The Weekly - Murky Markets


The weekend has delivered the latest twist in the Brexit debate with Corbyn shifting his position.  Politics is a dirty game and participants will stop at nothing to make difficulties for those in power and this is a brazen attempt at doing just that.  There is an obvious contradiction in wanting a customs union with the EU and being free to negotiate independent trade deals.  However, the Labour Party has probably calculated that this could well cause a defeat for the government if they were to seek an amendment to the Brexit Bill in this regard.  There are probably enough Tory rebels who would support it and that could pose danger for Theresa May.  This was always the big risk when she lost her majority after the last election and this is now going to be exploited for party political purposes.

This is nothing about what is best for the country and what would be the most favourable trading relationship with the EU and the rest of the world.  Labour have previously been aligned with the government strategy but this now shows a deviation and does risk alienating Brexit supporters.  However, this is all about gaining power and causing difficulty for the incumbent government and pity the poor voter and all those who want Brexit to mean freedom from EU control.  The complicating factor in all this is the Irish border and how we can stay out of a customs union but not have a hard border.  Perhaps Labour MPs are also of the view that they would rather compromise on their Brexit stance if a shot at power was the prize.  This will require the government to fall and an election to be called which at the moment looks like a tall order.  Theresa May’s forthcoming speech on the future trade relationship is key as there will now be a significant divergence with the alternative from Corbyn and it would appear that the EU is already sceptical before she has even laid it out.  The advantages of sitting in opposition with rocks to throw and targets to hit when you’re not in the hot seat are all too evident.

Whatever transpires, the message for the business community and internationally is a country in political turmoil which could see a lurch to the left in the near future.  Hardly an incentive to open your wallet and invest.  We remain underweight to UK equities although nationally, economic growth is being propped up by the rest of the buoyant world at the moment which is settling the equity market.

This week also provides us with the first opportunity to see the whites of the eyes of Jerome Powell, the new Chair of the Federal Reserve Bank.  He has two speeches on Tuesday and Thursday when he testifies on the economy before congressional committees.  Commentators will be focusing on his views on inflation and rate hikes but we wouldn’t expect any fireworks or a sudden enhanced hawkish tone.  He will be well aware of how his every word will be analysed and interpreted.  Either way it will be useful to determine the consistency of his message with the perception in the markets that rates are likely to rise at least another three times this year.  That will be okay whilst the economy is strong and there are no clouds on the horizon.

More generally, investment markets have settled into a narrow trading range a few percent below their previous highs.  Bond yields have ticked up further since the original wage growth rumpus but this change appears to have now been priced in and has been accepted and quantified in the economic landscape and outlook.  Whilst rampant wage growth would be of significant concern, modest wage growth would be a positive so long as it is accompanied by rising prosperity for all, a feature that has been famously missing from the economic recovery since 2009. 

Markets always have to have something for the bears as that is what creates a bid and an offer price.  Whilst the valuations underpinning the US equity market are eye-watering and at a significant premium to others, there are also some uniquely attractive aspects regarding the US economy.  Economic growth is the strongest of the major developed global economies, unemployment is at record lows and a significant liquidity stimulus has just been enacted in Congress via corporate and income tax cuts.  We are not advocating an overweight strategy but you can see why investors are reluctant to sell when the US economic machine is starting to fire on all cylinders.

The global co-ordinated growth story does mean that there are other equity markets connected to growing economies which are cheaper but most come with either political risk, currency risk or some other longer term argument to be more cautious, whether than be Eurozone stability worries, UK Brexit worries or Chinese debt worries.  The US arguably always deserves to trade on a premium, merely for reasons of hosting the world’s reserve currency which provides a level of security second to none.  If the domestic economy is also one of the strongest in the developed world and one of the most dynamic, then it is small wonder there are enthusiasts at almost any price. 

