The Weekly - Sovereignty – is it coming home?

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09/07/2018
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We always knew Brexit was going to be fraught with political turmoil and now it really has kicked off with firstly David Davis’ resignation and now Boris Johnson.  We hear that they hadn’t actually seen the proposal at Chequers beforehand which tells us that Theresa May has now taken the gloves off and is willing to call time on those not entirely falling into line.  She may fall on her sword in the process and who knows what that will then deliver in terms of her replacement and from which party.  These are historic and fascinating times for the UK as a nation.  She will be gambling that the hard-line Brexiteers cannot raise enough support to mount a challenge to her leadership and that none of them would want her job right now.

This is where the markets and not the media are an interesting guide.  Sterling has remained steady and the UK equity market is settled.  At the time of writing, our interpretation is that the soft Brexit proposal as presented will be broadly welcomed by UK plc and removes much of the worst-case scenarios for British businesses which have been whirling around in the last few weeks.  It is a long way from the reported expletives regarding business which have come from Boris Johnson which he must regret as they damage his credibility.  As for Gove, well he seems to be playing a unifying card of support and it will have to be someone else that gets the knife out – perhaps he sees himself as the heir-apparent with a foot in both camps?  The plots currently being hatched must be numerous and frenetic.  Bizarrely, Theresa May’s weakest card is also her strongest in that her lack of a majority encourages unified party support through fear of letting Corbyn in.  Flushing out and isolating the dissenters who have pledged allegiance at Chequers has certainly brought things to a head.  At least David Davis and Boris Johnson didn’t have to get a taxi back by resigning at Chequers having immediately lost their ministerial cars!

Meanwhile, the UK is hosting Donald Trump this week with an inflatable balloon and not the Stars & Stripes – it will be easily punctured from the US embassy across the river.  No doubt he is likely to create further combative headlines at the NATO summit on funding before meeting Putin who will relish the inevitable spat.  This summer’s silly season really is providing so much political media fodder - life was so dull in the Cameron and Obama era!

As investors, it is vital to remain focused on what we invest in and keep the political background in perspective.  The biggest market risk is Trump’s pursuit of tariffs and not the gyrations of Brexit.  In terms of global equities, as measured by the FTSE All –World Review for the end of June 2018, the US equity market accounts for 52.6% of the total, followed by Japan on 8.4% with the UK third on 6.0%.  Next comes China on 3.6% followed by France, Germany and Canada.  This is our opportunity set as equity market investors and when you consider that at least 70% of the UK equity market comes from overseas earnings, the current Brexit turmoil doesn’t really matter to much of the quoted exposure in the world.  Overseas investors usually lump the UK in with their Pan-European exposure as evidenced by the paucity of investible UK mutual funds available to the overseas investor.

What really matters is the health of the US economy but more specifically at the moment, how far Trump is prepared to go to extract trade concessions from US trading partners.  We all know that his tariffs harm everyone but his sole focus at the moment is on the November mid-term elections and avoiding humiliation.  He is not a personality that tolerates humiliation or criticism and will want to demonstrate that his strategy of America First is making progress by beating up trading partners, whether they be friends or foes.  Business is business and why let diplomacy and history get in the way?

Most UK based private investors will have the lion share of their equity exposure in sterling based UK quoted equities.  This is to moderate currency risk and also jurisdiction risk.  China has been a great place to invest but how certain can an investor be regarding the accounting regulations, legal framework and shareholder’s rights?  Some exposure is justified but the allocation has to be limited for that reason.  Whilst it is easy to criticise UK regulatory oversight, illustrated most recently via Carillion, fortunately it is rare and there will be changes resulting from the current stewards enquiry.  This doesn’t always happen in overseas markets which is why we always advocate overseas diversification and a healthy allocation to developed overseas markets, totalling over 80% of our current equity exposure.  The ongoing robust US economy matters far more than Brexit.

One way or the other it is almost certain that we will leave the EU.  The softer the agreement, the more market friendly that becomes in the short term, as the disruption and uncertainty is minimised.  This is why many Remainers voted as such – better the devil you know.  The ‘no deal’ scenario is probably looking more likely now as the EU knows how split the UK parliament is and may well push even harder to gain concessions in the full knowledge that Theresa May is of the same mind-set and is willing to railroad her cabinet, if she survives.  This is why the required ratification vote in parliament was argued so strongly by some.  It stops a Trump style imposition of what is a decision of nationally historical importance.  Indeed, the Trump administration has demonstrated just how much power lies with the US President and how little influence Congress has on much of what he does.  It could be argued that this is why the US economy accounts for over half the global quoted universe – they get things done without endless parliamentary consultation.  Of course, the risk is that a maverick gains power and he upsets the global applecart before he himself also falls out.

Dominic Raab has been appointed as the new Brexit Secretary – a pro-Brexit minister with significant international negotiating experience.  New blood without any bad but maintaining the balance in the Cabinet.  We carry on after what now feels like a predicted and choreographed event and suggests a sure-footed Prime Minister in control.  Boris has done his best to disrupt that.  The key question for us mere voters has to be how much Sovereignty and control will be ceded on Brexit and just what life will be like outside the EU.  Will we crystallise the lauded benefits or will the whole exercise end up preserving what we had before with added expense and bureaucracy?  The timetable is such that on 18-19th October, there will be a quarterly EU summit to agree the withdrawal treaty which will agree the rights of citizens, mutual financial commitments and how to keep the Irish border full open.  It will also include the transition deal and the broad terms of a free trade agreement. 

Mr Raab has a lot on his plate and now sits in the hottest of hot seats.  Although having just achieved such high status, he is probably going to do as he is told from here.  This all feels like David Davis was expected to resign and sends a powerful message to the rest of the collectively agreeing Cabinet.  Perhaps Boris was expected as well – we will see.

Markets Mixed As Latest Trump Tariffs Come Into Effect

Global markets treaded water last week as US tariffs on Chinese goods came into force. Tariffs on $34.0bn worth of goods kicked in during the early hours of Friday morning as the President seeks to protect US jobs and stop the transfer of US intellectual property to China. This followed similar levies on the likes of steel and aluminium imports coming from the EU and Canada a few weeks ago. As promised, China responded with tariffs on $34.0bn worth of goods travelling the other way with further tit-for-tat measures expected as the US ramps the pressure.

In the US, equity markets pushed forward during a holiday shortened week with the S&P500 rising by +1.5%. Friday’s labour market report revealed another 213,000 new jobs were added to the US economy over the course of the previous month although wage growth remained subdued. 10-year Treasury yields were 4 basis points lower at 2.82% as the Dollar pared some of its recent gains with modest losses recorded against both Sterling and the Euro.

Elsewhere in the equities sphere, European markets pressed ahead despite trade fears looming overhead. President Trump had suggested that automobiles would be next in the tariff firing line, no doubt putting the likes of Germany and Japan on red alert. Despite this, the German DAX30 and French CAC40 ended the week +1.6% and +1.0% higher respectively. Unfortunately the same could not be said for the Nikkei 225 which endured a difficult week, falling by -2.3% as the banking sector slumped to its lowest level for more than 18 months. Domestic equities were also in reverse with both the FTSE100 (-0.3%) and FTSE250 (-1.0%) losing ground.

Briefly covering the commodity markets, oil retreated from its recent 3 years highs with Brent Crude closing the week -2.9% lower at $77.11 a barrel. Meanwhile, gold benefitted from the bout of weakness in the Dollar with the precious metal rising by +0.3% ($4.0) to $1,254.84 an ounce.

The Week Ahead

President Trump’s arrival in the UK on Thursday as part of a four-day trip will no doubt draw many headlines this week. The scale of the security operation has already raised eyebrows as the UK prepares to mobilise police officers in numbers not seen since the 2011 riots to combat protesters.  In terms of data, the UK is to become one of the first major world economies to publish economic growth figures on a monthly basis. On Tuesday, the Office for National Statistics will produce its first monthly GDP estimate amongst other statistical indicators to gauge the strength of the British economy. Manufacturing Production is also due Tuesday in what is otherwise a fairly quiet week of economic data.  Elsewhere, the European Central Bank is due to publish minutes of its latest monetary policy meeting, whilst inflation data is scheduled on Friday in the US.