Market Commentary – 12th September 2017
UK Inflation – Is this a reason to raise UK interest rates
The UK’s inflation rate climbed to its joint highest in more than five years in August as the price of petrol and clothing rose resulting in the Consumer Prices Index rising to 2.9% in August, up from 2.6% in July. This has been predicated by the fall in the value of sterling since the EU referendum which has continued to be a major impetus for rising prices, the Office for National Statistics said. It was not only that which caused it though in addition the rebound in the price of oil also had an impact, pushing up fuel prices.
As a result, the market has reversed its view on UK Interest Rates and that has caused Sterling to rise and comes ahead of the Bank of England’s next announcement on interest rates on Thursday. However, economists said the Bank was still highly unlikely to raise rates at the meeting. Our reasons for assuming this is although we have inflation higher than anticipated it is still being impacted by movements in Sterling and fuel and not solely on the consumer side, accepting the conversation should be being had and interest rates do need to rise. Despite this Wages are not rising and as inflation is now higher than wage inflation and has bene since February 2017 and this is not good for anyone.
Global Economic News
In the UK, we have had positive news on employment numbers, house prices and manufacturing production and negative news on construction orders, inflation and average earnings as noted above. The data is still mixed and with Brexit negotiations not really going anywhere and the expected meetings next week being delayed by a week to allow further negotiations we do not see the UK economy doing anything but stalling. Consumer spending was still robust and the week ahead will focus on this as the new retail sales figures will be announced next Wednesday. On Thursday, this week we have the Bank of England convening so it is going to be an interesting week for Sterling.
In Europe, we have again had mixed data starting with factory orders in Germany being significantly less than expected last Wednesday, and overall euro area production year on year being 3.2% instead of the expected 3.4%. The news flow is still good but we are continuing to see a slight undershoot with no signs of the much-needed inflation coming through. The week ahead will be interesting as with the UK as we get to see the European Union consumer confidence numbers and we have an ECB meeting and although nothing new is expected anyone who is anyone will be looking for direction from Mario Draghi as regards to the future direction of rates and QE in Europe.
In the US, the news flows has been dominated by Hurricane IRMA which although devastating for the Caribbean region and Florida Keys blew itself out before it hit the mainland and that was a relief and caused the markets to rally on Monday, especially insurance relate stocks. The data flow is mainly positive with Non-Manufacturing data all higher than anticipated with most other data point coming in in line with expectations. We are now seeing a focus back on domestic policies and the original trump agenda with Treasury Secretary Steven Mnuchin talking about the tax cuts saying that they are considering backdating tax cut to Jan. 1 and that this would be a “boon to the economy”. He is still confident that a tax reform plan will get passed this year, despite the fact that Congress has not yet released a proposal. As a negative though he did also say that President Trump’s goal of chopping the corporate tax rate to 15 percent will be tough to achieve. Watch this space though as we expect October to be a month of movement on this, which will result in further stimulus, and potentially reverse the slide in the US$ that we have so far seen YTD against a basket of global currencies.
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.
Earnings Scorecard: For Q2 2017 (with 100% of the companies in the S&P 500 reporting actual results for the quarter), 73% of S&P 500 companies reported positive EPS surprises and 70% reported positive sales surprises. For Q3 2017, the estimated earnings growth rate for the S&P 500 is 4.9%. Eight sectors are expected to report earnings growth for the quarter, led by the Energy sector. For guidance 73 S&P 500 companies have issued negative EPS guidance and 43 S&P 500 companies have issued positive EPS guidance. On a valuation basis the forward 12 month P/E ratio for the S&P 500 is 17.4. This P/E ratio is above the 5-year average (15.5) and above the 10-year average (14.1). The US is therefore expensive but earnings are robust and supportive of equities still.
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 continue to increase with corresponding valuations decrease in the UK and the Eurozone with them remaining flat in the US. Bond markets have continued to be quite volatile recently given the geopolitical tensions between North Korea, and the US and the US’s allies. 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.
The pound has climbed again due to inflation and the move this week has been quite big despite the weaker than expected data. The currency, which was skirting an 11-month low, a few weeks ago is now up against the Japanese yen, dollar and the euro. A strong pound tends to devalue the foreign earnings of London-listed firms, hitting their share prices as well being a negative as regards to returns.
GBP / USD – Range 1.32 – 1.20 – Today at 1.33 and last week 1.30 – Weekly change 2.3% which is not good for portfolios invested overseas
GBP / EUR – Range 1.15 – 1.04 – Today at 1.11 and last week 1.09 – Weekly change 1.83% which is not good for portfolios invested overseas
GBP / JPY – Range 150 – 130 – Today at 146 and last week 141– Weekly change 3.5% which is not good for portfolios invested overseas
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 flat and demand continues to increase. Despite many reasons though for the price to rise we still see to see both Crude and Brent not track higher than $50 and $55 and it is therefore likely that the production cuts we have seen so far this era will continue.
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 remain static at circa $1,334 a troy ounce at the time of writing. Given the current global outlook, investors seem to be holding as a hedge against risks safe-haven assets as the current market risks are high following the new sanctions against North Korea. On a 5 year chart we are still significantly below the lows seen in 2012 following the US down grade in late 2011 and as the economy continues heading towards the end of the end of the cycle this asset class is seen as relative good value.
We are looking within portfolios to create a position but we are waiting on what we hope is positive news from the BOE which will push sterling higher in the short term before we open a position. If anything was to happen again with North Korea this asset class would benefit significantly.
Model Portfolios & Indices
Over the past week we have seen the portfolios decrease slightly due to the movement in sterling against the assets we hold ameliorating the gains in the underlying assets. This is expected in the short term especially after a period of sterling weakness. As an observation, all assets over the summer have given nothing with high levels of volatility as noted by the chart below. This though has not just been equities, I have also included the UK government debt chart which is just as volatile and still provided a negative return. This is not unusual as the summer is always quiet but as the traders returns and hopefully with continued positive data and the refocus on the Trump tax agenda will result in equity indexes across the World excluding the UK will benefit from the continued move towards normalisation before the expansion phase ends.
Within the portfolios we have taken the profit on our UK All Caps position as we saw no further upside from it and are currently holing cash waiting for a entry back into an overweight European Equity position, UK Strategic Bond position, Gold as a hedge against risk and Emerging Economy position that are more focussed on South America, Argentina and Asia than the traditional BRIC economies that have already seen the rally in prices.
This Day in History
1980: Missing Scottish bear is found – The bear who went missing on a Scottish island while being filmed for a Kleenex television commercial has finally been recaptured. Hundreds of volunteers have been involved in the search for Hercules since he went missing 24 days ago on Benbecula in the Outer Hebrides. A crofter spotted the 8 ft 4 in (2.54 m), half-ton animal swimming earlier today – almost three weeks after the hunt for the creature had been called off. The bear was shot with a tranquiliser dart, captured in a net and flown by helicopter back to his specially built coach where his owner – the wrestler Andy Robin – was waiting anxiously.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager