Market Commentary – 11th October 2017
Hammond raising his concerns over Brexit…
This morning, Chancellor Philip Hammond was being questioned and he has told the Treasury Select Committee that the uncertainty around Brexit talks is influencing the UK economy. He said that the “UK economy is fundamentally robust and we have some very positive things going on, with a strong outlook for the future”. He then raised his current concerns by stating “However, the cloud of uncertainty over current negotiations is acting as a temporary dampener and we need to remove it as soon as possible to make some progress. There is plenty of anecdotal evidence that businesses and consumers are waiting to see what the outcome is before firming up investment decisions.”
Global Economic News
In the UK, as the data coming out of the economy keeps sending mixed messages, it is likely that the next Monetary Policy Committee (MPC) meeting in November will signal a rate hike, it’s not so much that the interest rates have been increased by a likely 25 basis points, however its more that the economy is heading back towards higher rates and the policy members are more optimistic on the economy. September has seen modest growth with relatively improved figures from previous months, largely attributed by a devalued pound. Official output data for August showed industry, manufacturing and construction all seeing month-on-month expansions, a consistency rarely seen over the course of this year. But the pace of growth was modest and points to overall GDP growth struggling to have exceeded 0.3% in Q3. Meanwhile, a widening in the trade deficit suggests that the overseas sector probably dragged on output in the quarter. A gap between buoyant manufacturing surveys but downbeat official data had been one of the puzzles of the economy earlier in the year, but August saw that gap continue to be resolved in a favourable direction. A 0.4% rise in output was the fourth consecutive monthly increase and left the sector 2.8% bigger than a year earlier, the best year-on-year performance since February. Growth in manufacturing supported a 0.2% monthly rise in overall industrial production, with a maintenance-driven drop in oil and gas production dragging the industry number down. Meanwhile, the three months to August saw the industrial sector expand by 0.9%. August also yielded a 0.6% rise in construction output, the first monthly rise since May. But weakness earlier in the summer meant the sector contracted by 0.8% in the three months to August, implying that a fall in output in Q3 as a whole seems highly likely. Official services data is currently available only for July, but economist’s short-term models, which usually use business survey results to plug the gaps in the official output data, points to Q3 repeating the soft 0.3% rise in GDP seen in the first two quarters of the year. As to the sources of that growth, a £10.8bn trade deficit in the three months to August was the biggest in almost a year, consistent with net trade dragging on output in the quarter.
In Europe, after the “surge” in German industrial production in August (+2.6% over the month), yesterday’s data for Italy and France, which together account for more than 30% of Eurozone industry, were a mixed bag. Italian industrial output increased by 1.2% in August. While August is usually a difficult month to predict due to summer closures often making the data very volatile, the outturn was well above consensus expectations. Moreover, it came after the strong expansion in June and further growth in July. Following the very strong sentiment indicators coming from the industrial surveys for last month, such as the manufacturing PMI at its highest since 2011, French industrial production unexpectedly dropped by 0.3% in August, after a 0.8% expansion in July. However, the weakness in August is probably due to the volatility of the summer season, which for now leaves economists confident that the underlying positive trend of industrial activity in France is intact. Adding to the very positive industrial production data released on Monday, yesterday’s trade figures show that German exports also boomed in August. This is encouraging given the appreciation of the euro and is reflective of strong global demand. Seasonally adjusted exports increased by more than 3% over the month, well above the market consensus, while imports rose by 1.2%. This resulted in an expanding trade balance, which grew to €21.6bn from €19.3bn in July. Combining all the industrial production data released so far, which accounts for around 80% of total Eurozone industrial output, suggests an increase of industrial activity of more than 1.5% in the region in August, which would be the first robust expansion in a few months following a weak start to the quarter. And although not as strong as Q2, where industrial activity expanded by 1.2% over the quarter, a positive expansion in industrial activity in Q3 is expected, consistent with GDP growth in the Eurozone of around 0.5%. Moreover, the recent indicators, such as the Eurozone manufacturing PMI for September, suggest that this process is set to continue until at least the end of the year. The Eurozone manufacturing PMI for September, which is currently at a reading of 58.1, was the highest reading in seven years, and did not show any signs that the rise of the euro was having a negative impact on export performance so far.
In the US, we got important economic data on Friday last week regarding the US Unemployment rate and non-farm Payrolls. The September non-farm payroll count (-33,000) was adversely affected by Hurricanes Harvey and Irma. While the Bureau of Labour Statistics (BLS) could not quantify the precise impact, the number of individuals with a job but not able to get to work due to the weather, jumped to a 21-year high of 1.5 million, versus 31,000 reported a year ago in September 2016. As further confirmation of a weather impact, 111,000 jobs were lost in the leisure and hospitality sector (jobs were impacted in the Florida and Texas areas due to the storms). However, the big news was the broad-based 0.5% jump in average hourly earnings that lifted the year-on-year rate to 2.9%, which followed an upward revision to the annual pace in August to 2.7% from 2.5%. The annual advance of 2.9% is now back to the pace recorded in December 2016. Another reassuring element came from the 906,000 surge in household employment that pushed the official U-3 unemployment rate, which fell 0.2 percentage points to 4.2%, marking the lowest rate since February 2001. The U-6 unemployment rate also declined a large 0.3 percentage points to 8.3%, the lowest since June 2007. Meanwhile, the labour force participation rate rose to 63.1% from 62.9% in August, the highest since September 2013. The continued tightening in the labour market and the reacceleration in average hourly earnings support a December rate hike by the Fed, despite inflation readings remaining below the 2% target. Further, given the surge in household employment and the experience from hurricane Katrina disruptions in 2005, it is believed the 33,000 drop in payrolls will be revised up in the coming months.
