Market Commentary – 18th July 2017
Is Trump Struggling?
Apologies that this week’s market commentary is a day earlier than usual. We thought it is important to highlight key events that have taken place since our last commentary. Volatility remains present in the markets, first prompted by central bankers’ hawkish comments on raising interest rates and now Trump, and how he is struggling to pass his policies through to congress.
President Donald Trump blamed Democrats in Congress, as well as a few Republicans, for Senate Majority Leader Mitch McConnell’s decision to abandon efforts to pass a broad Republican-only replacement of Obamacare and opting instead to seek a straight vote on repeal. A repeal without a replacement is almost certain to get blocked in the Senate. The inability to deliver on seven years of Grand Old Party (GOP) promises to repeal and replace the Affordable Care Act would be the biggest failure yet for Trump and the Republicans, since they won control of Congress and the White House. McConnell’s move came after two more Republican senators (Mike Lee and Jerry Moran) announced their opposition to the Republican leader’s plan. Lee and Moran said in a statement that they wouldn’t support McConnell’s bill, because it didn’t go far enough to address the rising cost of health care. It was also highlighted that the Republicans ignored Trump’s tax cuts. These political risks today lowered the US Dollar spot rate, which in turn has had a snowball effect on international markets.
Global Economic News
In the UK, today we received key data regarding the UK’s inflation rate. This piece of data is key, as inflation shows whether the UK economy is overheating with pressures from excess spending driven by a strong labour force. Inflation is categorised in two, Consumer Price Index (CPI) and Retail Price Index (RPI). CPI is also known as harmonised index of consumer prices and is the key indicator used by economists to show the adjusted prices of any basket of goods. RPI on the contrary includes the cost of housing. Today, CPI inflation surprisingly slowed from 2.9% in May to 2.6% in June. Falling petrol prices accounted for some of the fall in the headline rate, but the downside surprise was largely a function of a soft reading for core inflation. The chances of CPI inflation getting to 3% are now disappearing. Petrol prices are falling in reaction to the drop-in oil prices, a fall which economists expect to be sustained. The bulk of the increases in domestic energy bills have already occurred.
Now that we are a year on from the post-referendum slump in the value of sterling, the bulk of that impact is likely to have already occurred, a notion which is corroborated by the continued cooling in inflationary pressures earlier in the supply chain. Indeed, given that we expect sterling’s recent rally to continue over the coming year, these pressures should now soon start to reverse. Today’s reading should help to supress some of the more hawkish rhetoric that has been coming from the MPC of late, whom have been trying to increase the Bank of England interest rate. Usually, when inflation seems to be increasing constantly, central bankers will intervene with fiscal policy and increase the rate of interest which counter balances inflationary pressures. The next MPC meeting is now scheduled for the 8th of August and today’s figures make it very unlikely that rates will increase based on a slow down in inflation. Today’s data should also encourage markets to think again on prospects further out. Based on how the Brexit negotiations go, it is predicted by economists that the first-rate hike is likely to come in Q2 2019. Also, we would like to report that growth in UK house prices has continued to slow (which is shown in RPI), but the cost of the average home still increased by 4.7% in the year to May 2017. Figures from the Office of National Statistics (ONS) show a drop from the 5.3% rise in the year to April, but the average UK house price was still £10,000 higher in May than the same month last year at £221,000.
In Europe, investors are watching the European Central Bank (ECB) President, Mario Draghi who is due to speak on Thursday regarding raising or keeping interest rates where they are. From our past commentaries, it might be evident that Europe has been strong and doing well, which might be enough evidence for the ECB to hike the current interest rate. Despite the recovery continuing to build steam, no clear commitment on the size and duration of QE asset purchases in 2018 is likely at July’s ECB press conference, and Draghi is likely to hint that the ECB has no plans to commit to a QE end-date just yet, a sign that policy normalisation will be gradual and slow, following on from Yellen’s statement earlier this month. The ECB may signal that a September announcement is likely by changing the current guidance on asset purchases and dropping the commitment to increase the size of asset purchases in the event of adverse shocks, and changes to the forward guidance were discussed in the June meeting. Away from the ECB, the Eurozone inflation rate was confirmed at 1.3% in June, whereas the measure of core inflation rose to 1.1% from 0.9% in May. Despite this uptick in core prices, inflationary pressures remain weak, especially considering the Eurozone is currently experiencing its strongest growth in a decade. Other indicators corroborate the absence of inflationary pressures. Additionally, despite recent signs of an incipient change in trend, wage growth remains extremely weak. The ECB will remain very cautious when deciding how to withdraw its monetary support. It is expected that they will announce a reduction in its monthly asset purchases to €40bn a month starting in January 2018, but that it will keep its QE programme open-ended in order to maintain the flexibility to tweak the programme later on, if economic conditions warrant it.
In the US, industrial production (IP) rose a solid 0.4% in June, driven by gains in manufacturing and mining output. The rise in manufacturing output was underpinned by broad based gains in durables while non-durables were flat, and a 1.6% gain in mining output further supported the headline gain. Utilities meanwhile were flat, ending the streak of three consecutive monthly gains. Taking a step back, the trend in industrial output remains buoyant. An improving global economic backdrop and solid domestic demand will keep industrial activity on an expansionary footing. The recent decline in oil prices and persistent policy uncertainty present downside risks. Manufacturing output rose 0.2% in June after retreating 0.4% in May. Considering the details, durable goods output increased 0.4%, owing to a bounce in automotive output. The motor vehicle assembly rate rose to an 11.448m unit pace in June, up from a 11.440m pace in May. Non-durable goods output meanwhile was flat in June after increasing 0.2% in May. Mining output gained 1.6% after rising 1.9% in May. Recent gains in mining have been driven largely by rising oil & gas extraction activity as oil prices have stabilized. Further to this, coal mining was up 4.6% in June after falling 1.8% in May. Utilities output was flat in June after increasing 0.8% in May. On a quarterly basis, utilities’ output rose 18.5% in Q2, recovering from a 17.4% decline in Q1. The swing between Q1 and Q2 reflected a return to more seasonal weather after a warm winter. Gross value of final output was flat in June despite the +0.4% reading on June IP. That said, Q2 was given a solid lift by a 1.4% gain in April. Overall, gross value of industrial product rose at a 6.4% annual rate in Q2 after retreating 2.5% in Q1.
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 Q2 2017), 80% of S&P 500 companies have beaten the mean EPS estimate, and 83% of S&P 500 companies have beaten the mean sales estimate. For Q2 2017, the blended earnings growth rate for the S&P 500 is 6.8%. Nine sectors are reporting or 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 a 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 decreasing. Across the board, the changes haven’t been as significant or dramatic as they have been before, however it’s clear that 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 weakened versus all its major peers after annual consumer-price inflation slid to 2.6% last month, below the 2.9% forecast. However, Sterling climbed earlier to its highest level against the US Dollar since September after the stalling of U.S. President Donald Trump’s health reform, which cast doubt on any future deregulation and tax measures. This morning Sterling reached 1.31, however has fallen back due to a drop in the US Dollar and inflation figures. The slowdown in inflation will support the arguments of the members of the Monetary Policy Committee, who contend that the UK economy is weakening while the pick-up in inflation may only be temporary.
As sterling, as well as the US Dollar dropped today, the euro has made robust gains following strong sentiment from European Central Bank and President Mario Draghi’s speech on Thursday, where he is expected to have a similar stance to Yellen’s speech.
GBP / USD – Range 1.32 – 1.20 – Today at 1.30
GBP / EUR – Range 1.20 – 1.10 – Today at 1.12
GBP / JPY – Range 150 – 130 – Today at 145
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 slightly and is heading closer to the $50 mark. WTI Crude is currently trading at $46.78 and $49.22 for Brent, up approx. 1.8% for them both. Prices have inched higher this month after it was reported that stockpiles had fallen by more than is normal at this time of year. With less oil available on the market, investors hoped it would fetch a higher price. Another reason for cautious optimism has been a slower increase in the number of oil rigs producing the commodity in the US than expected. This week, only another two rigs came online, bringing the number currently drilling to 765. Oil prices have tumbled over the past two years thanks to a massive global oversupply, at as much as 94 million barrels per day, as there has been too much oil being produced to keep prices rising. From a 2014 high of $112 per barrel, the price plummeted to just $30 a barrel in February 2016. Since then, there has been a modest but sustained recovery with prices hovering around the $45-$50 per barrel mark. Hopes that the price might consistently top $50 per barrel earlier this year were dashed ,when production cuts by OPEC nations and Russia were not sufficiently severe – and US production bounced back to fill the gap.
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 improve and it has increased by approx. $24 an ounce to $1,240 a troy ounce. The yellow metal has been sliding in recent weeks, as central banks around the world have hinted at a tightening of monetary policy and higher interest rates – referred to as a “hawkish” stance. Non-yielding assets like precious metals tend to respond negatively to rates rises, as their opportunity costs are higher relative to assets that provide an income stream. Having said this, part of the reason why gold has been improving was due to comments by Yellen to a Congressional committee that interest rates would rise only “gradually” in the months and years ahead, after three rates rises in the past eight months. This brought back confidence in the markets and demand for gold started to improve.
Model Portfolios & Indices
Over the last week, we have seen most of the indices that we track improve. However today, US stocks have opened lower after the dollar fell and several companies’ earnings reports disappointed investors. The US Dollar has dropped today after two Republican senators rejected their party’s bill to repeal Obamacare, effectively killing it and throwing Donald Trump’s economic agenda into doubt. The US Dollar is currently 0.9% lower against the euro at 0.8637 euros.
Based on China’s stronger than expected growth rates, China’s mainland indexes clawed back early losses, heading slightly higher after an early retreat of small-cap stocks. Sixteen stocks, most of them small-caps, plunged by the 10% trading limit on the mainland indexes. Based on China’s robust growth rates, commodities such as copper strengthened bringing up mining stocks, globally benefitting indices. Markets elsewhere in Asia were broadly lower, with the Nikkei falling 0.6% to finish just below the 20,000 mark, while Hong Kong’s Hang Seng Index snapped a six-day winning streak. Concerns over new capital requirements for banks helped to push Australia’s ASX 200 1.18% lower.
Given the current level of uncertainty and volatility in the markets, over the past week our portfolios have remained relatively flat. This is a perfect example which shows how our portfolios are less volatile than their benchmarks and the market indices. With political and economic risks at an all-time high, we can reassure you that the fund managers protect your capital as well as take any upside advantage where possible.
This Day in History
With our iconic few hot days of summer prompting us sitting ludicrously close to our fans and air-conditioning units, we thought that we’d share that on this day in 1931, the first air-conditioned ship, Mariposa, was launched. Her maiden voyage took place on 16 January 1932 with a capacity of 475 first class and 229 cabin class passengers. The ship was operated under the War Shipping Administration during World War II, carrying supplies and troops.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager