The Weekly - G7 - Rattling the Sabre

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11/06/2018
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You need not have read or seen the news over the weekend, but you would have got the gist of how well the G7 summit went from one photograph. It was the photo of several G7 leaders standing round a table looking at Donald Trump who was sat down with his arms crossed. It was a scene that most people will be familiar with, that is if you have ever seen parents scolding a petulant child.

However, this should not be seen as a barb to Donald Trump, as I’m sure many parents will testify, sometimes the only way to resolve the situation is to give them what they want. If you can’t reason with him then it leaves very little room to manoeuvre. This could well be a smart move by Donald Trump. World leaders are generally not used to conducting business with someone who is so unwilling to negotiate. It is either Trumps way or no way.  Of course the EU has retaliated with the implementation of several retaliatory tariffs.                                                

The US runs a huge trade deficit; therefore they do have a lot of clout to swing in any trade war. In 2016 the US defect with the EU was $147 billion. While the EU is their largest trading partner, the US also runs deficits with Canada and Mexico. An EU tariff on Harley Davidsons and Bourbon is hardly going to scratch the surface, but what it almost certainly will accomplish is angering Mr Trump which could leave him implementing further and wider reaching tariffs on the EU.

The US might be rattling the sabre, but we find ourselves agreeing with Theresa May when she asked for calm before implementing any retaliatory measures. The US does have some legitimate gripes around trade and other matters. Much of Donald Trump’s focus seemed to be on the dairy tariff implemented by Canada.  Canada does actually impose a 270% tariff on milk, and this is while the US dairy industry continues to suffer from continuous overproduction resulting in US farmers dumping over 100 million gallons of surplus milk last year. With many US dairy farmers entering insolvency some would say Donald Trump does have a point.

His other main gripe is on defence spending of America’s closest allies, or lack thereof, especially those countries within NATO. The US does have the largest defence budget in the world so it does make up the majority of spending within NATO, and other countries within NATO are not meeting the 2% of GDP spending requirement on defence. Donald Trump’s argument is that EU countries are overly reliant on US defence and so they see little need in spending their own money. Again, there is an element of truth in this, especially when facing an increasingly hostile Russia.

While Mr Trump might have some legitimate points that need addressing, a trade war is not how you resolve these. As David Cameron will testify, negotiating with the EU is not the easiest job but open dialogue with your largest trading partner has to be better than a trade war which will have a negative economic impact on all those who partake in it.  

Some of Donald Trump’s strongest insults were aimed at Justin Trudeau, Prime Minister of Canada. He labelled the Canadian meek, mild, dishonest and weak. These insults arrived in the form of a tweet from Air Force 1. Donald Trump had left the summit early to attend the much anticipated summit between him and Kim Jong-Un on the potential denuclearisation of North Korea. It is difficult to feel sorry for the leader of North Korea, but if the G7 summit is how Donald Trump treats his closest allies and friends, then Kim Jong-Un must feel a certain sense of trepidation approaching these talks as a traditional enemy of the US. It will certainly be interesting to see how the talks between the two leaders progress. Given these are two men who are used to getting what they want we are not overly optimistic of a long-term solution. Some would argue that Kim has already got what he wants, and that is to be seen on a world stage as an equal with the leader of the world’s foremost superpower.

However, despite the chaos of the G7 summit there are signs that the markets are growing used to Mr Trump’s sense of showmanship and have largely shrugged of the chaotic G7 summit with European markets in positive territory on Monday.

Plastic not so fantastic - One of the proposals of the G7 summit was to agree to an ocean plastics charter. The US and Japan declined to put their names on the charter. In what has been dubbed the ‘Blue Planet effect’ everyone is seeing the damage that plastics are doing to our oceans. This is good news, and any reduction in plastic usage coupled with more environmentally friendly alternatives will be welcome by everyone, not least by the environment. Plastic manufacturers are understandably concerned, however, despite potential regulatory headwinds many are still performing well, though their share price might not reflect this.   

Tougher regulations usually mean a tougher trading environment. No company wants a government or regulatory body imposing rules which may affect their business, and when they do it often leaves investors in those companies scrabbling for the exit. However, we believe this is often the wrong strategy. Regulatory headwinds are often part and parcel of doing business. Regulations are often a corrective measure of something that has gone unnoticed previously and in some cases can actually improve how a business operates. Of course, not all regulations are necessarily beneficial; some may have a detrimental impact on future business, and then there is the cost of implementing these regulations. However, what investors also tend to forget is regulations often act as a good barrier to entry, thus preserving existing market share.

It is often beneficial to look past any regulatory headwinds and look at the broader investment landscape. A good example is the tobacco industry which has faced continual regulatory crackdowns, not just over the last few years, but over the last few decades. They have faced advertising bans across television, magazines and radio. As well as having written warnings on their products they now have a collection of pictures illustrating the dangers. All this coupled with tax increases for smokers every year in the budget. It’s easy to see why investors not worried about the ethical implications of investing in tobacco would be concerned. However, these regulations have preserved their market share. Imagine trying to create a new business selling tobacco products, how would you advertise your product and get it to market? Despite recent tobacco weakness, over the last twenty years it has been a remarkably good investment. Plastic may well be the tobacco of today, despite the dangers to the environment it may well be a habit that is too hard for us to kick. The regulatory headwinds should be seen as an opportunity for plastic manufactures to spend more on research and development so there is better recycling and better plastics available, while hopefully cutting out single use plastics all together.

Finally, in the continued bloodbath on the high-street, Poundworld entered administration today. In a statement issued by the retailer it confirmed that that it had suffered from ‘high product cost inflation’. However, we would argue that if you are aiming to sell everything in your shops at a £1, without putting your prices up or taking into account inflation, then administration should be a foregone conclusion.

Strong Employment Data Leads US Markets Higher

US stock markets recorded a strong week following the release of the latest Labour Market report on the previous Friday. The report showed unemployment, non-farm payrolls and average earnings all beating expectations in what was a particularly impressive update. Unemployment fell to an 18-year low of just 3.8% and the 223,000 new jobs added during May was more than 30,000 ahead of forecast and the highest since February. Strong manufacturing and services data was also well received, helping lift the S&P500 by +1.6% to its highest level since early March.

Domestic markets were a mixed bag as the FTSE100 failed to build on its recent momentum with a weekly decline of -0.3%. The mid-cap focussed FTSE250 had a better week, gaining by just over +0.8%. European equities also endured a mixed week as the G7 meeting approached. The German DAX30 rose by just over -0.3% with the French CAC falling by a similar amount over the same period. Japanese stocks rallied despite confirmation that the economy contracted during Q1. The Nikkei was +2.4% higher for the week.

Sterling was back on the front foot against the US Dollar reversing some of the losses recorded recently, rising by +0.6% against the Greenback to $1.34. However, it continued its volatile ride versus the Euro this time declining by -0.3% to €1.14.  In the bond markets, sovereign yields trended slightly higher with the 10-year Gilt yield rising by 12 basis points (bps) to 1.45% with the US equivalent Treasury adding 5 basis points to 2.95%.

Regarding commodities, oil prices pulled back slightly with Brent posting a weekly decline of -0.4% to $76.45 a barrel. It has risen by more than +20.0% over the course of the last 3 months. Meanwhile, gold was flat with the precious metal remaining at the $1,298 mark.

The Week Ahead

This week’s much-anticipated summit between President Trump and North Korean Leader Kim Jong Un takes place in Singapore on Tuesday, hot on the heels of the weekend’s tumultuous G7 summit.  A busy week on the central bank calendar will also see three major developed nation central banks hold their respective monetary policy meetings. Most pertinently, the Federal Reserve meet on Wednesday and are expected to add a further 25 basis points to the US base rate given that the world’s largest economy has shown little deterioration in economic data whilst others have. The European Central Bank and the Bank of Japan follow on Thursday and Friday respectively.

Retail Sales and inflation data is due on both sides of the Atlantic this week, providing a gauge as to the strength of consumer spending in the UK and the States. The UK is also scheduled to see updated employment numbers on Tuesday, including wage growth data which has remained fairly modest, falling behind expectations in the last two months.