The Weekly - Market déjà vu rarely happens

11/02/2019
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Throughout 2019 to date, markets have continued to wrestle with the same stories and challenges that were in evidence towards the end of 2018.  This caused a peak in bearishness on Christmas Eve and lows in many equity markets.  Nothing has actually changed as we progress through February apart from perhaps the perception that several political headaches are coming to a head.

As we see it, for the UK investor, these boil down to three issues; US-Chinese tariff negotiations, US Government Funding negotiations and UK Government Brexit negotiations.  It is a feature of our open society in the west that the media is now able to report each step of the way almost instantaneously.  Gone are the days of secret talks behind closed doors that few are aware of.  The power of social media ensures that leaks are almost guaranteed and as most politicians are driven by ego and their appetite for power, few can resist the temptation of firing off a tweet in full knowledge that it will go viral within seconds if the content is juicy enough. 

We are all aware and probably have experience of the dangers of engaging in email arguments which rapidly get out of hand when confined to the safety of one’s computer screen.  People will often type things which they would never dream of saying when face-to-face.  Not unlike drivers who fall into the trap of road rage as they become impatient and lose self-control, in full knowledge they can speed away in their anonymous car.

Unfortunately, this is what is infecting western politics today.  Minority views become mainstream and the more sensationalist the statements, the more the media reports them regardless of the authenticity of the author.  There is no debate about the success that anti-democratic movements have had with regard to sowing chaos via social media.  Some conspiracy theorists believe that Brexit and Trump are entirely the result of campaigns from these sources and if you believe this then they have been very successful indeed.  The democratic world feels unstable, angry, troubled and confused with the old modus operandi of carefully considered diplomacy and polite negotiation long gone.

None of this serves any useful purpose for the business world in that potential concerns are exaggerated and catastrophising has become the norm.  Absenting oneself from social media is an extremely rare thing as people need to feel connected with the world and how they fit within it.  Turning one’s back on the internet seems like the realms of hippiedom back in the sixties by pursuing a completely different way of life.  It is difficult to see this ever becoming popular with the young and so the future of the likes of Twitter, Facebook and Netflix are probably assured as they become the route to millions of eyeballs and marketing opportunities.  However, with this comes teenage bullying, depression and unwelcome intrusion from foreign nations and fake news.  Big Brother was envisaged as the ultimate influence and control from the state, but the state is actually not the problem here – it is the truth and what or whom to believe.

With that comes added uncertainty when it comes to the investment markets.  Social media adds to the potential for anxiety and the media more generally has become all powerful.  This has to be positive because it empowers the people and moves democracy to another level.  Unfortunately, this also means that all views are heard and given similar exposure, so that we all end up arguing with ourselves incessantly and get nowhere.  As Winston Churchill once said, ‘Democracy is the worst form of government except all those other forms that have been tried from time to time’.  The challenge for investors has always been to identify the relevant from the irrelevant, sift the wheat from the chaff, find the next big thing and ignore all the speculative noise.  Today, this is harder than it has ever been with more noise confusing the picture and more reasons for a potential investor to lose sight of what he is buying, scared by the media stories of chaos.

It would be easy to assume heightened market risk as we approach the expiry of the US Government shutdown truce on Friday and the US-Chinese tariff suspension on 1st March, not to mention Brexit at the end of March.  However, the VIX Index, often referred to as the fear index which measures volatility and perceived future risk, reached a peak on 23rd December but is now at the lowest level since the beginning of October when the market rout started. 

It is a common mistake that investors make when they believe that markets will be affected in the same way when the same set of circumstances re-emerge.  It is the unexpected which affects the markets, causing a temporary spike in risk aversion as traders learn how to price in the new risk.  Once they have done that, asset values adjust and then the repeating original story becomes old news and fails to register anything like the previous influence.

Trying to rationalise this is very difficult, not unlike the differing views on a no-deal Brexit.  One view is to relax, it will be fine and is all part of Project Fear.  The opposing view is economic carnage and chaos.  The truth is nobody knows but markets and their valuations are the rational culmination of all views.  If you plan for the worst outcome, then there is only upside.  So why has the UK equity market rallied by 6.2% since Christmas Eve despite the voting down of the Brexit deal?  Why has the S&P 500 risen by 13.4% over the same period despite the political situation becoming more precarious?(1)  The explanation lies somewhere between familiarity with the issues, investor fatigue and a realisation that political noise comes and goes.  Profits and dividends are what matters, and all appears rational and in-line with forecasts, albeit weakening forecasts.

Whilst there may be heightened political turmoil in the West, the impact of populist democracy has been diluted as voters realise that electing the radical and extreme may satisfy their emotional views for change, economic turmoil serves no useful purpose and ultimately leads to hardship and unemployment.  Be very careful what you wish for.  Greece learnt this the hard way when it voted to end austerity by electing President Tsipras to take on the EU.  When they realised that exiting the Euro would cause a 50% fall in national wealth as the Drachma collapsed, they had little choice but to fall into line. 

The UK is finding this with its Brexit negotiations.  Even if we do manage to agree a post backstop process which preserves our sovereignty, how will we ever agree a trade deal without an Irish border where there are potentially different future tariffs on either side?  The UK market seems to believe there is no appetite for a no-deal and that if we run out of time, then both sides will desire an extension to the timetable.  This would explain why Brexit sensitives have rallied as this has become a widespread reality view.  The same applies in the US.  Trump caved in on the government shutdown which could well rear its head again, but ultimately, either via this or the US-China negotiations, he needs some positive announcements to sustain or reinvigorate his perceived popularity. 

The fact that he measures his success by the performance of the stock market is a comfort as this means ultimately, he will listen to the capitalists and serve their need.  Perhaps the markets are gaining confidence from the fact that shortly, Brexit, tariffs and Mexican walls will be history and apart from this, equities look good value.  Markets look forward and whilst there is likely to be more brinkmanship over the forthcoming weeks, solutions can be seen which will preserve political reputations.

Source: FE Analytics (1) - Accessed 11/02/19

Equities quietly edge higher amid mixed data

Volatility was modest last week compared to recent levels, despite a raft of S&P 500 companies publishing earnings reports. The index technically recorded its seventh consecutive week of positive gains, though last week’s return amounted to a negligible few basis points and was for all intents and purposes flat. The UK’s FTSE 100 index fared better, climbing +0.7%.

Meanwhile, Eurozone markets dipped last week; Germany’s DAX 30 falling -2.5% and the French CAC 40 down -1.1% over the course of the week. The European Commission expect economic growth to slow to an annualised rate of 1.3% in 2019, down 60 basis points from their most recent estimate.  Falling demand from China is major contributing factor to the likely deceleration, whilst clearly Brexit uncertainty is also likely to weigh on sentiment on both sides of the Channel.

The Institute for Supply Management released an updated gauges of US activity in the all-important Services sector, which indicated solid growth, if not quite at the record pace set in previous months. Whilst this was a shade behind forecasts, it reassured many investors that economic weakness in other areas like manufacturing was not such a concern within Services.

Domestically, the UK’s own measure of business activity in Services dropped within a hair’s breadth of a contraction according to data on Tuesday. Services represent more than 75% of the UK economy.  Meanwhile, the Bank of England’s monetary policy committee unsurprisingly left interest rates unchanged at Thursday’s meeting and no rate rise is forecast for some time, at least while Brexit uncertainty remains at the forefront of economic concerns.  

The price of oil drifted lower with Brent crude down -1.2% over the course of the week, closing a shade over $62 per barrel.

Data sources: FE Analytics, Forex Factory - Accessed 11/02/19

The Week Ahead

This morning, domestic GDP data confirmed 2018 as the weakest year of economic growth since 2012. Output increased by just +1.4% over the previous year having expanded by just +0.2% during the final quarter of 2018. In terms of other UK related figures to keep an eye on this week, Thursday brings producer and consumer inflation whilst retail sales are reported on Friday. Inflation and retail sales data are also due in the US this week alongside industrial production which is forecast to have grown by +0.3% during January.

Meanwhile in the Eurozone, the preliminary reading of Q4’18 GDP data is released on Thursday with the economy also forecast to have grown by +0.2% over the period - if proven accurate, it will leave overall growth for 2018 at just +1.2%. Looking at Asia, Chinese trade numbers are the standout with close attention once again likely to fall on its trade surplus with the US which hit a new record last year. Japanese GDP is due in the early hours of Thursday morning.

Source: Datastream - Accessed 11/02/19