. Some of our Multi- Asset and Fixed Income funds have exceeded our 6 month targets.

 

Following the positive performance of our above positions, the Investment Committee has decided to take 100% of the profits on the UK Mid Cap position as we feel that this has reached a peak with the instability and concerns surrounding the UK election. This position was added into our portfolios in June 2016 and has delivered 38% from a Value at Risk (VAR) perspective. From a returns perspective, we set out an expectation for the fund to deliver 10%, however, it has delivered 18%. Based on this, we believe it is an appropriate time to cash the profits as we see limited upside in the short term. We have also dialled down our other UK exposure due to the political risks looming around the corner.

 

We have further decided to not take any profits on any of our other 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 apparent sub Investment Committee Meeting, 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 Day in History

On this day in 2008, Usain Bolt breaks the world record in the 100m sprint, with a wind-legal (+1.7m/s) 9.72 seconds. Bolt is a Jamaican sprinter. He is the first person to hold both the 100 meters and 200 meters world records. He also holds the world record as a part of the 4 × 100 meters relay. He is the reigning world and Olympic champion in these three events. Due to his unprecedented dominance and achievements in sprint competition, he is widely considered to be the greatest sprinter of all time.

As always have a wonderful week and stay safe.

VBW

Jason