Market Commentary – 26th July 2017

Where is our Prime Minister?

It has yet been another unmoved week in the face of UK politics, but this may rise the question as to what’s going on? Where is Theresa May and what’s happening in this time of uncertainty? Since the Hung Parliament, Theresa May has kept her cards even closer to her chest and is manoeuvring her party through this uncertain time cautiously.

With US politics, Donald Trump’s administration is trying to make timely progress on pledges to investment huge sums into the economy, cut taxes and substantially enhance growth, however these are now starting to raise concerns. Trump has run into trouble in the Republican-controlled Congress with his flagship Obamacare repeal bill, suggesting he will struggle to deliver other campaign promises. The administration is also seemingly never far from internal disaster, with the latest twist its own chaotic brief history coming with the resignation of White House press secretary Sean Spicer on Friday last week.

Global Economic News

In the UK, today morning the Office of National Statistics (ONS) released GDP Growth Rate figures which showed that the UK economy grew by 0.3% in the three months to the end of June. This is a slight improvement on the first three months of the year when GDP increased by 0.2%. The ONS said the growth was driven by services, which grew by 0.5% compared with 0.1% growth in the first quarter of 2017. The largest contributors to growth in services were retail trade, which improved after a fall in the first quarter, and film production and distribution. Construction and manufacturing were the largest downward pulls on quarterly GDP growth, following two consecutive quarters of growth. It reckoned GDP per head had increased by 0.1% during the second quarter. The economy has experience a notable slowdown in the first half of this year, driven by the uncertainties around Brexit. Despite lacklustre growth so far this year, there are tentative signs that things might improve in the second half. Last week saw news that retail sales rose ahead of expectations, indicating the consumer may still have some petrol in the tank – though the Bank of England has expressed caution over rising levels of personal debt. Meanwhile inflation began to recede, which if it continues in the coming months could end the squeeze on real incomes. Yesterday a CBI survey showed UK factories increasing output at the fastest rate since the mid-1990s, suggesting manufacturing – which makes up around 10% of the economy – might make a meaningful contribution to overall economic growth in the third and fourth quarters. The pick-up in growth in the second quarter could prove to be a high point for the UK economy this year. Inflation is likely to resume its upward trajectory in the coming months and this could trigger a sharper economic slowdown by increasing the squeeze on consumer spending which is a major driver of UK economic growth. Rising inflation together with continued uncertainty over the longer-term impacts of Brexit is also likely to stifle investment intentions.

In Europe, early this week we got Eurozone PMI Data. Composite PMI fell to a six-month low in July, it seems increasingly likely that Q2’s probable 0.7 to 0.8% quarterly rise in GDP will prove to be the high-water mark for the recovery. The key question for policymakers, firms and markets will be how much GDP growth will slow. The general 2017 baseline GDP growth forecast is 2.2%, which is at the upper end of the forecast spectrum, assumes that the quarterly pace of growth will ease to about 0.5% in Q3 and Q4, notably weaker than Q2’s likely rise and a touch below the Q1 outturn of 0.6%. But the current consensus GDP forecast of 1.9% for 2017 mechanically implies that, unless Q2 surprises to the downside of the 0.7% to 0.8% estimate, the quarterly growth rate would need to plunge to about 0.2% in Q3 and Q4. But even though the surveys show signs of a slowdown, there are several reasons to remain optimistic about H2 growth prospects. Although the direction of travel of the surveys in the initial stages of Q3 is negative, it is less of a worry in an environment where some surveys have been overestimating the underlying pace of economic growth. Note that the drop in the composite PMI in July was driven by the manufacturing component, which this year has diverged markedly from the hard data.

In the US, tonight we will hear about the Fed’s interest rate decision. Following the June 13th and 14th FOMC policy meeting, the Federal Reserve issued an addendum to the Policy Normalization Principles and Plans (PNP&P) of September 2014. The update, in which the committee did not specify a start date for the change in reinvestment policy, laid out a series of redemption caps for both Treasury securities as well as Agency and related mortgage-backed securities (MBS). Only maturing amounts more than those caps will be reinvested. The cap for Treasuries will be initially set at $6 billion and increase every three months by $6 billion until it reaches $30 billion. The cap for principal payments on Agency MBS will initially be set at $4 billion and increase by $4 billion every three months until it reaches $20 billion. The FOMC anticipates that the “caps will remain in place once they reach their respective maximums so that the Federal Reserve’s securities holdings will decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively.” Based on the Fed reinvestment guidelines outlined in the addendum to the June 14th PNP&P, Stone and McCarthy Research Associates (SMRA), put together a schedule of reinvestments and roll-offs of maturing Treasuries, Agencies and principal payments on Agency MBS on a monthly basis through 2022. Based on this schedule of reductions to the System Open Market Account (SOMA), and embracing the baseline assumption used in the New York Federal Reserve’s open market operations desk’s annual report, normalization would occur when the volume of securities held in the SOMA is associated with a reserve balance of $500 billion. As a result, it is expected that normalization will occur in May 2021, with a SOMA balance of $2.862 trillion. The ultimate normalization date and SOMA size would obviously vary depending on the underlying assumption of the level of reserve balances to be held at the Fed at the point of normalization. This is something the FOMC has yet to determine. Much depends on whether the Fed continues to control the Fed funds rate and other short-term interest rates using the floor system it adopted in the fall of 2008, or whether the Fed returns to an operating protocol similar to that which prevailed prior to the crisis.

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 19% of the companies in the S&P 500 reporting actual results for Q2 2017), 73% of S&P 500 companies have beat the mean EPS estimate and 77% of S&P 500 companies have beat the mean sales estimate. For Q2 2017, the blended earnings growth rate for the S&P 500 is 7.2%. Nine sectors are reporting or are expected to report earnings growth for the quarter, led by the Energy sector. These strong earnings have lead the S&P 500 to record highs.

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, for the UK we have seen bond yields increase with corresponding valuations decrease. The opposite is the case for the US and America. In relative terms, their yields increased slightly over the past week with corresponding valuations dropping slightly. 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.

Over the past week sterling has remained relatively flat against the US Dollar. Is isn’t because sterling is particularly holding well against the Dollar, but this is largely driven by Dollar weakness based on the concerns over Trump and his policies. Sterling was unmoved as Britain’s second quarter GDP estimate was in line with market expectations for growth of 0.3% from the first quarter. Sterling traded much in the middle of the day’s range after the release, clinging to the $1.30 handle. The numbers were not great, but completely as expected. Coupled with the recent fall in inflation there is little cause for the Bank of England to alter course in August.

GBP / USD – Range 1.32 – 1.20 – Today at 1.30
GBP / EUR – Range 1.20 – 1.10 – Today at 1.11 (Close to 1.12)
GBP / JPY – Range 150 – 130 – Today at 145

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 been volatile, but at the same time improving. WTI Crude is currently trading at $48.35 and $50.57 for Brent, up approx. 3.4% for WTI and approx. 2.7% for Brent. Oil has been an interesting topic recently and the current growth has been largely attributed by Saudi Arabia’s decision to reduce oil exports in August which adds to other measures that will limit output, leading to higher crude prices. The volatility in the price is purely driven by the fact that there is simply too much oil in inventories at present. OPEC and non-OPEC members have been meeting in Russia to discuss what additional measures can be taken to reduce the oil glut. On Monday, it appeared that Nigeria would cap its output. Saudi Energy Minister Khalid al-Falih said that his country would limit its crude exports to 6.6m barrels per day next month, almost 1m barrels per day lower than a year earlier.

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.

Over the past week, we have seen the price of gold inch upwards approx. $5 an ounce to $1,245 a troy ounce. Helping the upswing is growing doubt over the ability of Donald Trump’s administration to make good on pledges to investment huge sums into the economy, cut taxes and substantially enhance growth. That would have boosted the dollar and made a stronger case for higher interest rates, both of which are negatively correlated to gold. In addition, the Federal Reserve meets this week and gold is always likely to remain subdued before such an event. The general consensus out there is that the Fed will not raise rates now given Yellen’s tone of raising rates “gradually”.

Model Portfolios & Indices

The markets got off to a gloomy start this this week:

  • In the UK, the FTSE specifically hurt by comments from the International Monetary Fund (IMF) downgrading the growth outlook. The Washington-based entity revised the UK’s 2017 growth forecasts lower, from the 2% target set in April to a seemingly Brexit-dragged 1.7%. IMF economic counsellor Maurice Obstfeld blamed the UK’s ‘tepid performance’ so far, this year for the revision, with the outlook for 2018 unchanged at a fairly dismal 1.5%. Of course, the FTSE wasn’t best pleased about this news, dropping half a percent to complete the shedding of all the growth managed in the back half of last week. Earlier this week, the FTSE 100 was lifted following a rise in copper prices and other commodity prices.
  • With the US, the Dollar shed short-lived gains on Tuesday on the Dow. The S&P 500 is at record highs based on better than expected earnings.
  • With Asia and Australia, Asian markets barely moved while investors awaited the next US Federal Reserve meeting. Japan’s Nikkei and Korea’s KOSPI retreated slightly and momentum slowed down after hitting record highs. Today Hitachi Construction Machinery and Komatsu both helped to push the Nikkei 0.48% higher in the search for gold. Australian shares pushed higher, led by industrial, material and healthcare stocks and helped by surging oil prices.

Again, with all the uncertainty in the markets, it’s important to note how our portfolios are much less volatile than the indices. This is down to the diversification of the portfolios and the sectors we have strong conviction in. This shows that our chosen fund managers are investing in areas which are deemed to be less volatile with high growth convictions. As we progress through the economic cycle, we will continue our defensive approach and will directionally invest your capital in areas we have strong conviction in once markets start to improve.

This Day in History

On this day in 1803, the Surrey Iron Railway, arguably the world’s first public railway, opens in south London. The Surrey Iron Railway ran south from the Thames at Wandsworth (South London) towards the Wandle Valley industrial area. It was later extended further south. This was the first public railway in Britain and was therefore a significant milestone. It was horse powered and the wagons running on it used plain wheels (unflanged) running on ‘L’ shaped rails. It was a direct descendent of the rutted track ways of antiquity.

As always have a wonderful week and stay safe.

VBW

Jason