The Weekly - Burgernomics

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21/08/2019
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On Monday it was announced that CK Asset Holdings made a bid of 850 pence for Greene King, the brewer. This is not news, companies buy other businesses all the time. However, what was noticeable was the premium that was paid for the brewer. CK Asset made a bid that was at a 51% premium to the closing price of Greene King on Friday. Of course, this offer is subject to shareholder approval, but it seems likely to be accepted. The board of Greene King has recommended that shareholders accept the offer.

CA Asset Holdings is based in Hong Kong and is owned by the billionaire, Li Ka Shing. This implies to us that the UK is undervalued and despite the uncertain political climate, international investors might be looking for bargains in the UK.

As anyone who has taken a summer holiday this year already knows, Sterling is at a multi-year low against most of the other major currencies. The UK stock market has also underperformed many of its peers. This could be an attractive time for many international investors looking for a foothold in the UK. Other international markets may not look as attractive as the UK to some, despite ongoing Brexit uncertainty. With uncertainties surrounding the continuing trade war between the US and China, troubles in Iran, pro-democracy protests in Hong Kong (to name but a few), coupled with the fact that Germany looks like it might be sliding into a recession suggests that many investors might be looking at opportunities in the UK again.

Markets hate uncertainty so hopefully as Brexit becomes clearer in the weeks and months ahead, so too may investment inflows in the UK, regardless of whether we leave or stay within the EU.

Many investors might look at the exchange rate, but this is only half the story. What kind of uplift or drop should investors expect? One interesting, light-hearted way of looking at whether currencies are at their correct level is looking at the Economist’s Big Mac Index created back in 1986. It is based on the theory of purchasing-power parity (PPP) between two currencies. Why the Big Mac?

Purchasing power often looks at the cost of a basket of goods and services and compare them to the same basket of goods in another country. However, the trouble is a basket of goods and services in one country are often very different to another – so it’s difficult to accurately compare purchasing power to see whether one currency is ‘fair value’ versus another. However, as a global restaurant chain, McDonald’s has sold billions of burgers around the world, of which the most well-known is the Big Mac. What the Big Mac Index effectively does is compare the price of a Big Mac in one country to another to see whether, at the present exchange rate, the currency is priced fairly.

Currently a Big Mac in the UK costs £3.29 (source: Mc Donald’s UK) and the cost of a Big Mac in the US is $5.74 (Source: McDonald’s US). This means the implied purchasing power parity is $1.74 to £1, that is $5.74/£3.26. This compares to an actual exchange rate, of $1.20 to £1. The difference between the Big Mac Index and the actual currency implies the Sterling is undervalued by 45%!

Of course, this is not a perfect comparison and like any index it should be interpreted with just a pinch of salt! For example, the index also implies that the Swiss Franc is 60% overvalued when compared with the UK. I doubt this is really the case, and the more likely reason is the fact that McDonald’s in Switzerland is seriously overpriced!

Nevertheless, it does suggest to US investors concerned about a selloff in the US that maybe an investment in the UK might make more sense than piling into US long-term treasuries. We mention this because currently there is speculation that the US might be entering a recession with last week showing the yield curve inversion between the 3 month and 10-year US treasury bonds (historically, inversions of the yield curve are often seen as an accurate forecast of an impending recession). This is because longer-term bonds are demanded over shorter dated bonds, thus sending the yields down.

It could be a case of ‘double bubble’ for overseas investors that now choose to invest in the UK. With UK markets underperforming against their peers, coupled with the UK being (in some cases) unreasonably discounted when compared to other currencies, then it could mean the UK is an attractive investment opportunity.

 

Global equity slump continues on recession fears

Equity markets fell for a third consecutive week as investors digested inverted yield curves on both sides of the Atlantic. Both the US and UK government bond markets saw their respective 10-year yields drop below 2-year yields, a phenomenon that could signal a period of economic contraction in the not too distant future. Many commentators viewed the sharp declines in equity markets as an overreaction and the US curve had reverted by the conclusion of the week although it arrived too late to prevent weekly losses across all of the major indices.

In the US, S&P500 had recorded a single day loss of around -3.0% on Wednesday before bouncing back to record a weekly loss of -1.0%. Domestically, the FTSE100 dropped by -1.9% with the mid-cap focussed FTSE250 declining -1.4% whilst in Japan, the Nikkei 225 fell by -1.3% as geopolitical and domestic headwinds continue to take hold. Meanwhile on the Continent, the German DAX30 and French CAC40 slipped by -1.1% and -0.5% respectively.

10-year Gilt yields continued their descent towards 0.00%, dropping by a further 2 basis points (bps) over the course of the week to just 0.47%. As noted above, there were big moves in the US treasury markets as the 10-year dropped by a hefty 19bps to 1.54%.

The ongoing rout in Sterling paused for breath with the domestic currency recording weekly gains against a number of the peer group. It rose by +0.5% against the US Dollar and +1.4% over the Euro to close out the week at $1.214 and €1.094 respectively.

Finally, in the commodity markets, oil held firm with the Brent crude price largely flat at $58.64 a barrel although it’s worth noting that it has fallen by almost -20.0% over the course of the last 3 months. Gold remained above the $1,500 threshold after a weekly rise of +0.4% left the precious metal at $1,508 an ounce.

 

The week ahead

With a fairly light schedule in terms of data this week, investors will likely focus upon central bank guidance with the release of policy meeting minutes from both the Federal Reserve and the European Central Bank, before attention turns to the Jackson Hole symposium on Thursday. The Fed minutes on Wednesday evening may give a little more insight into the bank’s decision to raise interest rates for the first time since the financial crisis, whilst Europe also looks close to confirming a return to further easing measures.

At Jackson Hole, economists and central bankers are scheduled to speak at the annual event over three days, kicked off by Fed chair Jerome Powell on Thursday. With many market participants left disappointed by the lack of a clear schedule of rate cuts following from Powell, many will be looking to this event hoping to glean some insight into the future path of monetary policy as well as the current state of the global economy.

 

The value of an investment with Rowan Dartington may fall as well as rise. You may get back less than the amount invested. 

Past performance is not indicative of future performance. 

Source: FE Analytics (information correct as at 19 August 2019) 

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