Market Commentary – 31st October 2017
Hammond’s Budget dilemma detailed by the IFS
Chancellor Philip Hammond is “between a rock and a hard place” as he prepares his 22nd November Budget, according to the Institute for Fiscal Studies (IFS). The Institute says Hammond may have to abandon his deficit reduction target if he wants to spend more on public services – and must also deal with an expected cut in productivity growth.
The chancellor has said he wants to get to budget balance by the mid-2020s, that’s going to require him to continue cutting spending or increasing taxes. But of course, all the pressure is to do quite the reverse. There’s no chance of getting any tax increases through parliament, and the demands for more money for the NHS, a pay increase for public sector workers, potentially to reverse the very large benefit cuts coming through the pipeline… These demands are very big, but if he cedes to any of them, then he’s saying he’s not taking the fiscal rules he’s supposedly set himself seriously.
Global Economic News
In the UK, on Thursday we will be watching the Bank of England’s Monetary Policy Committee (MPC) as they set out their Quantitative easing mandate and the much-anticipated Interest Rate Decision. Will they increase interest rates, with them being at record lows since the 2007/8 financial crisis? The committee’s September meeting saw a majority on the MPC conclude that a rate rise was likely to be appropriate over the coming months. However, with the current political landscape and macro data being soft, this meeting looks finely balanced. The bank has concluded the programme of gilt and corporate bond purchases, which was announced in August 2016. With no impetus to change the degree of monetary support to the economy from QE, policy in this area is set to stand pat. On Monday morning, mortgage approvals in the UK fell to 66,232 in September, according to the latest statistics from the Bank of England. That’s the lowest number since June. Meanwhile, the Bank of England consumer credit statistics published on Monday morning showed that consumer borrowing climbed 9.9% to £204bn in the year to September 2017. While the growth is in line with previous months, it grew 10% in the 12 months to August, which is worrying. It is stipulated that the FCA must step in to curb the worrying rise in debt, by banning credit card firms from pushing more credit onto people who haven’t asked for it, and compelling them to offer support sooner when it’s clear people can’t pay.
In Europe, this morning it was published that the Eurozone grew by 0.6%. Unemployment dropped slightly, but still high at 8.9% and inflation is down 1.4% which is below the ECB 2% target. Very low inflation can make it harder for a central bank to respond if there’s a downturn, and the ECB is trying to get price rises to pick up. Last week, the ECB successfully moved to taper quantitative easing last week by announcing that asset purchases would be reduced to €30bn per month from January. However, in the spirit of ‘lower for longer,’ they indicated that this level of purchases would be maintained until September. Despite this policy being well telegraphed beforehand, markets appear to have interpreted the latest policy change dovishly with both the euro and bond yields falling. In part, this reflects the fact that the activity data continues to point to a booming domestic economy. Manufacturing activity shows no sign of slowing, with the German IFO index (Business Climate Index) hitting another record high this week. Inflationary pressure meanwhile continues to be largely absent, with the impact of this year’s earlier euro appreciation likely to take inflation down in the first half of next year. This would appear to rule out all possibility of a rate increase in 2018. Also, on Tuesday we gained French GDP figures which shows that the French economy grew by 0.5% in Q3 from the previous three months. This means that GDP expanded by 2.2% over a year, the fastest pace of growth since 2011.
In the US, this is a big week. On Thursday, President Donald Trump will mention whom he wants to chair the US central bank. Trump’s pick for the most powerful job in economics will have a big impact on his ambitions for US economic growth, and on the world of finance. In recent weeks Jerome Powell, an existing member of the Fed board – has emerged as the favourite to replace current chair Janet Yellen. Seen as a safe pair of hands by the markets, he’s been a governor on the Federal Reserve board since 2012 and has never cast a dissenting vote on monetary policy. Economists who research the matter say that “He ticks all the boxes”. He’s been a Republican adviser, offers stability, backs low interest rates, and is open to deregulation of the financial sector. Friday is Job Day when we get unemployment rates and non-farm payroll figures. This will be closely watched, following the astonishing 3% growth published recently.
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 blended earnings growth rate for the S&P 500 is 4.7%. Six sectors are reporting earnings growth for the quarter, led by the Energy sector. For Q3 2017 (with 55% 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 67% have reported positive sales surprises. 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).
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 for a negative money flow. 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, with the anticipation that they will continue to rally upwards at this juncture.
MFI.FTSE FTSE 100 = 62.571
MFI.INX S&P 500 = 49.157
MFI.STOXX Euro STOXX 600 = 69.255
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 drop with corresponding valuations rising in the UK and in the US. The opposite was true for Europe as the ECB pointed out that they will reduce their bond buying programme by half from 2018. Like we have written in our past commentaries, it is becoming more evident that markets could be on course for a correction at some point, based on what central bankers will do with interest rates. 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. Having said this, volatility remains high in these assets which should not be functioning like this, considering they are low risk investments. 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 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 strengthened across the board this week in anticipation over the MPC raising interest rates on Thursday and, we could expect Sterling to pass our range against the US Dollar closer to the rate decision. From what we have been reading and listening to over the week; Interest rates may go up, and if they do, we will have to re-adjust our ranges below. The currency received a boost after the European Union’s chief Brexit negotiator, Michel Barnier, said he was ready to speed up Brexit talks.
Mr Barnier said that the agenda and dates for the next round of Brexit talks would be set “in the next few hours or days”.
GBP / USD – Range 1.32 – 1.20 – Today at 1.32 GBP / EUR – Range 1.15 – 1.04 – Today at 1.13 GBP / JPY – Range 150 – 130 – Today at 149.83
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.
At the time of writing, the price of oil since our last publication has risen quite sharply. WTI Crude is currently trading at $54.18 and $60.57 for Brent, up approx. 5.8% for WTI and approx. 4.13% for Brent. Prices this week have rocketed after OPEC and non-OPEC producers have cut back on output, which is having an impact on the price of the commodity. Despite this, the consensus by oil analysts is that the market would have shot up the price even further, were it not for shale oil production. Shale oil is helping to keep prices low, as it is bringing in a new source of supply, which in turn is reducing the price. Shale oil production in the US was hitting six million barrels of oil a day, compared with 10.5 million barrels a day of oil output in Saudi Arabia.
Gold is a safe haven and a spike in price can be an indicator of increasing underlying economic concerns and as always, the opposite.
We have seen the price of gold remain relatively flat since our last commentary. The price inched up by approx. $2 an ounce to $1,275.50 a troy ounce. Gold remains flat as investors continue to favour the equity markets over the safe haven asset.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track improve, with gains being made in Europe and Asia. European markets have been performing well following strong data feeding into the markets, and Asia is remaining resilient after the Japanese elections and a relatively low US Dollar. If oil prices continue to rise, we could expect this bloc to slow down. Nevertheless, 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, we are taking a balanced approach with the underlying asset allocation and will continue to, until we gain some further view and direction on the markets.
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 charges but exclude other fees such as adviser, custodian, switch 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 1950, 21-year-old Earl Lloyd becomes the first African-American to play in an NBA game when he takes the court in the season opener for the Washington Capitols. 57 years later, the NBA now comprises of more than 70% African American players.
As always have a wonderful week and stay safe.