Market Commentary – 18th October 2017
Is a ‘no-deal’ Brexit better than a bad deal?
With Brexit negotiations deadlocked, the possibility of Britain crashing out of the EU without a formal agreement has become a real possibility – but what would a “no-deal” Brexit actually look like?
If there is no arrangement by 29th March 2019, under Article 50 of the Lisbon Treaty bilateral trade agreements fall away. The 1.2 million Britons living in the EU, and a further three million EU citizens residing in Britain, could be stripped of their rights, and the fragile peace along Northern Ireland’s border with its southern neighbour could collapse. Much would then depend on how long both sides have had to prepare for this, but the consequences of having no deal would affect almost every aspect of life from a currency collapse to job losses.
So, what is happening with the negotiations? Well, on Monday Theresa May had a private dinner with Jean-Claude Juncker and Michel Barnier in Brussels which ended with the Prime Minister in the same position she left in with no apparent progression, which shows the complexity of the task at hand. The risks and outcomes of Brexit are now becoming a reality, which is feeding itself into the markets and the economy. As highlighted below, inflation yesterday reached 3% with subdued real incomes (not so real as they aren’t being adjusted for inflation) not matching to the higher cost of borrowing. The think tank, Resolution Foundation, says poorer families would bear the costs of leaving Europe without a trade deal.
Global Economic News
In the UK, this morning the claimant count and unemployment rate figures were out which were in line with the last data reading. Unemployment fell by 52,000 in the three months to August 1.4 million. Also, wage growth slowed to 2.1% in the three months to August, although it was slightly better than the 2% estimated by economists. Yesterday, we got the much-awaited inflation data for Consumer Price Index (CPI) and Retail Price Index (RPI). CPI inflation edged up from 2.9% in August to 3.0% in September, the highest reading since April 2012! Though last month’s acceleration in clothing prices – caused by changes to the timing of late-summer discounting unwound as expected, this was more than offset by a sharp pickup in food prices. It is expected by economists that we will see inflation accelerate further next month. Mid-September’s 12.5% increase in domestic electricity bills by British Gas came too late to be captured in this month’s release. But more broadly, economists remain of the opinion that we are close to the peak in inflation and that the peak will be a little north of 3%. Several of the factors that have driven up inflation over the past year, namely the pass-through of last year’s depreciation of sterling, the impact of higher oil prices and base effects, are set to become less influential or even switch direction. With slight evidence of any second-round effects on wages or inflation expectations, economists generally expect inflation to slow and drop back below the ±2% target as we move through 2018. Economists still believe that the case for a rate hike is very weak, but with the majority of the MPC seemingly already convinced, there is unlikely to have been anything in yesterday’s release to cause that conviction to waver. Some experts have argued that now is not the time to raise interest rates, but on the flipside, a rate rise could increase mortgage costs. The Bank of England must raise interest rates to help tackle the effects of inflation and strengthen the pound. Consumers have dealt with a double blow of poor income growth and rising shop prices over the past year. For many, this has increased dependency on credit, but with defaults now on the rise it’s clear that many families are finding it next to impossible to balance the books. Evidently, it’s not a lending hand they need from the Bank of England right now, but a savings one.
In Europe, the Eurozone trade data for August has been consistent with the recently released national figures. Exports continued to recover on a monthly basis after their summer slowdown. Export momentum remains solid and regionally broad-based. Increasingly solid intra-European demand should soften the negative effects of the appreciation of the Euro, and points to a more self-sustaining European recovery. With the risks, it is without a doubt that Austria and Germany are headed for a period of uncertainty with their noisy coalition talks after their recent parliamentary elections. But the economic and market implications should be minor as both enjoy a very encouraging economic background. Irrespective of the eventual coalition outcomes, economists do not expect any material changes to either Germany’s or Austria’s macroeconomic trajectory. The two economies are the main beneficiaries of the export strength of the bloc. The export boost set their respective economies on course to the highest GDP growth since 2011. With the regional elections in Germany on Sunday, the vote in the state of Lower Saxony, the fourth most populous, is primarily of interest due to its implications for the federal level. It was the last hurdle that needed to be passed before Chancellor Merkel can begin the likely long and complicated coalition talks in Berlin. The first round of preliminary meetings will begin tomorrow. Even if things go smoothly, market participants do not expect a new government to be formed long before Christmas. Overall, the economic implications of the new governments are hard to judge at the current juncture, but the early phases of the coalition talks should provide more clarity on the government priorities and the potential economic implications.