Globally, the International Monetary Fund (IMF) has said that they expect global growth to strengthen as they see the global economic recovery is strengthening further. In its latest World Economic Outlook, the IMF has revised its forecast for the global economy and is now expecting slightly stronger growth. It now predicts growth of 3.6% this year and 3.7% in 2018. The IMF’s forecast for the UK is the same as in its July report. It expects growth to slow from 1.8% in 2016 to 1.7% this year and to 1.5% in 2018. Although the UK is an exception to the pattern of strengthening growth in the IMF’s assessment, for this year and next the growth projections are stronger than two other G7 economies, Japan and Italy.
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, the estimated earnings growth rate for the S&P 500 is 2.8%. Seven sectors are expected to report earnings growth for the quarter, led by the Energy sector. For Q3 2017 (with 5% of the companies in the S&P 500 reporting actual results for the quarter), 87% of S&P 500 companies have reported positive EPS surprises and 78% have reported positive sales surprises. The forward 12-month P/E ratio for the S&P 500 is 18.0. This P/E ratio is above the 5-year average (15.6) and above the 10-year average (14.1).
By calculating money flows, we can analyse investors’ perceptions on the markets and quantify whether they were positive or negative. A positive money flow is when a stock is purchased at a higher price, or an uptick and vice versa. This indication will give us a sign on where we are on the economic cycle and the current sensitivity as we edge closer to the top. To be able to quantify this, we have looked at the Money Flow Index (MFI) which is a momentum indicator that measures the strength of money entering or leaving a market. The MFI adds volume to the Relative Strength Index (RSI) and is also commonly referred to as the volume-weighted RSI. An MFI of over 80 suggests that the security in question is overbought and under 20 indicates that it is oversold (over the past week).
Given where global stock indices currently are, most are trading at record highs which would indicate that net money flows are positive at this current juncture and investors are willing to pay a premium for the stocks.
MFI FTSE 100 = 86.908
MFI S&P 500 = 65.215
MFI Euro STOXX 600 = 69.425
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 in the US and in Europe. The contrary was true for the UK with bond yields increasing very slightly with corresponding valuations increasing slightly. The changes in valuations aren’t as high as they have been and the risks remain relatively subdued from our comments last week, however 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 over the past week has been improving following the strong sentiment from central bankers that we can expect interest rates to rise soon. Strong manufacturing data that came out earlier this week also helped the currency edge higher. With the Euro, relief over Catalonia has also pushed the euro to a two-week high. It’s the first time that it’s been above $1.18 since the 01st October vote. But the markets remain wary and the euro has gained little traction. It’s unlikely we’ve heard the last of this debate, despite cooler heads prevailing which could lead to the currency struggling further. With the USD, on a spot basis it has remained relatively flat over the past week, however over the long term the dollar has been weakening and it is waiting for Trump to pass his tax reform through congress
GBP / USD – Range 1.32 – 1.20 – Today at 1.31 (edging closer towards 1.32)
GBP / EUR – Range 1.15 – 1.04 – Today at 1.11
GBP / JPY – Range 150 – 130 – Today at 148
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. WTI Crude is currently trading at $51 and $56 for Brent, up approx. 2% for WTI and approx. 3% for Brent. Oil has been improving after news yesterday revealed that more countries might join the OPEC agreement which has brought the price up well above the $50 much anticipated 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 increase approx. $14 an ounce to $1,289 a troy ounce. As gold remains to be one of the most common safe-haven assets, investors will continue to closely watch the asset as we get some direction from central bankers, especially the Fed, indicating where global interest rates will head. Until then, it is expected that gold will continue to hover around $1,300, indicating high risks in the markets currently.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track improve with gains being made in in the US, UK and Asia. Spanish stocks have now helped to drive global stocks to an all-time high. They hit a fresh all-time high on the MSCI World Index, albeit briefly. There was a chance Carles Puigdemont (Catalan leader) would have made a decisive declaration, so now yields are dropping because there is room for negotiation left. With Asia, Tokyo’s main stock market index, the Nikkei, closed at a 21-year high in more than two decades today as optimism spread across global markets. It was the best finish for the index since 1996 and follows fresh record highs on Wall Street overnight. The 21-year high comes in spite of the continuing problems at Japan’s Kobe Steel, which has lost more than $1.5bn (£1.1bn) in market value in two days. In contrast to the Nikkei’s gains, Hong Kong’s Hang Seng index fell 101.26 points, or nearly 0.4%, to close at 28,389.57.
As equities continue to rally and reach record highs based on strong earnings, our portfolios have edged higher over the past week with less market volatility based on the equity and non-equity split. As we near closer to the end of the equity rally, we will keep a close eye on the economic fundamentals and the politics. As we gain some clarification over various concerns holding the markets down, such as the process of Brexit, Donald Trump’s fiscal stimulus packages and issues with the US and North Korea, we will increase our equity allocation.
This Day in History
On this day in 1990, Oil hits a record high of $40.42 per barrel. Oil has gone below this level since with lows of $25 a barrel at the start of 2016 and highs of over $145 a barrel in 2008.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager