The Monthly - October 2017

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As ever we start with the performance of the FTSE 100 and note that September was pretty volatile compared to the summer doldrums with the index having opened at a level of around 7440 before closing out at roughly 7370 but not without first posting an intra-month low of 7210. The catalyst for these ructions appear in the main to be the apparent imminent threat of nuclear war between America and North Korea which knocked sentiment in the early stages of the month before the danger seemingly dissipated and a recovery in the price of crude oil following OPEC discussions and demand growth for other commodities helped propel the market higher. As we have previously noted the FTSE 100 is particularly susceptible to volatility on the back of oil and/or mining stocks given the composition of the index and September illustrated the point rather nicely.

From an economic perspective we saw perhaps a turning point in forecast domestic interest rate policy with the Governor of the Bank of England, Mark Carney, at pains to paint a hawkish picture of rising debt levels and the inherent potential risks to the wider economy. This was broadly interpreted as an indication that the first UK interest rate rise is looming- perhaps as soon as November. This is something of a surprise given recalcitrant real wage growth which has remained stubbornly low in spite of low unemployment albeit inflation remains above the notional target of 2% and the Office for National Statistics revised UK Q2 growth lower. In addition there appears to be an element of weakness in the London housing market which hasn’t been seen for some time and, although not replicated across the rest of the country, ought to be considered on the basis of the strong correlation between housing market and consumer confidence- arguably the engine that drives economic growth in the UK:

Source: BoE & Nationwide

Then again, what is the “right time” to raise interest rates? Many would say that there was no requirement to lower them further following the surprise Brexit referendum outcome last June albeit one must acknowledge that for the most part the national economy is slow to respond to such stimuli. In addition no-one can be absolutely certain what would have happened or been different in the absence of such accommodative action. This, my friends, is the danger of implementing an emergency policy for an extended period, especially when such a response was only ever intended to be used in exceptional circumstances. Perhaps unsurprisingly currency markets reacted and sterling strengthened appreciably. Going forward it will be interesting to see how the BoE fares. We saw the adverse equity market reaction in the US when the Federal Reserve failed to raise interest rates as expected back in 2013- investors’ concern at that stage was based on the assumption that the US economy was in such dire straits that it had to remain on the life support package of exceptional measures in order to survive. One wonders if the BoE is waiting for such a signal from equity markets to show that investors are primed for interest rates to increase (as they surely have to at some stage). In the meantime it is arguably the case that the expectation of a November rate rise is baked into prices and hence provides an indication to rate setters of the extent of market reaction to such an increase. We will see…

Across the pond renewed proposals to cut taxes saw the S&P 500 advance while the expectation that interest rates are to be raised in December supported financials amid comments from Federal Reserve Chairwoman, Janet Yellen, that rate setters should beware raising rates “too gradually” – clearly a very different picture to that confronting the Bank of England. Proposals to cut corporation tax from 35% to 20% were received positively due to the potential economic stimulus that such a measure could deliver although we note that similar legislative amendments have been quashed by Congress.

Closer to home European economic data continues the relatively consistent theme of positive surprise while Angela Merkel held off challenge from her political rivals amidst an uptick of support for AfD. In Spain the push for Catalan independence has gained momentum in spite of attempts by the Spanish Government to quell what is seen by some as a populist uprising which could potentially further destabilise the European Union.

Meanwhile Chinese data constituted a positive surprise and their demand for raw materials increased, which provided a catalyst for emerging market indices to trade higher.

At portfolio level we have continued to seek to reduce risk as the domestic political and economic outlook remains unclear. The Conservative party conference was widely perceived as being indicative of party instability with numerous fringe events and back benchers apparently briefing against the current direction of policy, particularly with reference to Brexit. Meanwhile Boris Johnson is supplying an almost constant stream of high profile headlines while publically supporting Theresa May, whose conference speech was beset by a publicity stunt, coughing fit and set malfunction. These factors overpowered the content of her speech and shone what must be unwelcome light on her premiership. At this stage, with Brexit negotiations seemingly going nowhere and with the prospect of “no deal” growing ever more probable, it would be something of a surprise if anyone actually wanted to depose Mrs May and take the top job but such an outcome would uphold a long tradition of forced succession.

We are hearing more and more from business leaders who are holding off from further investment in the UK until such a time as the outcome of Brexit negotiations becomes clear at a time when consumer spending is being crimped by stagnant wages and inflation (and shrinkflation- where goods remain the same price but reduce in size. Incredibly the Office for National Statistics methodology for calculating RPI does not have a mechanism to account for such a phenomenon). With such an outlook we remain underweight the UK equity asset class relative to our neutral allocation and are actively seeking to manage down risk through increased diversification and lower correlation.