In the US, the minutes depict that Fed officials had a full and robust discussion about the future trajectory of inflation. The more hawkish officials continue to believe in the traditional relationships that dictate that as the labour market continues to tighten and “transitory” factors fade, inflation in the medium-term should rise to the 2% target rate. Within this, it is also expected that wage increases will pick up going forward and some suggest a broader acceleration in wages has already unfolded. In this light, the average hourly earnings data released in the September employment report supports this assertion. The US also released retail sales figures last week Friday, which shows that retail sales jumped 1.6% in September, supported by stronger car and gasoline sales stemming from the recent hurricanes. As for the outlook for economic growth, policy makers remarked that Hurricanes Harvey, Irma, and Maria would affect economic activity in the near term, but growth should rebound beginning in the fourth quarter. The storms are unlikely to materially alter the course of the national economy over the medium term. Last Friday we also got inflation data out of the US which beat economists’ expectations. It is likely that the Fed is likely to look through the temporary headline increase and focus on the trend inflation which has remained below the target. That said, the Fed has indicated it is likely to raise rates again in December. However, if low inflation readings persist, it supports a slow pace of tightening in 2018.
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% of the companies in the S&P 500 reporting actual results for the quarter), 81% of S&P 500 companies have reported positive EPS surprises and 78% have reported positive sales surprises. For Q4 2017, 5 S&P 500 companies have issued negative EPS guidance and 5 S&P 500 companies have issued positive EPS guidance. The forward 12-month P/E ratio for the S&P 500 is 17.9. This P/E ratio is above the 5-year average (15.6) and 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 that investors are willing to pay a premium for the stocks.
MFI.FTSE FTSE 100 =70.634
MFI.INX S&P 500 =78.937
MFI.STOXX Euro STOXX 600 =57.216
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.
Since our last commentary, we have seen bond yields increase with corresponding valuations decreasing in the US and Europe. The opposite was true for the UK with yields decreasing and valuations increasing. It is evident that markets could be on course for a correction at some point, however if we look at bond valuations and compare them to the share market, the share market isn’t overvalued, which is one way to determine if we’re in a bubble territory. 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.
Following the inflation data out this morning, sterling is slightly up against the US Dollar after figures showed CPI inflation is currently at 3% in September. Sterling initially rose in the wake of this as a report suggested a rate rise might now be more likely, but then comments from Sir Dave Ramsden the Bank of England’s new deputy governor, raised doubts. The deputy governor said he was not close to voting for an interest rate hike because he saw little sign of inflation pressure building in Britain’s labour market. Despite continued robust growth in employment there is no sign of second-round effects onto wages from higher recent inflation. Inflation has only reached this high and above the Bank of England’s ±2% target based on the devalued sterling following the referendum. However, over the past week Sterling has been strong in relative terms but will remain a key topic as we edge closer to the next MPC meeting in the first week of November.
GBP / USD – Range 1.32 – 1.20 – Today at 1.3180
GBP / EUR – Range 1.15 – 1.04 – Today at 1.1201
GBP / JPY – Range 150 – 130 – Today at 148.292
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 since last week Wednesday has increased. At the time of writing, WTI Crude is currently trading at $52.08 and $58.30 for Brent, up approx. 2% for WTI and approx. 3.5% for Brent. The price has been pushed up this week following Iraqi forces taking control of oil fields. This raised short term concerns over scarcity and undersupply boosted the price by almost 1% on Monday. Iraq is OPEC’s 2nd largest producer and supply is therefore influential on the 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.
Since last week Wednesday, we have seen the price of gold remain flat peaking over $1,300 late last week and back down to $1,283 a troy ounce, around $6 down. Investors remain invested in the safe- haven asset as risks are currently high in the market.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track improve with most of the earnings being seen in Asia, which has been reaching record highs, again being driven by a low US Dollar. The FTSE 100 is also at record highs given the depreciation of sterling, which is helping the 100 constituents with trading as only 25% of the FTSE 100 companies are driven by domestic sales, so global activity and global growth is important.
The IMF also helped markets last week by increasing its global growth forecasts estimates for next year, and this year. Regardless, we will continue to keep a close eye on the barometers to see when we may reach the point when the data starts to turn but momentum is driving equities higher. With our portfolios, they have remained relatively cautious, of the imminent bear market and we will remain cautious until we get some reassurance regarding various geo-political and economic risks.
The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance.
Performance figures quoted include the fund manager chargers but exclude other fees such as an adviser, custodian, swith and/or discretionary investment management fees.
Unless otherwise instructed and accrued income is reinvested into the portfolio.
This Day in History
On this day in 2006, the United States population reached a high of 300 million people. The North American population today is approximately 323.1 million people and given that nature of population is an exponential function, ceteris paribus (all things being equal), the population could rise to an estimated 438 million in 2050.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager