Market Commentary – 8th November 2017
Trump in Asia… what’s he up too?
US President Donald Trump started his trip with speaking to the South Korean parliament and warned North Korea “Do not underestimate us” and “Do not try us”. He addressed Kim Jon-Un directly, telling him that “The weapons you are acquiring are not making you safer.” You may say to yourself that the tensions seemed to have calmed with no nuclear tests being carried out, however the risks in the markets are that Trump may just spark up the North Korean leader again. Trump has travelled to China today where he is scheduled to discuss North Korea and trade with Xi Jinping. Let’s just hope Trump takes a diplomatic stance whilst he’s out there and doesn’t provoke Kim Jon-Un too much.
Global Economic News
In the UK, early this week the British Retail Consortium (BRC) released figures indicating that retail sales have fallen, and this has been the most its dropped in the past 7 months. It’s anticipated that retailers are cautious just before Christmas, which is an expensive month. Also, Halifax released their house prices survey which showed that house prices have declined month-on-month by 0.3% from 0.8%. On the contrary, year-to-year, house prices have increased by 4.5% from 4.0%. This would be largely attributed to the position the UK was in post referendum. New car registrations in the UK decreased by 12.2% year-on-year to 158,192 in October 2017, the seventh consecutive month of decline, as falling confidence among buyers continued to impact the market. With the Monetary Policy Committee’s decision to hike interest rates from 0.25% to 0.50% at its November meeting, this did not come as much of a surprise, as it had been over 90% priced into markets ahead of the meeting. And while the 7-2 split in favour of raising rates (with Sir John Cunliffe and Sir David Ramsden dissenting) was more hawkish than the consensus had expected (6-3), economists’ initial feelings are that the overall tone of the summary, minutes and Inflation Report is fairly dovish. Admittedly, it did not suggest that this is merely a “one and done” where they will increase rates just once. However, the fact that inflation is expected to be only just above the MPC’s target at the end of the three-year forecast horizon seems to endorse the market’s view that there will be only another two hikes over the same period. The MPC also sounded a bit more downbeat on the impact of Brexit on the economic outlook than before, while all members continued to agree that any future increases would be “at a gradual pace and to a limited extent”. Nonetheless, we think the dovish market reaction looks a bit overdone, given that the MPC’s growth forecasts are broadly unchanged from August.
In Europe, the current situation is referred to as “The Golden Decade” and this is because the eurozone is in its fifth year of expansion, having grown 17 consecutive quarters, and is enjoying the strongest growth in a decade. While the short-term outlook is undeniably the most positive we have seen in a long time, research shows that over the longer term there is plenty of room left to grow, which could put us right in the middle of a decade-long expansionary cycle. Expansions do not die of old age and policy responses continue to be the most likely cause of death for an expansionary cycle. Thus, a lot hangs on determining how much spare capacity there is left in the Eurozone. If we are approaching capacity constraints, we should see prices and wages accelerating rapidly, thus increasing the odds of a recession as the ECB would be forced to tighten policy more aggressively than expected. Fortunately, this is not the case. Although the output gap is notoriously difficult to estimate, there is no indication of price or wage pressures building in the Eurozone, and economists expect an extraordinarily dovish ECB, providing a still sizeble level of monetary support over the next three to five years. If all is good, what are the risks? These can come from abroad or originate within the Eurozone. With the external shocks, a disrupting geo-political event (e.g. war) or a big protectionist shock to world trade are the main external risks. As a relatively open economy, the Eurozone has been a great beneficiary of the strong pick-up in global trade, thus a significant deterioration in the outlook for trade could prove to be very damaging for the region. With the domestic shocks, political risk remains the main domestic threat. Unfortunately, this could take many shapes and forms, be it the Catalan push for independence, the risk of a populist government in Italy or the possibility of a hard Brexit, among others. Fortunately, the Eurozone is now more resilient to political risk than it has ever been.
In the US, last week was a busy one with data from manufacturing, the trade deficit and payroll figures, as well as a new fed chair. The ISM non-manufacturing index rose to 60.1 in October, cresting the 60-mark for the first time since August 2005 (with 50 indicating growth). Recovery efforts after the hurricanes boosted already strong conditions. Stronger business activity and continued solid new orders are keeping demand for new employees on the rise. Supplier delivery times are still long as hurricane impacts are slow to subside. With the trade numbers, the trade deficit widened in September as imports outpaced exports. With the view ahead, the synchronised global upswing will support further export gains, while moderate domestic demand will maintain a steady pull on markets. The October employment report overall was a bit disappointing when taking into consideration the retracement in average hourly earnings to a 2.4% annual rate and the drop in the labour force participation rate to 62.7%, both of these measures are now back to May’s levels. The post-hurricane snap back of 261,000 in October payrolls was weaker than expected, but given the net upward revision of 90,000 for September and August payrolls, the level of payrolls was in line with economists’ expectations. The unemployment rate fell further to 4.1%, but this is not a sign of strength since the participation rate fell on a 765,000 contraction in the labour force, and finally with the construction numbers, construction spending increased 0.3% in September as the hurricanes took less of a toll than economists expected. The increase in construction spending was due entirely to a gain in public construction spending. Economists, familiar with the matter, suggest that the strong gains will not continue going forward…
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 81% of companies in the S&P 500 reporting actual results for the quarter), 74% of S&P 500 companies have reported positive EPS surprises and 66% have reported positive sales surprises. For Q3 2017, the blended earnings growth rate for the S&P 500 is 5.9%. 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 18.0. This P/E ratio is above the 5-year average (15.7) 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 FTSE 100 = 78.336
MFI.INX S&P 500 = 72.743
MFI.STOXX Euro STOXX 600 = 76.487
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. It is becoming more evident that markets could be on course for a correction at some point, as equity markets continue to reach new highs and based on what central bankers are doing 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 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 dropped when interest rates rose in the UK on Thursday last week and dropped from 1.324 to 1.305. When interest rates rise, this indicates economic strength and there is usually strong correlation to the domain currency, however in this case the currency dropped due to the expectations and the uncertainties in the market. This week, Sterling has rebounded slightly after its biggest one-day fall since the week after June 2016’s Brexit vote. Despite the Bank raising rates for the first time in over a decade, it also told markets to expect only two further hikes in the next three years. Sterling will continue to struggle until we see the results from the fresh Brexit meetings in Brussels tomorrow and on Friday.
GBP / USD – Range 1.32 – 1.20 – Today at 1.30922
GBP / EUR – Range 1.15 – 1.04 – Today at 1.1292
GBP / JPY – Range 150 – 130 – Today at 148.692
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. At the time of writing, WTI Crude is currently trading at $57.04 and $63.46 for Brent, up approx. 5% for WTI and Brent. Oil prices have steadied this week as Chinese crude imports fell to a one-year low, but losses were offset by investor caution over rising political tensions in the Middle East. Brent crude hit $64.65 earlier this week, its highest since mid-2015, as political tensions in the Middle East escalated after a sweeping anti-corruption purge in top crude exporter Saudi Arabia, which in turn has confronted Iran over the conflict in Yemen.
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. $15 an ounce to $1,280.45 a troy ounce. By looking at gold, it’s fair to suggest that investors are cautious, but still looking at the safe haven asset as a refuge if and when markets will tumble.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track improve with most of the gains being fed through from the US and benefitting Asia. The Dow Jones, S&P 500 and the NASDAQ have all reach record highs and they are showing no signs of slowing down. From a correlation perspective, our portfolios have benefitted from this and are showing signs of resilience in the current market conditions, considering the high risks. 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
It has been exactly one year since Republican Donald Trump was elected President of The United States of America, defeating democrat Hillary Clinton despite Clinton receiving 2.9 million more votes. Since this monumental event, the US equities market has rallied with the Dow Jones going from approx. 18,000 points to 23,500 points, the S&P 500 climbed from 2,100 points to 2,590 points (up 20%) and the Russel 2000 has climbed from 1,200 points to 1,470 points.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager