Market Commentary – 05th July 2017
It’s been a relatively calm week on the face of politics over the last week in comparison to what we’ve recently had with all the political chaos following the disastrous general election. The focus has predominately been on central bankers and their stances on hiking rates over the past week.
Global Economic News
In the UK, the services PMI slipped from 53.8 in May to 53.4 in June, the weakest balance since February. And as with the manufacturing and construction surveys earlier in the week, there was worrying evidence that the slowdown is becoming entrenched, with growth in new business slowing to a nine-month low and respondents’ expectations for future growth being at their weakest level since the aftermath of the EU referendum. The one crumb of comfort from today’s survey was further evidence that inflationary pressures are cooling, with average prices rising at their slowest pace since July 2016. In this context, the more hawkish noises coming from some MPC members recently look even more misplaced and it is speculated by economists that markets’ recent rush to price a first-rate hike around the turn of the year is premature. The headline PMI from the CIPS manufacturing survey fell from a downwardly-revised 56.3 in May to a three-month low of 54.3 in June. The decline came as something as a surprise given the strength of June’s CBI survey and robust readings for orders and backlogs of work in May’s CIPS survey. The detail of the June survey was also pretty uninspiring, most notably the softest growth in new orders for almost a year. Within this, the five-month low for export orders was particularly disappointing given the tailwinds from a weak pound and the recent strength of the UK’s biggest market, the Eurozone. Disappointing though the June survey was, it was still consistent with a much better performance than has been seen in the official data over recent months. Friday’s Index of Production release for May will give us a strong steer as to the performance of the manufacturing sector in Q2 but as things stand it is likely that output is likely to be flat in Q2. In other data this week, UK car sales figures were out today morning and it is speculated that the disappointing figures can be attributed to Brexit and Inflation and also a road tax increase in April. New car sales have been around 5% lower in June, compared with June last year. Also today morning, productivity figures were released. A fall of 0.5% in the first three months of the year takes the UK economy’s ability to create wealth back below the level of 2007. If an economy cannot create wealth efficiently, then the debates about government spending, public sector pay and austerity become all the harder. If an economy cannot create wealth, then tax receipts – the mainstay of government income – weaken.
In conclusion, it is apparent that the UK is slowing down and will continue to slow down until we get clarity in terms of Brexit and also the direction the Bank of England will take in terms of increasing Interest Rates.
In Europe, today’s data releases confirm that the pace of growth in the Eurozone may have accelerated further in Q2. Finally catching up with other more upbeat surveys, the final June composite PMI reading was revised up from 55.7 to 56.3. Most of the revision was driven by a stronger reading in the services sector – revised to 55.4 from 54.7, leaving the index pointing to GDP growth of 0.6-0.7%. The upward revision to the services index was especially strong in France, where the services PMI was revised up to its highest level since 2011, i.e. 56.9. Sentiment in services also inched up in Spain – the composite PMI thus rose by one point to 57.7. By contrast, both services and the composite PMI fell in Italy, respectively to 53.6 from 54.6 and 54.5 from 54.9, where political uncertainty and a slower recovery have been less positive for consumer confidence. In line with strong services sentiment, Eurozone retail sales in May surprised on the upside, rising by 0.4% on the month compared with April’s 0.1% gain, leaving sales on track to expand by about 0.7% in Q2, up from 0.3% in Q1. This provides further evidence that household spending has not been too badly hit by the rebound in inflation at the start of the year. Not only has the labour market recovery bolstered consumers’ financial outlook, the stabilization of energy prices also suggests that inflation will continue to slow in H2 from the Q1 peak, and thus provide less of a drag to real disposable income.
In conclusion, Europe is strong and will continue to remain strong as France and Germany, in particular, are doing well.
In the US, the ISM Manufacturing Index moved higher to 57.8 in June after two months of more moderate readings. The index managed to cap the near-term high of 57.7 in February and was the highest since 57.9 in August 2014. The index was up on higher levels for four of five components. Overall the ISM index has maintained a moderate-to-robust pace of expansion since the start of 2017 on strong new orders and increasing production. The factory sector is healthy with no hint that the underlying conditions will change in the near term. Four of five components in the ISM Manufacturing Index were up and one was down. The gains were all substantial, while the decline was small. The new orders index rose 4.0 points to 63.5 in June from 59.5 in May. The June reading continued the upward momentum of the prior two months and was consistent with vigorous activity. Order backlogs were up 2.0 points to 57.0, and in line with the trend for expansion in place since February. With orders coming at a quicker pace and backlogs building, activity should remain strong for the present. The production index rose 5.2 points to 62.4 in June from 58.6 in May, and was the highest since 62.9 in February. Factories have picked up the pace to meet an influx of new orders. The employment index rose 3.7 points to 57.2 in June from 53.5 in May, and has firmed since the somewhat lower readings of the prior two months. New hiring has seen some short-term bursts upward to meet rising production. There may be some constraints in the availability of skilled workers, as noted by ISM survey respondents. Job openings may be there, but with insufficient applicants, it could lead to further upward pressure on wages. The component for delivery times gained 3.9 points to 57.0 in June after 53.1 in May, and was the highest since 57.7 in February 2014. The threat of bottlenecks developing in supplier deliveries has increased with high new orders and tight inventories. The index for inventories dipped below neutral to 49.0 in June from 51.5 in May. This component continued to hover around the neutral mark as concerns that conditions could change with the political climate keep manufacturers reluctant to expand inventories. A month or two of restocking is being followed by a pullback in activity. The index for export orders rose 2.0 points to 59.5 in June from 57.5 May. This matched the 59.5 in April when it was the highest since 59.5 in November 2013. The underlying pace of activity remained stronger in the last four months than at any time since late 2013. Conditions in the global economy appear to have improved in recent months and orders are arriving at a faster pace. The import index was up 0.5 point to 54.0 in June from 53.5 in May. Imports continued to show modest expansion. The index for prices paid was down 5.5 points to 55.0 in June from 60.5 in May. This was the lowest since 54.5 in November 2016. There was further downward pressure from energy costs, in particular on declines in gasoline prices. Prices remain on the upswing, but at a less speedy pace. Some respondents to the survey noted higher prices for raw materials and global price increases in commodities. Later today we get the FOMC Meeting minutes which will give us an insight on inflationary pressures and remarks on how they plan to bring down the balance sheet.
In conclusion, the US is strong and will continue to remain strong whilst Trump provides positive sentiment, however this will remain a cause of concern until Trump can pass his fiscal and tax policies pass congress.
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 23 companies in the S&P 500 reporting actual results for Q2 2017), 18 S&P 500 companies have beat the mean EPS estimate and 20 S&P 500 companies have beat 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. It has been apparent that earning in the US have been pretty strong over the past 6 months and continue to strengthen.
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 slightly with corresponding valuations decrease. Valuations around the bloc are now below 0% indicating high risks. 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 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.
Sterling has been at a bit of a roller coaster over the past week as it raised from 1.28 to 1.30 and is now down to 1.29 against the US Dollar. The greenback has been bolstered by better than expected data on manufacturing activity in the US during June compared to lacklustre activity in the UK. The latest PMI data showed UK factory activity grew much more slowly than forecast in June, with export orders rising at the weakest pace in five months. The data suggested that the supposed silver lining of a currency weakened by the Brexit vote was proving elusive.
GBP / USD – Range 1.32 – 1.20 – Today at 1.29
GBP / EUR – Range 1.22 – 1.12 – Today at 1.14
GBP / JPY – Range 150 – 130 – Today at 146
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 improved. WTI Crude is currently trading at $47.00 and $49.61 for Brent, up approx. 7% for WTI and approx. 6.8% for Brent. Since peaking in 2011/2012, tax revenues from oil and gas have been in decline because of ongoing decommissioning and cleaning up of old oil fields, for which rebates of up to 50% are offered. The decline accelerated rapidly in late 2014, when oil prices more than halved from well above $100 a barrel. They have not recovered since, despite picking up markedly late last year following a deal to cut production by OPEC and other major suppliers including Russia. Prices last week saw their first gain for six weeks in what has now become an eight-session rally – the longest for five years – on the back of a modest decline in US output. Nevertheless, trading is down 14 per cent for this year. Gains are tempered by worries over global supplies, especially as oil output from OPEC unexpectedly rose by 280,000 barrels in June
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 decrease approx. $34 an ounce to $1,219 a troy ounce. The US Federal Reserve increased interest rates for the second time this year last month and are projected to increase them again at least once more before the end of 2017. Rates rises decrease the relative value of fixed-income assets, which reduces demand, hits prices and ups yields. Gold tends to be positively correlated with bond prices – and so negatively correlated with yields – because it offers no income and loses lustre when rates are rising. Also hitting gold this week has been a recovery for the dollar after a poor run, as concerns ease over global political issues, including the UK government’s stability.
6 Months Review
Now we are half way through the year, we thought we’d give you an insight of our investment thesis, strategies and decision moving forward.
The chart above shows our OBI Active portfolios gross YTD returns. These portfolios are well diversified from low- risk, low- return assets such as Absolute Return to high- risk, high- return assets which include equities. It has been apparent throughout this year that markets have been rallying upwards due to various social, economic and political factors which has benefited our equity positions. To profit from this rally, our higher-risk portfolios (OBI Active 6 upwards) were skewed higher towards this exposure to take advantage of the rally.
Once OBI Active 8 reached 10% YTD return, it was decided that we would turn down our equity exposure and develop a more defensive approach by adding the proceeds to our non- equity universe and include funds which would do well during a period of volatility. This rebalance was completed at the beginning of June where we locked in the profits from our high conviction positions. Since President Trump was inaugurated into office in January, US Markets have done extremely well, with the DOW Jones passing over 20,000 and currently around approx. 21,450. This boost has driven other international markets. Following this strength, the US Dollar has also strengthened which has benefited our Asian positions as they get more in terms of purchasing power parity when they export to the US. Within our non-equity space, we have noticed that yields on government debt have been decreasing which has been increasing risks. To achieve ‘Normality’ in the markets, we will need yields to start increasing and equities to continue to raise but at a much more slow and sustainable pace. As central banks increase interest rates (or plan to do so), this would reduce demand in fixed income securities therefore reducing prices and increasing yields which will reduce these risks.
With the remainder of the year, we do expect global equities to continue to raise, however it is a bit more complicated with the UK, surrounding the uncertainties that lie with Brexit and given the economic data which suggests that economy is slowing down. The 2019 expectation is now easing based in poor economic data. We took profits from this in our June rebalance and now do not hold any positions which can be disadvantaged from the slowdown.
Away from the UK, our past commentaries have highlighted strong PMI data in Europe, the US and Asia which would lead to sustained global growth as PMI data continues to improve. We have positions in our portfolios which will benefit from these.
As a whole, we would like to let you know that, yes markets are slowing down, but this is normal considering the momentum they have achieved in the past 6 months. Volatility seems to be back in the markets, but this is as central bankers have all had synchronised central bank meetings which explains the volatility on inflationary global pressures. News will panic the markets, this is normal and it has always been the case. We remain strong on our convictions and will become more defensive or aggressive based on data and clarity.
Model Portfolios & Indices
Over the past week, we have seen most of the indices that we track drop further driven by comments from central bankers. With the Australian markets, the index strengthened this week when the Reserve Bank of Australia kept interest rates on hold. It is speculated that this is to see if wages respond in line with low rates to achieve higher inflation figures. The Italian MIB also strengthened following strong Manufacturing PMI data. The German DAX was however down 2% despite solid German manufacturing PMI. With the FTSE 100, this has been on a roller coaster following the unstable pound and slowing down PMI data as highlighted above.
Over the past week we have seen our portfolios drop slightly in the wake of high volatility, however we feel that the momentum rally hasn’t yet stopped and we expect to get a bit more from our positions, even though it has slowed down.
This Day in History
The Bank of England on this day in 2007, raised rates to 5.75% and this was the last time they raised rates over the past 10 years! Slashing rates aggressively into the fiscal crisis was intended to provide instant relief to tightening financial conditions – in effect acting as the great shock absorber to a business cycle going into a downturn. It is apparent form our previous commentaries and the media that rates now need to go up to reflect inflationary pressures, however this puts it into perspective in terms of how long rates have been on the downwards spiral.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager