Market Commentary – 30th August 2017
How to avoid a nuclear catastrophe in North Korea?
The UN Security Council will convene an emergency meeting tonight to discuss North Korea options, after Pyongyang fired a ballistic missile over the Japanese island of Hokkaido. Theresa May, who flew to Japan today, said she was “outraged” by the “reckless provocation” that North Korea has posed. Shinzo Abe, the Japanese Prime Minister, said he favours “increased pressure on North Korea in co-operation with the international community”. Meanwhile, Donald Trump said that “all options are on the table”, but what options are left to deal with Kim Jong-un and the rogue state of North Korea?
- Step up economic sanctions
On 5th August, the UN Security Council passed sanctions blocking $1bn (£770m) worth of North Korean exports in industries including seafood, coal and iron ore. China, which accounts for about 90% of North Korea’s foreign trade, also buys crude oil, textiles and clothing from Pyongyang, which could be targeted with new sanctions. With no data being reported, oil might be a way to either squeeze or support the regime without any outsiders being able to scrutinize what they are doing.
Some argue that pressure and sanctions cannot fundamentally solve the issue. “The only way out is through dialogue and consultation. This may be what Kim is looking for. The prestige of negotiating directly with a superpower is something North Korea really is looking for. There’s no way the US is going to give that to North Korea without some significant concession.
- Turn the screws
The US and its allies may opt for a limited attack or series of conventional military attacks using aerial and naval assets, possibly including narrowly targeted Special Forces operations. These would have to be punishing enough to significantly damage North Korea’s capability, but small enough to avoid being perceived as the beginning of a preventive strike. The goal would be to leave Kim Jong-un in power, but force him to abandon his pursuit of nuclear ICBMs.
- Full-scale attack: The ‘fire and fury’ option
Trump has already threatened Kim with “fire and fury” should North Korea threaten the US or its territory in Guam with nuclear-tipped intercontinental ballistic missiles. He then upped the rhetoric by saying that the US military was “locked and loaded”. This week, the US President’s language was less dramatic. When Trump has been asked what are his plans, Trump replied: “We’ll see, we’ll see.”
Global Economic News
In the UK, this morning the Bank of England released their latest monthly data on money and credit in the UK economy. The total lending to individuals rose 4% in July to £1.548bn. Consumer credit (which excludes mortgages) rose by 9.8% to £201.5bn. This was the lowest growth rate since April 2016 which shows that UK consumer credit has slowed down. You may have heard in the press this week on Sterling’s weakness being more than just a Brexit story. The pound’s divergent performance against the euro and dollar offers good cause to think that its weakness is far from just a consequence of domestic developments. That said, it is not difficult to identify home-grown factors weighing on sterling. UK GDP growth of 0.3% in Q2 was half the pace of that achieved by the eurozone, a margin of underperformance unchanged from the first three months of the year (eurozone growth of 0.5% versus 0.2% in the UK). The sluggishness of the UK economy, combined with evidence that inflationary pressures are easing, should quash the initial signs off a more hawkish bias among MPC members that was becoming apparent earlier in the summer. Some backtracking was already evident in August’s Inflation Report and it is expected that the Bank Rate will remain at the current level of 0.25% until at least early 2019. The BoE is set to remain firmly outside the pack of central banks engaging or preparing for the end of “emergency” policies. There are of course Brexit uncertainties that are likely to intensify as we move into the autumn, a period which will encompass a new round of UK-EU negotiations in the week of 27th August, the Conservative Party Conference in early October and the, at least hoped-for, conclusion to the first round of “divorce” talks between the UK and the EU, which are due to occur between October and December. It is positive that the Government has recently offered its view on how it sees the UK’s relationship with the EU developing post-Brexit. But as some of the big separation issues, notably the “divorce bill” have yet to be grasped, there is a risk that the negotiations will slow down, which raises the chances of no deal being reached. However, developments across the Channel suggest that sterling would be under pressure even if conditions in the UK were more benign.
In Europe, the second release of Q2 GDP for France (yesterday) confirmed that the economy has enjoyed three quarters of stable growth of 0.5% – pointing to a more self-sustained economic recovery. Both investment and consumption were key contributors to Q2 GDP, suggesting that domestic demand remains an important driver of growth. Data also confirmed net trade recovered, highlighting that France is benefiting from the global trade upswing. Looking forward to Q3, consumer spending data in July highlighted that consumption will add further to growth. Consumption rebounded by 0.7% on the month, offsetting the 0.7% decrease in June. Encouragingly, durable goods consumption increased markedly, highlighting that the recent drop in consumer confidence, which appears more linked to politics than households’ confidence in their future financial outlook, will not weigh significantly on consumption dynamics. As such, Macron’s popularity has dropped further in August, suggesting his reform programme is set to be challenged. Nonetheless, confidence indicators, such as the PMI, remain at elevated levels and most of the GDP indicators that we use points to 0.5% growth in Q3. Meanwhile, yesterday the euro reached its highest level in two years, breaking above the 1.20 mark against the US Dollar. Nonetheless, these latest developments appear to be mostly linked to a weakening dollar, as the hurricane in Texas is set to weigh on US economic activity and tensions with North Korea suggest the dollar may be less of a safe-haven, and so investors went to the Japanese Yen. While the ECB does not target the euro exchange rate, it has expressed some concern recently over the strengthening currency. A stronger euro is likely to weigh on activity by affecting exporters’ competitiveness. It is expected that the ECB will continue to tread cautiously when normalising its monetary policy. It is also expected in the markets that the ECB will announce a reduction of asset purchases to €40bn per month (from the current €60bn) starting in January 2018, either at the September or October policy meeting. Everyone is closely watching this.
In the US, Hurricane Harvey battered Texas with record amounts of rainfall, howling winds and multiple tornadoes. The storm has crippled Southeast Texas, with Houston, the fourth most populous US city, feeling the brunt of the storm. The Federal Emergency Management Agency expects Harvey will end up being the worst natural disaster to hit Texas in its history. Early estimates point to infrastructure damage worth $10 billion of insured damages and as high as $30 billion in terms of total damages, which would put it on par with Hurricane Sandy (which pummelled the East Coast in 2012). Damage to infrastructure will not affect Q3 GDP growth since it doesn’t factor into the GDP calculation, but it is expected that rebuilding efforts will provide a mild boost to GDP growth in subsequent quarters. In the private sector, insurance will cover some of the reconstruction costs, but not all. Other reconstruction may not be done at all. Further, even reconstruction covered by insurance is not a “free lunch”, since it comes out of insurers’ profits and could lead to higher insurance premiums. The drag to economic activity will come mainly through permanent losses in economic output. Businesses across most of Southeast Texas are closed and consumers are shuttered in their homes, or shelters. Neither are likely to “make up” for lost spending once the storm passes. While storm preparation sales and clean-up activity may mitigate some of these losses, they are unlikely to completely offset the loss of spending, resulting in a net drag on local and state GDP growth in Q3. Houston, where Harvey’s impact has been concentrated, accounts for about 2.5% of national GDP. Disruptions along the energy supply chain and log-jams at key ports on the Gulf Coast will also have negative implications for the wider domestic economy. According to media reports, roughly 25% of US oil and gas production is currently shuttered and 10-15% of US refining activity is offline. One of the main ways this will come to affect the broad economy will be by pushing gasoline prices higher. On top of the rise in gasoline prices, the hurricane’s impact will also be felt in the national-level labour market data. Using the experience with Hurricane Katrina as a guide, initial jobless claims will rise over the next few weeks as workers in Southeast Texas apply for compensation benefits, but claims should settle back down as economic activity in the region resumes and reconstruction begins. Importantly, the hurricane is unlikely to have a meaningful impact on August nonfarm payrolls, since the survey data is collected for the pay period which includes the 12th of the month (before the hurricane hit) and only 10% of employees are paid on a monthly basis. However, the hurricane’s impact could be felt in the September employment figures or even thereafter. Much depends on how quickly businesses can re-open and how quickly reconstruction gets underway.
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 it stands from the week before last, 91% of the companies in the S&P 500 reporting actual results for Q2 2017, 73% have reported positive EPS surprises and 69% have reported positive sales surprises. For Q2 2017, the blended earnings growth rate for the S&P 500 is 10.2%. Ten sectors are reporting or have reported 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 decrease with corresponding valuations increasing for Europe and the UK. On the contrary, the opposite is true for the US, where bond valuations dropped, with corresponding yields increasing. 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 fallen further and has now sunk to 11-month lows against the euro, and yesterday the exchange was trading at 1.07. There are several reasons that the pound is being undermined at this juncture. The UK’s sluggish GDP and the fact that interest rates do not look like they are going to rise anytime soon. All these uncertainties surrounding Brexit raises the question in the markets “could the pound hit parity against the euro?”. This could be a possibility, but not in the short term. As Brexit matures, we could expect the pound to fall further, and since it’s not too far from parity, it may be a possibility. The Euro at the same time is also strengthening with the Eurozone strengthening. This will only continue to close the gap. With the Japanese Yen, this is considered as a safe-haven currency asset, and despite the North Korean missile flying over Northern Japan, investors seek refuge in the currency which tends to benefit during times of geopolitical or financial uncertainty, and this shot up early this week.
GBP / USD – Range 1.32 – 1.20 – Today at 1.29
GBP / EUR – Range 1.22 – 1.12 – Today at 1.08
GBP / JPY – Range 150 – 130 – Today at 142
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 dropped. WTI Crude is currently trading at $46.16 and $51.67 for Brent, down approx. 3.2% for WTI and approx. 0.14% for Brent. The flooding and storm damage caused by Hurricane Harvey disabled almost a quarter of US refineries, raising fears of fuel shortages. For instance, the largest US refinery, Motiva Enterprises’ 603,000 barrels-per-day plant in Port Arthur, Texas, was shutting down on last night because of flooding. So, while oil prices have dropped, US gasoline prices have climbed to their highest price since mid-2015 due to supply shortages.
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 approx. $23 an ounce to $1,307 a troy ounce. Gold prices climbed almost 1% yesterday alone, as investors went to seek out safe havens on the back of global concern over the North Korea missile crisis and the damaging effects of Hurricane Harvey. The precious metals’ 1% rise yesterday was its largest one-day hike since May, as the US dollar weakened on expectations that the Federal Reserve will ease off on further interest rate rises. The price of gold has reached its highest point of the year after climbing 15% since the start of January.
Model Portfolios & Indices
Global stock markets didn’t respond wildly to the North Korea missile launch on Monday and didn’t react drastically for two main reasons:
The fact that Donald Trump didn’t tweet anything inappropriate after the launch, and;
- North Korea’s main ally China has called for restraint, which helped put some commentators’ minds at rest and helped global stock markets breathe a sigh of relief.
Markets have now rebounded following the losses as the tensions have started to ease. Japan’s Nikkei rebounded from a four-month low, adding 0.74%, while South Korea’s KOSPI also headed slightly higher. Hong Kong’s Hang Seng surged more than one percent, while the mainland Chinese indexes also edged higher, despite a pull-back in the banking sector. Australia’s ASX opened higher, but shed most of its gains after the country’s biggest telecommunications provider Telstra fell 6.1% after it dropped a plan to raise money by selling income it receives from a government-owned broadband network. It is however astonishing what shakes the markets. Currently, markets and investors are watching what’s happening in the global economy and what’s happening on company results, which are the key fundamentals we should be focusing on and not geopolitical noise. Unless these missiles start going off on land and it suddenly goes to the next stage of a terrible breakout of war, these markets aren’t going to react much.
With our portfolios, they have remained relatively flat over the past week with changes following the global geo-political tensions driven North Korea. This is down to the mandate of our OBI portfolios, which are well diversified to consider changes in the markets with considerably less volatility. As the tensions with North Korea ease, investors will keep an eye out on strong economic fundamentals rather than the political noise, which will continue to be a positive for our portfolios.
Following the Investment Committee Meeting last week, we sold down the Artemis Pan European Absolute return fund yesterday and will allocate the proceeds to Sterling Strategic Bonds for our low risk portfolios (OBI 3, OBI 4, and OBI 5) and we will add the proceeds to Europe and Emerging Markets for the high-risk portfolios (OBI 6, OBI 7, OBI 8 and OBI 9). Given the current economic cycle, we have strong conviction in these areas, which has been strengthened by external economists who share the same view.
This Day in History
On this day in 1860, the first British tram opens in Birkenhead. The inaugural route was from Woodside Ferry to the main entrance of Birkenhead Park. Birkenhead’s great green space had been one of the major inspirations behind the design of New York’s Central Park which had opened three years previously. Less than a year after the tram ran in Birkenhead, the inventor, George Francis established the train line into London, running between Notting Hill and Marble Arch, where services began in March 1861.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager