We have identified two developments worthy of comment that may indicate a shift in sentiment and by extension are supportive of markets. Following the Brexit first stage agreement in December, we considered the financial bill to be a bargain and consequently this was the first feather in the cap of Theresa May for a long time. She has subsequently been enjoying a rebound in her parliamentary standing. Many had speculated that she would unleash internal turmoil if she sacked Damian Green with David Davis threatening to resign. However, when it became obvious that the ministerial code had been breached, Davis backtracked, handing Theresa May an opportunity to stamp her authority. Her cabinet reshuffle is further evidence of her strengthening position which has to be good for Sterling, the Brexit negotiations and the UK’s International standing, although there is no evidence to support this as yet.
The other development which somewhat slipped under the radar just before the holiday was a declaration from both the Bank of England and the Financial Conduct Authority that they are willing to allow the continuing operation of banks and financial institutions with UK based European subsidiaries under the same regulatory rules as are currently in place. What this means is that, from the UK perspective at least, our oversight authorities are entirely comfortable with a ‘business as usual’ relationship when UK based overseas institutions are trading in Europe. These statements came shortly after Michel Barnier had said there could be no continuing of passporting. What this effectively says is that the UK authorities are making the trading arrangements as open and familiar as currently and that it will be for the EU to prevent businesses from continuing to trade freely in Europe. If the EU insists on this, then all major financial institutions will need to set up subsidiaries within the EU and, as Michel Barnier hopes, consider moving their European subsidiary from the UK to another financial hub in the EU.
The card that has been played here is a subtle but important one. Any bank in the EU, and the world for that matter, that wants to be considered a serious international player, will have a subsidiary in London precisely because that is where all the major banks of the world are also cited – specifically the big American banks. London is the world’s financial centre due to geography, time-zone and language but also due to infrastructure and administrative support, legally and technologically. The EU may think they can attract players away from the largest international financial hub but in reality, businesses will only do as little as necessary to comply with whatever rules transpire, whilst remaining fully represented at the top table in London, which is bigger than all the EU financial centres added together. If the US banks remain in London, and English remains the language of international finance, then City workers and the UK financial services industry has little to fear.
There is a point where industry stands up to the politicians and bureaucrats and makes demands in unison. As the trade negotiations begin, with jobs, profits and importantly tax revenues at stake, businesses like Airbus, the car industry, airlines, farming, fishing and financial services will be lobbying hard for the likes of Angela Merkel, once she has formed her coalition, to remember who votes for her and what really matters in this whole negotiation. This is why a transition deal is almost inevitable and the whole Brexit process will be very drawn out. The UK consumer is very important to the economies of Europe and Michel Barnier will soon be reminded of that.
Returning to the ever rising markets and the ever stretched valuations. For the time being, investors are remaining invested, mainly in equities and bonds, because there are few available alternatives and whilst there are no dark clouds with respect to earnings on the horizon, everyone is prepared to ignore the valuation concerns and keep their fingers crossed. The gyrations in Bitcoin throughout December show what can happen when greed turns to fear, literally overnight. The worst of this resulted from fraudulent activities leading to Bitcoin wallets being hacked and trading suspended on some exchanges. Those who bought the futures contracts when they launched will be nursing significant losses. However, it is a wake-up call for us all such that when a market correction comes, it will be sudden and savage as real fear returns. Any investor who is not prepared to remain invested for the longer term and needs to crystallise value within the next couple of years should be very careful indeed and consider a staggered programme of crystallisation rather than continue to ride the wave in anticipation of perfect timing. Arguably, the longer the bull market runs, the more savage the shock when it ends.
Most likely, any correction will be greeted with calls of this being ‘a buying opportunity’ and a short term bounce will be highly likely. What is key, is the catalyst, which will likely be analysed and quantified and discounted, which is what happened initially with the GFC (Great Financial Crash) and is almost a certainty given the events that were discounted in 2017. For now, the bull market continues and all is rosy but be prepared for this to end at some point. When that occurs, it will be vital to consider your objectives, their duration and whether you really have the stomach to stay invested or should sit on the side-lines for a while, ignoring the supposed ‘buying opportunity’. When long-term investing and short-term speculating become intertwined, it is important to determine which camp you are in and have a pre-prepared strategy in place to diffuse the temptation to speculate (buy) or panic (sell). Rarely do either of these kneejerk reactions end well.
Markets continue to break record levels
Developed equity markets on both sides of the Atlantic continued their push to new record-breaking levels over the Christmas period and during the first week of the New Year. The Dow Jones Industrial Average closed above the 25,000 mark for the first time on Thursday whilst the S&P 500 gained +2.6% over the four-day week. On home soil, the FTSE 100 added a further +0.5% last week to its record-high close at the year-end.
This came in spite of the latest US Labour Report that saw Nonfarm payrolls undershoot expectations on Friday; the US economy adding 148,000 new jobs versus a consensus forecast of 190,000. The unemployment rate remained unchanged at 4.1% whilst wage growth, as measured by average hourly earnings, accelerated +0.3% on a month-on-month basis or +2.5% year-on-year. The yield on US 10-year Treasuries climbed 5 basis points higher during the week to 2.48%, though the US Dollar closed the week modestly lower against Sterling and the Euro, down -0.3% and -0.2% respectively.
European markets also enjoyed a strong run; Germany’s DAX 30 climbing +3.1% and the French CAC 40 up +2.7% over the holiday-shortened week. European inflation released on Friday fell at the headline level to 1.4% (Consumer Price Index), well below the European Central Bank’s target rate of 2%. The European Central Bank is reining in its quantitative easing programme, halving its asset purchases from this month onwards.
Purchasing Managers' Index (PMI) data last week continued to show solid growth in UK Services, Manufacturing, and Construction Sectors. Whilst Manufacturing and Construction marginally undershot expectations, all three continue to comfortably achieve growth.
The introduction of Markets in Financial Instruments Directive II (MiFID II) took place across the industry last week, the only hiccup being a surprise last-minute extension for ICE Futures Europe and the London Metals Exchange who were able to delay some aspects for a further 30 months. The directive is widely seen as one of the largest regulatory reforms to impact financial services in recent years and it is estimated to have cost the industry €2.5bn to implement so far, according to reports last week.
The Week Ahead
It’s a relatively steady week of domestic macro activity with a number of key figures to keep an eye on. Tomorrow, the British Retail Consortium releases its latest sales data which will highlight how the overall sector performed during the crucial Christmas period. Wednesday brings trade and industrial production data in addition to GDP data, albeit not an official calculation but a Q4 estimate from the National Institute of Economic and Social Research. The Bank of England meanwhile, releases an updated credit conditions survey on Friday. In the US, the most important data arrives on Friday in the form on retail sales and CPI inflation, the latter of which is expected to remain above the Fed’s 2.0% target at headline level. On Thursday, the ECB publishes the minutes from its most recent monetary policy meeting with the main Eurozone data of the week arriving a day earlier in the form of unemployment. Chinese data is dominated by CPI inflation which is expected to have risen by 20bps to 1.9% whilst trade figures are due later in the week. There is nothing of any real significance from Japan this time around.