Invincible Markets

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13/11/2017
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The anticipation ahead of next Wednesday’s Autumn Statement is heating up. Every interested party has the usual view of desperately needing policy assistance whether that be for savers, lenders, the housing market, the young, the old, business, pensions or the public sector. A first in recent times would be a budget where there are no forced reversals such as that which engulfed Philip Hammond last time involving self-employed national insurance contributions. We can recall the lambasting that George Osborne endured following each of his latter budgets. Observe how the media has exposed Priti Patel over her Israeli connections and more recently Boris Johnson and now Michael Gove over their comments regarding Iran. This is a feature of our times whereby the power of the media is almost greater than those in political power. This is a point not lost on Russia and Iran where cyber-propaganda and social media interference is now common place and explains why those nations including China are so paranoid about free speech in cyber space.

We are told that the Government is now listening but this budget will be a big test to see whether that is the case, or more importantly, whether the media believes this to be the case. Many of the disgruntled Tory backbenchers are baying for blood with scores to settle following the election in June and the forced cabinet resignations in the last few weeks, all through media exposé. Jeremy Corbyn is having to do and say very little whilst the Tory Party fractures from within. We hear this week that up to 40 MPs are ready to vote for a no-confidence motion in Theresa May – whether this is true or just another ‘fake news’ headline hardly matters because it captures the mood and has some degree of credibility. What is noticeable is that no-one has come out fighting in support of Theresa May as they don’t want to be seen as backing the wrong horse as and when the inevitable challenge comes.

Whatever your political persuasion this is not good for economic and consumer confidence. The recent interest rate rise and the guidance from the Bank of England beforehand have stopped the speculators shorting sterling and provided some stability. That said, if the Brexit negotiations do take a decisive turn towards a ‘no deal’ scenario, which is now being seriously considered in Brussels and on Wall Street, then we would probably see a leadership challenge. Weak leaders are always bad for economic growth especially when the alternative is so polarised in political view. Businesses cannot invest on a three year view if they don’t have stability of economic and tax policy. The UK’s productivity growth is already demonstrably inferior to that of other G7 countries and without clarity soon, this will remain dormant and fall further behind.

The three stumbling blocks preventing progress appear to be the Northern Ireland border, the size of the Brexit bill for ongoing commitments and the role of the European Court of Justice with regard to EU citizens resident in the UK during any transition period. Add to that the numerous amendments that Parliament wish to make to the Repeal Bill with a significant possibility of it being voted down, and you can see why there is so much leadership speculation and talk of ‘no deal’. Whilst this persists, and it is likely to get worse before it improves, the UK equity market is off-limits to many international investors. In addition, the IA UK All Companies sector has seen the highest level of outflows this year as investors have sought opportunities elsewhere, having captured the honour of worst selling sector for 4 of the last 5 months whilst Global Equities have captured the best-selling in 2 of these months.

The contrarian investor will be getting interested in the UK, especially as so many other areas look expensive. Since the Brexit vote, stripping out the devaluation effect of sterling, the Hong Kong and Japanese stock markets are both up by around 50% whilst Emerging Markets and the Nasdaq are up by over 40%. These are huge returns but psychologically it is always hardest to take those gains whilst the outlook appears positive and alternatives appear relatively unattractive. We know that past performance should be considered as no guide to the future but whilst the going is good, it is a brave investor who jumps off this bandwagon, especially because in doing so at any point in the last 8 years would have cost you dear. Following the herd is a lot easier because then everyone misses the top and everyone is in the same boat as it springs a leak and starts to sink.

Even the weakest performing FTSE-100 is up by 28% since the Brexit vote, or an annualised figure of 19.2%, surprisingly only just below the S&P 500 at 29% and 20.3% respectively in US Dollars. The hottest areas have all delivered annualised returns over this same period of around 30%, in local currency terms. What is particularly revealing is the annualised returns in the 7 years prior to the Brexit vote starting from March 2009 which marked the index lows following the credit crunch. All the major market returns in local currency are around 10-12%, with the exception of the US which is 17-20% depending on the index. Whilst on the higher side of conventional wisdom which says long-term equity returns should be nearer 8%, this can be explained by the strong recovery returns in the early part of this period.

What really stands out, is the post-Brexit annualised returns. We all know that bull markets climb a wall of worry but this has been akin to a stampede bulldozing through any threat that has presented itself. Of course, we know there is too much liquidity in the system and we also know that global growth is robust but these kinds of returns cannot continue. Correction calls over the summer have now gone somewhat quiet as the voices now lack credibility. When the bears go quiet and even capitulate back into the market, that is when the bull market is in its final phase. But there needs to be a capitulation catalyst and perhaps the artificial intelligence, robotics and electric vehicle revolution is the final chapter of misguided optimism.

Wherever we are in the cycle of this current bull market, we must be nearing the end with the so-called FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) continuing to rise on ridiculous valuations in triple figures in terms of price/earnings ratios. Many are looking for the catalyst and in its absence, remain invested, missing the point that the catalyst will come from an unforeseen area. This is when investing morphs into gambling. Fundamentals get ignored and past performance takes on a greater influence, not unlike gambling addiction. I know the odds are that I will lose at some point, but I made more money last week, last month and year to date and so I will keep on winning for the foreseeable future until I see that losing catalyst. The trouble is, when it arrives, everyone else will also see it by which time it will be too late.

Locking in some of these extraordinary gains has to be the correct strategy but this goes totally against the psychological tide when returns have been so strong. Timing is everything.

 

Oil Rally Continues as Saudi/Iran Tension Mounts

Brent crude continued to rise last week as tensions in the Middle East escalated. Firstly we had the resignation of the Saudi backed Lebanese prime minister Saad al-Hariri who blamed Iran’s grip on the country for his decision to leave the post. This was followed by an Iranian backed Shiite rebel group in Yemen firing a missile into Saudi Arabia which was intercepted outside of Riyadh. Brent finished the week +2.5% higher at $63.52 a barrel having retreated slightly from the 2 year high set during Thursdays trading.

Elsewhere in the commodities sphere, Gold benefitted from a weaker Dollar to record a weekly gain of +0.7% with the precious metal closing Friday at $1,276 an ounce. The Dollar came under pressure due to growing uncertainty surrounding the proposed Republican tax cuts in the US. The American currency weakened by -1.2% versus Sterling and by -0.4% against the Euro to $1.32 and $1.17 respectively.

US stocks also came under pressure after the Senate Republicans unveiled a vastly different tax proposal to the one set out by the House. The most important difference was a year’s delay in the implementation of the corporate tax reduction. The S&P declined by -0.4% to post its first weekly decline for two months as a result. And it was just US equity markets feeling the pain. The domestic FTSE100 dropped by -1.7% with retailers feeling the pressure after British Retail Consortium released its weakest non-food sales figures since the category was introduced 5 years ago.

Across the Channel, European equities were on the back foot after a spate of weak earnings reports. The German DAX30 declined by -2.6% whilst its French counterpart, the CAC40 declined by -2.6%. Only Japanese equities bucked the negative trend seen elsewhere in the world’s leading equity markets. The Nikkei225 posted a weekly gain of +0.6% despite some weakness in Tech stocks during Friday’s trading.

Despite the US political uncertainty and Saudi/Iranian tensions, sovereign bond yields actually crept higher last week. Domestic 10-year gilts were 6 basis points (bps) higher at 1.366% whilst the equivalent US Treasury saw its yield rise by 7bps to 2.412%. By its own standards, German bund yields had a largely eventful week, rising by 5bps on Thursday and by another 3bps on Friday to reach 0.410%.

 

The Week Ahead

There is plenty of economic data due this week for Chancellor Phillip Hammond to consider ahead of next Wednesday’s budget. The headline inflation rate as measured by the Consumer Price Index (CPI) is forecast to rise to 3.1% when released on Tuesday. If correct, this will prompt an open letter from the Bank of England Governor Mark Carney who is required to explain any deviance in excess of 1% from target. When combined with Wednesday’s employment data, it will reveal the extent to which negative real wage growth persists despite low unemployment. Finally, Thursday’s retail sales data will give an indication of the strength in consumer spending given these headwinds.

European inflation data is also due on Thursday but many on the continent will be looking to Tuesday’s preliminary Gross Domestic Product reading as the key data point this week. Across the Atlantic, data has been volatile recently following the hurricanes in the southern states. The US is also scheduled to see updated CPI readings and retail sales data, both Wednesday.