Market Commentary – 25th October 2017

Brexit: Tusk says the UK could still U-turn on Brexit

“Britain could still abandon Brexit”, EU President Donald Tusk told MEPs yesterday, claiming that only the UK can decide the shape of its future relationship with the EU. Legally, it’s not clear whether Article 50 of the Lisbon Treaty (which is the legal mechanism for the EU departure triggered by the Prime Minister in April) is reversible.

Tusk’s comments come after a leaked report that Theresa May “begged” EU negotiators for a Brexit lifeline during a meeting in Brussels last week. Angela Merkel, the German Chancellor, was furious about the leaks. European Commission chief Jean-Claude Juncker and his chief of staff, Martin Selmayr, have publicly denied being the source. Meanwhile, The Guardian states the EU’s chief negotiator, Michel Barnier, is warning that Britain can expect a trade deal “little better” than what was agreed between the EU and Canada, and even that would take years to negotiate.

Global Economic News

In the UK, despite the poor progress with the Brexit negotiations, this morning we received GDP figures which showed that the UK economy grew at 0.4% in Q3. GDP per person is 2.5% higher than the start of the 2008 recession (over 9 years ago). It was 18.8% higher at the same stage of the 1990 recovery. Having run at 0.3% in the first two quarters of the year, Q3 saw a slight acceleration in GDP growth with the quarter delivering a 0.4% rise in output. This left YoY growth unchanged at Q2’s 1.5%. But while the third quarter’s pick-up was welcome, it still left quarterly growth below the 0.5% averaged since the current expansion began in late 2009 and the post-war norm of 0.6%. The output breakdown showed the dominant services sector continuing to drive the economy, with a 0.4% rise in output repeating Q2’s performance. The Industry shrugged off its Q2 stretch and expanding by 1%, a five-quarter high. But a 0.7% drop in construction output, following Q2’s 0.5% fall, left the sector in a technical recession for the first time since 2012. That growth in Q3 came in ahead of the 0.3% expected by the Bank of England which will bolster the position of those MPC members who argue that declining “slack” in the economy, and the inflationary risks that follow, favour an immediate hike in the Bank Rate. Raising rates when quarterly growth is still relatively soft would be an unprecedented move by the MPC, but it is one that the odds now favour when the Committee’s next meeting concludes on the 2nd of November. Stepping away from this, gross mortgage lending in September was 5% higher than the same month last year at £21.4bn, according to estimates by UK Finance, which represents 300 of banking and finance firms in the UK. Credit card borrowing from High Street banks rose by 5.5% compared with last year, while across the whole market it was 7.8% higher. However, business borrowing has “moderated over the course of 2017, with the growth rate for borrowing by wholesale and retail businesses slowing the most, as these customer-facing sectors could be affected by any cutbacks in consumer spending”, the group said.

In Europe, tomorrow is the European Central Banks (ECB) interest rate decision day, and Mario Draghi will be pleased with yesterday’s strong PMI data, which painted another bright picture of the Eurozone economy which suggested that the strength and breadth of the recovery is continuing into Q4. In line with the strong results of both the Sentix and ZEW sentiment indicators released earlier this month, yesterday’s PMI releases also suggest that the Euro boom will continue in Q4. The composite indicator for October slipped marginally to 55.9 from 56.7, remaining at levels consistent with a 0.5% GDP expansion in Q4. The breadth of the recovery remains a key feature of this cyclical upswing, with both the services sector and manufacturing PMI surveys pointing to faster expansion. That said, since the start of the year, the manufacturing sector has been pacing ahead, bolstered by dynamic trade and the acceleration in investment spending. This continued to be the case at the start of Q4 with the manufacturing PMI rising to its highest point since early 2011, while services slipped slightly from its September level. PMI numbers for France and Germany both underlined the strength of activity in the manufacturing sector. The French indicator rose to 56.7 from 56.1, its highest level since 2011, while the German PMI was practically unchanged from last month’s six year high, while the services PMIs show that renewed dynamism in the services sector is ongoing. Consistent with the PMIs, the French INSEE business confidence survey show industry confidence reaching its highest level since 2007, on the back of a more upbeat production outlook. With this, the French sentiment based GDP indicator suggests a further acceleration of GDP growth in Q4 to 0.6%, slightly higher than economists current 0.5% forecast. The ECB Bank Lending Survey (BLS) released yesterday was also positive. In Q3, access to credit eased further for households and remained unchanged for firms. Low interest rates prompted demand for loans to rise further, along with increased consumer confidence and firms looking to ramp up their investments as aggregate demand firms up. Firms’ demand for loans rose in all core Eurozone countries, but more markedly in Germany and France, where loan growth continues to pace ahead of their Eurozone peers. Similarly, household demand for loans rose in all core economies expect France, where households may have delayed some of their investment decisions ahead of the government’s fiscal reform.

In the US, President Donald Trump’s party’s progress on developing a fiscal stimulus package in DC has been encouraging. A renewed sense of realism amongst policymakers means the odds of a fiscal package passing Congress in the next couple of months remains around a 60-70% possibility according to Oxford Economics. If Trump’s policies are passed by Congress, the final package will fall short of the Republican $2.7 trillion tax blueprint, but it will likely be larger than the general baseline assumption of economists tracking the matter of $500 billion over the next ten years. Away from the White House, on Friday we received existing home sales data, noting that existing home sales inched up 0.7% in September to a seasonally adjusted annual rate (SAAR) of 5.39 million. Home sales fell slightly in the South, where hurricanes held down sales, but that decline was offset by increases in the Midwest (1.6%) and the West (3.3%). The decline in home sales in the South was due entirely to a fall in sales of residential houses and co-ops (-11.1%). YoY, home sales declined 1.5% in September, the first YoY decline since July of last year. Existing home sales contribute to GDP growth, through broker commissions. The September home sales data doesn’t change the call for a small decline in residential investment in the third quarter by economists. Economists expect a rebound in residential investment in the fourth quarter as the impact of hurricanes recedes. Their real GDP tracker for the third quarter currently stands at 2.4%, annualised, which may be achievable.

Barometers

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 17% of the companies in the S&P 500 reporting actual results for the quarter), 76% of S&P 500 companies have reported positive EPS surprises and 72% have reported positive sales surprises. For Q3 2017, the blended earnings growth rate for the S&P 500 is 1.7%. Six sectors are reporting earnings growth for the quarter, led by the Energy sector. 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 above the 10-year average (14.1).

Money Flows;

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).

Over the past week, we have seen money flows generally strong in Europe and the US. With the UK, they have fallen slightly, under the threshold of 20, however over this quarter 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              FTSE 100              =             19.170

MFI.INX                S&P 500               =             37.705

MFI.STOXX          Euro STOXX 600 =            30.689

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 increase with corresponding valuations decreasing in the UK. Bond yields have been volatile but remained flat over the past week for the US and Europe. 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 UK GDP figures released this morning, Sterling has gone up by almost 1% against the US Dollar as the markets are expecting a rate rise next week following the better-than-expected GDP figures and an increased likelihood of an interest rate rise on Thursday next week which is when the MPC meeting is scheduled. Sterling is also ahead on the euro. Economists are saying that it is unlikely that the Bank of England will now embark on a series of rate rises, but instead, this will now signal a move out of ’emergency mode’ for the Bank of England, providing the Bank with the ability to lower rates once again, should the economy need a boost around the Brexit deadline in 2019 (which is likely).

GBP / USD – Range 1.32 – 1.20 – Today at 1.32
GBP / EUR – Range 1.15 – 1.04 – Today at 1.12
GBP / JPY – Range 150 – 130 – Today at 150 (edging close to 151)

Oil Price;

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 decreased for WTI Crude and increased for Brent. At the time of writing, WTI Crude is currently trading at $51.21 and $58.17 for Brent, down approx. 1.7% for WTI and up approx. 0.2% for Brent. Yesterday, Saudi Arabia’s crown prince says that the demand for oil will keep rising, because it will be in demand for uses other than energy production, such as in the petrochemical industry. Oil will remain a topic of discussion at this juncture until we get some clarity on the OPEC supply cuts extension.

Gold 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 decrease approx. $16 an ounce to $1,273.09 a troy ounce. Gold is a quiet topic at the moment as investors’ confidence is high and will remain high until we get some direction as to what stance central bankers will have on their monetary policy outcomes.

Model Portfolios & Indices

Over the last week we have seen most of the indices that we track improve. The UK markets have been relatively flat over the past week and today the FTSE 100 is down following the rise in the pound after the stronger than expected GDP figures, which show that the economy is growing, despite various economic and political factors dragging it down. Miners are to be blamed for today’s fall in the FTSE 100 due to increased costs with relation to a strengthened pound. The US markets are reaching record highs again this week following strong earnings data for US companies. 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.

Important Information

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 the trend of UK GDP figures (which were out today) on this day in 2012, the infamous double dip recession in the UK economy finally ended with GDP growing approximately 1.0% in the third quarter of 2012. You may rememeber, that this was largely attributed to the London Olympic Games which helped rejuvinate the UK economy. Well done George Osborne!

As always have a wonderful week and stay safe.

VBW

Jason