Market Commentary – 27th September 2017
Is it the end of the UK’s ‘having cake and eat it’ plan?
The President of the European Parliament, Donald Tusk, said the UK’s “philosophy of having a cake and eating it is finally coming to an end” after Theresa May adopted a more “realistic” approach to Brexit negotiations in her Florence speech last week.
Speaking outside Downing Street following a meeting with the Prime Minister, Tusk said he was “cautiously optimistic about the constructive and more realistic tone” adopted by the government over the past week. But he said work was still needed on the rights of EU citizens, the Brexit divorce bill and the Irish border before negotiations could turn to a future trade deal.
European leaders are due to meet next month to decide whether sufficient progress has been made on the EU’s three red lines before granting the negotiators permission to begin discussing a future trading relationship.
Global Economic News
In the UK, not much data has come out over the past week however, Friday will be an interesting day as we get GDP figures which will indicate the resilience of the economy following the uncertainties it faces. A light week of economic data yielded some positives for the economy. Retail sales growth ran at a decent rate in August and the same month showed another improvement in the public finances. The focus of attention as far as the UK economy is concerned has been the growing possibility in the minds of many that the Monetary Policy Committee (MPC) is close to taking the plunge and delivering the first rise in Interest Rates since July 2007. This week’s developments yielded some ammunition for such a move to increase the Interest Rate. August delivered a 1% monthly rise in retail sales, the best performance since April, while growth in July was revised up a touch. Moreover, August’s performance capped off three consecutive months of growth, a consistency not seen since the first half of 2015. Short of a very poor reading in September, the retail sector should make a positive contribution to GDP growth in Q3 – even if sales volumes were to stagnate in September, retail sales would expand by 0.8% in the quarter.
In Europe, the first wave of survey data for the Eurozone in September has struck a very upbeat tone. Despite the strong euro, the robust start to the year seems to have been maintained in Q3 and momentum may even have built into the autumn. A key contributor to the Eurozone’s surprising strength since late last year has been exports. While China has played a role in this development, the export figures show that much of the recent strength has been down to trade within Europe. This, combined with solid domestic demand since last autumn and improving prospects in other advanced economies, hints at a more sustained period of economic strength and upside risks to the general forecasts of economists. Indeed, another year of GDP growth in excess of 2% in 2018 seems increasingly plausible.
In the US, last week the Federal Reserve decided on interest rates and the FOMC kept fed funds target range unchanged at 1.25%. However, the median dot plot estimates signal another rate hike this year, followed by three rate increases in 2018. It is suggested that concerns in the slowdown in inflation could be “persistent” will lead policymakers to forgo additional rate hikes this year and to only raise rates twice (50 basis points in total) in 2018. Further, Hurricane Harvey and Irma are playing havoc with the economic data, obscuring the Fed’s view of underlying economic trends. The policy statement included a comment on the hurricane impacts. Storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term. There will be some higher inflation in the aftermath, but only a temporary boost. While, the consensus on the FOMC continues to assert that the slowing in the pace of inflation is due to idiosyncratic factors, notable doves on the FOMC have raised concerns that inflation may continue to undershoot the 2% target. Fed Chair Yellen in her press conference was repeatedly asked about the continued low pace of inflation. While she maintained a balanced approach, saying that on one hand further tightening in the labour market should lead to higher wages and a rise in inflation over time, on the other hand she emphasised that Fed officials do not fully understand why inflation is remaining low for so long. Moreover, she said monetary policy projections could be altered if inflation does not rebound as expected. Despite the recent jump in the August CPI reading, it is expected that inflation will remain below its target through 2019. It is also expected that the slow pace of inflation will keep the Fed from raising rates again this year and the markets expect just two rate hikes next year.
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.
For Q3 2017 (with 6 companies in the S&P 500 reporting actual results for the quarter), 4 companies have reported positive Earnings Per Shares (EPS) surprises and 4 companies have reported positive sales surprises. For Q3 2017, the estimated earnings growth rate for the S&P 500 is 4.2%. Eight sectors are expected to report earnings growth for the quarter, led by the Energy sector. The forward 12-month P/E ratio for the S&P 500 is 17.7. This P/E ratio is above the 5-year average (15.5) and above the 10-year average (14.1) which is still in line with our past market commentaries highlighting that the US is expensive, however earnings are robust and supportive of the equity rally.
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, compared to the previous three weeks we have seen bond yields stabilise with corresponding stabilisation in valuations. 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 a sensitive topic and the story from the Telegraph which reported that Ms May’s watershed speech in Florence didn’t turn out as expected as she accepted a so-called ‘divorce bill’ fulfilling the UK’s pre-Brexit commitments, until then a major sticking point in negotiations, was dictated by representatives of the regional bloc. Perhaps the markets took the revelation to mean London might be pressured to take a harder line going forward. As a guide, 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 (Likely to drop back in our range)
GBP / EUR – Range 1.15 – 1.04 – Today at 1.14
GBP / JPY – Range 150 – 130 – Today at 151 (Likely to drop back in our range)
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 increased sharply. WTI Crude is currently trading at $51 (close to $52) and $58 for Brent, up approx. 2.4% for WTI and approx. 3.8% for Brent. Oil prices stood little changed since Monday, keeping most of their gains from the previous session to hold near their highest levels in months, as major producers meeting in Vienna said the market was well on its way towards rebalancing. Also, U.S. data showed an unexpected drop in crude stocks as refineries boosted output and amid threats from Turkey to cut crude exports from Iraq.
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. $17 an ounce to $1,292 a troy ounce. Last week the metal moved to its lows we are currently seeing in the wake of the stock market sell-off following terror attacks in Spain and ongoing political turmoil in the US. The political unrest in Washington, resulting from Donald Trump’s threat to shut down the government if he is not granted funds to build a wall on the Mexican border, is generally positive for gold. That it is instead trapped in a range below its 2017 peak of $1,295 is thanks to a focus on Jackson Hole, where Federal Reserve chair Janet Yellen will speak on Friday. This entire situation with Trump would continue to help gold in the short and longer term. The big upward push for the gold price which we are not seeing is because of the possibility of some unexpected hawkish comments by Janet Yellen during her upcoming speech. Markets are looking for signals as to whether the Fed will press on with its forecast third interest rate rise this year, most likely in December. Gold does not pay an income and tends to fall in value when interest rates are rising. If Yellen offers a more dovish tone on the impact on financial stability of ultra-low rates, gold could break higher and set a new high for the year so far, which is yet another reason why we now hold a directional position following our last rebalance.
Model Portfolios & Indices
Following the rebalance on the 18th of September 2017, we increased our exposure in European equities, added a UK Strategic Bond position, a hedged gold position and an Asia and Latin America focussed position. These positions were added to give us the level of diversification we require during the current high-risk period in the markets. Whilst the markets absorb the various changes with central bankers and the tensions between North Korea and the US ease off, we expect these positions to benefit the portfolios. Over the past week, our portfolios have remained relatively flat eliminating most of the risk from the markets based on the equity and non-equity split and the inclusion of our new positions.
This Day in History
On this day in 1825, George Stephenson’s “Locomotion No. 1” becomes the 1st steam locomotive to carry passengers on a public rail line, this was the Stockton and Darlington Railway in England.
As always have a wonderful week and stay safe.