Observing the technology stocks and their valuations presents an incredulous credibility gap that can only be explained by a belief in the entrepreneurial skills and creativity that rests within.  If you think this sounds like the stuff of bull market legend, you would be right but then again, if you had waited for Apple, Amazon or Facebook to look cheap on standard valuation measures, you would never have held them, missing out entirely on the digital internet revolution that is the foundation of their business models.  This is one of the hardest investment decisions.  When is a single figure price/earnings ratio a value trap or indeed cheap and when is a three figure equivalent ridiculously overvalued or in fact illustrating that the market analysts don’t understand the growth prospects ahead?

Whatever the right answer, the advice still has to always be to have a diversified pool of opportunities and never put too many eggs in any single basket.  Be sceptical of all you don’t understand and recognise when you have been lucky or when you are following the herd.  And finally, a profit is only a profit when you have banked it – don’t forget to sell.  However, don’t let that mind set morph into a loss is only a loss when you sell.  Many loss positions are never sold for this reason until it is too late.  In this scenario, the investor believes they can avoid the psychological pain of crystallising a loss if they hang on for a recovery back to their purchase price.  The best antidote to that is to come up with a new idea that you feel really positive about and earmark the loss position for the funding.  That way the new found optimism hopefully cancels out the long term negativity that has been preventing the sale in isolation.

If only the strategy regarding our future EU trading relationship was as clear.  It has just become more murky and uncertain with the respective motives behind the differing approaches riddled with political agendas.  That doesn’t usually bode well for domestic markets.  Overseas opportunities continue to be much easier to identify and sit more comfortably on a two year view.

Upbeat Fed Minutes Point Towards Imminent Tightening

The minutes from Janet Yellen’s final Federal Reserve policy meeting were released last week. Economic projections were revised higher thanks in part to the recent tax cuts which are expected to lift consumer confidence and drive increased spending. As a result, inflationary expectations picked up with the general tone one of an economy that is heating up. Further monetary tightening therefore feels imminent with 3-4 rate hikes expected for 2018 as a whole, the first of which is now likely to take place at next month’s meeting, Jerome Powell’s first at the helm.

US equity markets had a positive, holiday shortened week with both the S&P and technology led NASDAQ recording gains. European bourses also had a steady week with the German DAX30 and French CAC40 gaining by +0.3% and +0.7% respectively. In Japan, the Nikkei rose by +0.8% to record a decent week although disappointingly on the domestic front, the FTSE100 closed the week in negative territory (-0.7%) following a series of weak corporate earnings releases.

Sterling had a mixed week, rising steadily against the Euro whilst simultaneously losing ground against the Dollar. This was more to do with strength in the US currency which bucked its recent depreciating trend to also deliver weekly gains against both the Euro and the Yen. The comments contained within the Fed minutes no doubt acted as a bit of a kicker for the Greenback.

Sovereign bond markets were largely uneventful with 10-year UK gilt yields 5 basis points (bps) lower at 1.54%. The equivalent US Treasury yield decreased by 3bps to 2.87%.

In the Commodity markets, oil rallied on weak inventory data despite US production continuing to rise. Brent Crude was +3.8% higher at $67.31 a barrel, still some way below the 4 year high of just above $71.00 set last month. Meanwhile, the Gold price trended lower thanks largely to the uptick in the Dollar. The precious metal recoded a weekly loss of over -2.0% to just over $1,328 an ounce.

The Week Ahead

This week, the US Commerce Department publishes its second reading of Q4 economic growth.  The initial Gross Domestic Product estimate showed the American economy gaining momentum with an annualised growth rate of 2.6%. Marginally weaker consumption data since the initial estimate leaves open the possibility of a small downgrade; the consensus forecast amongst economists suggests a reading of 2.5%.

Manufacturing PMIs are also due from the US, China and the UK.  Domestically, PMI data for the Construction sector is also due, released on Friday, which has only achieved marginal growth in recent months.  In Europe, Consumer Price Index data is due on Wednesday which has been running below the ECB’s 2% target. At a headline level, the most recent reading showed that consumer prices have grown 1.3% year-on-year.