Market Commentary – 28th June 2017
May criticised for ‘shabby’ DUP deal
Theresa May has been ever so busy after the dreadful election results where she failed to win a majority. Despite this, her resilience continues to make a success of her time in office and after two weeks of negotiations, Theresa May has finally struck a power-sharing deal with the Democratic Unionist Party (DUP) that will help the Tories form a majority government and pass the Queen’s Speech on Thursday. The deal is believed to include £1bn of extra funding to Northern Ireland over the next two years, however this has been criticised. Welsh First Minister Carwyn Jones said the extra funding for Northern Ireland was a “straight bung”, while Labour called it a “shabby and reckless” deal that would harm the peace process. The Tories said they had a duty to provide a government.
Stepping away from Theresa May, SNP leader Nicola Sturgeon has “reset” her timetable for a second Scottish independence referendum and will not push for a vote until the terms of Brexit are clearer (whenever that may be). She had called for a poll in 2018 or 2019 but says she will now focus on influencing Britain’s exit talks with the EU. The SNP lost 21 seats in this month’s general election.
Global Economic News
In the UK, the latest quarterly meeting of the Bank of England’s Financial Policy Committee (FPC) delivered a list of mainly minor tweaks to the UK’s system of financial regulation, aimed at boosting the resilience of the financial sector. But there was also more substantive action in the form of a rise in the so-called ‘Countercyclical Capital Buffer’ (CCB) from zero to 0.5%. This reverses the cut that was made just after the EU referendum. And the FPC intends to raise the buffer further to 1% in its November meeting later this year. The CCB was introduced in March 2016 as a means of compelling banks to hold more capital in good times to draw on in the event of an economic downturn. The FPC’s move early this week will ultimately require UK banks to boost their capital buffers by an estimated £11.4bn. If the claim made by Governor Carney at the time the buffer was cut last year is to be believed, that additional capital requirement could have a sizeable effect on banks’ capacity to lend to households and firms. Last July, Mr Carney suggested that the 50 basis points fall in the buffer would expand this capacity “by up to £150bn” (over an undefined period), or more than twice the total net lending to households and firms in 2016. It follows that a one percentage point rise could cut lending by up to £300bn. In practice, the hit to lending from a higher CCB is likely to be much smaller. For one, the Governor’s claim last July assumed a very large multiplier from capital requirements to lending. Second, banks had been expected to meet the CCB by reclassifying equity, which was already held under earlier regulatory rules, an option which presumably remains open. And banks could choose to cut dividends to shareholders rather than lending as a means of achieving the required capital ratio. That said, the FPC’s action indicates that the Bank remains ready and willing to use macroprudential tools to tighten financial conditions, before resorting to the conventional approach of a rise in Bank Rate (albeit still with no direct action to rein in rapid growth in unsecured lending). In her valedictory speech last week, external MPC member Kristin Forbes argued that the availability of such tools was one reason behind the Bank’s “failure to launch” and hike rates.
In Europe, Draghi’s speech has triggered some sharp movements in financial markets as his comments appeared to challenge growing speculation that the ECB would avoid announcing a tapering of QE in the autumn and instead shift to a “one-step at a time” approach to the unwinding of asset purchases. The latter would effectively leave the end date for QE purchases open. Although his speech was littered with all too familiar comments such as “a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to build up”, this was combined with other comments which appear to justify a gradual tightening of monetary policy. These signals would suggest that the Governing Council is shifting in response to the healthy activity data. Admittedly, Draghi’s statement that the weakness of the path for inflation reflected “mainly temporary factors that typically the central bank can look through” might just be a signal not to expect any easing, as headline inflation falls back in response to the lower oil price. But there were other signs that there was a significant shift in tone. Draghi warned that the low level of core inflation was understating underlying inflation pressures in the Eurozone.
In the US, the International Monetary Fund (IMF) has cut its growth forecasts for the US economy to 2.1% in 2017 and 2018. Back in April the IMF said it expected the world’s biggest economy to grow by 2.3% this year and 2.5% next year, in part because of President Trump’s planned tax cuts and spending hikes. However, now the IMF says because of the lack of detail about the government’s “still evolving policy plans” it has decided to remove the assumed stimulus from its forecasts. The IMF also says it’s unlikely that the Trump administration will hit its target of more than 3% growth over a “sustained” period. Republican leaders have made much hay of their determination to achieve major tax reform and fiscal stimulus – “We are going to get this done,” House Speaker Paul Ryan said in a speech on tax reform last week. However, despite the “go big or go home” attitude, there are multiple obstacles standing in the way of policymakers’ fiscal ambitions. With a weaker boost from tax cuts and infrastructure investment, the US economy will struggle to escape its current 2% growth mode and it is expecting that GDP growth will average around 2.3% (compared with 2.7% in the June baseline). Smaller tax cuts for households will translate into slower real disposable income growth – just below 3% which, combined with a mild dip in confidence and stock prices, will constrain real consumer spending growth to about 2.4% in 2018. Reduced tax cuts for businesses and softer final demand will constrain business investment growth. This more downbeat environment will also weigh on the labour market. By the end of 2018, it is estimated that the economy would generate about 300,000 fewer jobs. With regards to the earlier mentioned mild dip in confidence, the Conference Board’s Consumer Confidence Index rose 1.3 points to 118.9 in June, up from a revised 117.6 in May (previously 117.9). The increase was driven by a sharp 5.7 point jump in the present situation component to 146.3, its highest point since July 2001. The combination of a strong labour market, low interest rates and cheap gasoline remain strong underpinnings of very elevated levels of confidence. Consumers are confident that job market entrants and job changers can find work. Add to that, mortgage rates are near historic lows and gasoline prices have dipped lower in recent weeks based on low oil prices.
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 11 companies in the S&P 500 reporting actual results for Q2 2017), 8 S&P 500 companies have beaten the mean EPS estimate and 9 S&P 500 companies have beaten the mean sales estimate. For Q2 2017, the estimated earnings growth rate for the S&P 500 is 6.6%. Nine sectors are expected to report earnings growth for the quarter, led by the Energy sector.
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 increase with corresponding valuations fall. 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. As Brexit matures, 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.
Over the last week, Sterling has strengthened against the US Dollar after falling to a low of 1.26. Current trading at around 1.29, Sterling strengthened early this week after Prime Minister Theresa May agreed a deal with the Democratic Unionists to support her minority government. Given the current level of uncertainty, any positivity in the political face could only improve Sterling. Sterling today jumped by more than 1% following comments by Mark Carney hinting that interest rates could rise if stronger business investment boosts the UK economy. With the Euro, it jumped yesterday to a high of €1.1245 after comments from European Central Bank President, Mario Draghi highlighted a recovering eurozone economy, however lost its ground today after reports showing that the markets had over analysed earlier comments from Mario Draghi. ECB chief Draghi had intended to signal tolerance for a period of weaker inflation, not an imminent policy tightening.
GBP / USD – Range 1.32 – 1.20 – Today at 1.28
GBP / EUR – Range 1.22 – 1.12 – Today at 1.129 (3 d.p due to range)
GBP / JPY – Range 150 – 130 – Today at 143
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.
After falling into a bear market, oil does seem to be improving from a new low last Wednesday week, WTI Crude is currently trading at $43.93 and $46.46 for Brent, up approx. 1.7% for WTI and approx. 2.2% for Brent. Oil does seem to be slowly improving as there is speculation that members of the OPEC oil producing nations will make another effort to drive up prices by limiting production, following their last meeting. Ministers from six OPEC countries are due to meet in Russia next month. It’s possible they could agree on some kind of production deal that would be presented to the full OPEC membership when they meet.
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 the price of gold increase by approx. $8 an ounce to $1,253 a troy ounce. As central bankers focus on interest rates, the price remains relatively steady. Gold did however suffer a bit of a hiccup on Monday after there was a spike in traded volumes, which was exacerbated by automated trading triggered by human error. A trade of 18,149 ounces would be a very typical trade, but a trade of 18,149 with lots of futures contracts (which is 100 times bigger) wouldn’t be. This exacerbated limit orders which is one negative for the rising technology in computer- driven algorithmic trading which in the past has caused extraordinary movements in financial markets, commonly known as “flash crashes”. The market seems to have absorbed this speed hump and re-stabilise itself. As these errors continue, investors remain relatively cautious on holding positions to limit their risks.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track fall. In the UK, the FTSE 100 and FTSE 250 have been impacted by a strengthening pound, which has meant that firms’ international profits are worth less when converted back into sterling. In the US, markets remained in a fairly sour mood early this week after the IMF poured cold water on Donald Trump’s economic plans. Even news of an unexpected increase in US consumer confidence failed to make much difference to the US markets. With the European stock markets, Draghi’s speech yesterday triggered some sharp movements as his comments appeared to challenge growing speculation that the ECB would avoid announcing a tapering of Quantitative Easing (QE) in the autumn and instead shift to a “one-step at a time” approach to the unwinding of asset purchases. One major index that stands out below is the CSI 300. This is following strong sentiment after the MSCI decided to include Chinese shares and is a true game changer, as this is a sign of China’s efforts to improve its corporate governance. In the past, the MSCI has denied the inclusion of China as their markets weren’t transparent enough, however this is a massive bonus for the Chinese markets which has built investors’ confidence.
Over the past week we have seen our portfolios remain relatively flat in line with the current macroeconomic outlook. Concerns lay around inflation and how central banks tend to cope with this. Year to date, the majority of our positions have exceeded our expectations and, we expect that our portfolios will continue to rise and gain further profits. Following the rebalance early this month, we have placed some defensive positions which will hedge our risk if markets continue to drop further.
This Day in History
On this day in 1820, the “poison apple” famously known to us as the tomato was proven to be non- poisonous. It was thought that aristocrats got sick after eating them, but the truth of the matter was that wealthy Europeans used pewter plates, which were high in lead content. Because tomatoes are so high in acidity, when placed on this tableware, the fruit would leach lead from the plate, resulting in many fatalities from lead poisoning. No one made this connection between plate and poison at the time up until 1820; the poor tomato was picked as the culprit.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager