Mr Putin must be grinning broadly as he observes the national euphoria behind Russia’s latest success. This comes shortly after his latest election win and contrary to all the negative speculation. 2018 really has been his year and this will be topped with his forthcoming summit with Donald Trump on 16th July, the day after the final. No doubt there will be smiles all round, agreement signings and warm handshakes which will make many US western allies squirm.
Merkel’s troubles within her German coalition are also partially of Putin’s making. His intervention in Syria has caused much of the migration crisis and subsequently her policy of accepting so many connected migrants – the same can also be said of Italy. Add to this his apparent cyber strategy and the flagrant undermining and manipulation of democracy in the West and he is doing a good job of disturbing the political status quo and stirring up populist discontent. Today’s media are overwhelmed with opportunity thanks to 24/7 social media which contributes to the constant frenzy of political speculation. However, this harbours discontentment with all leaders as no-one is immune to criticism and ridicule in an open democracy that allows free speech. This means that no western leader has the luxury of President Putin who squashes dissent and opposition before anyone becomes aware of it whilst the vast majority of his electorate believe what they are officially told and want to lead quiet lives. Putin has little to fear from the media whilst western leaders have everything to fear.
We would normally take much of this with a pinch of salt when it comes to investment markets as political spats and turmoil are ever present. However, Merkel’s challenges along with Italy’s political balance, when added to the ramifications of the UK’s Brexit, are causing some to question the sustainability of the Eurozone once more. Migration has been a significant influence behind the shifting sands of European politics over the last few years and is also now affecting American policy. Nationalism continues its rise. It was quite remarkable last week in parliament when Theresa May gave approval for St. George’s flag to fly above No.10 Downing St. and other government departments on England match days and Jeremy Corbyn was very quick to confirm that his own flag was on display in his office. Compare this to the prior guidance given to fans visiting Russia who were told not to fly the flag at all for fear of attracting unwelcome and violent attention. How the tables have turned.
This is also showing itself in the Brexit negotiations where the UK position would appear to be hardening and the real risk of a no deal scenario becoming more likely. Again, this has been endlessly speculated ever since the vote two years ago, but things are now coming to a head and time is short. Businesses are starting to sit up and be counted as they plan for the future and this is causing increased equity market uncertainty and volatility. We were all initially shocked when the major events of the Brexit vote and Trump emerged unexpectedly. The former is feeling like a slow downward grind for the UK economy until we emerge through the other side which is not going to be any clearer until the end of the transition period in December 2020.
As for Trump, he is a fickle chameleon who will befriend anyone if it will reflect well on himself at the polls, even if this means falling out with his allies in the process. The current trade standoff with all his major trading partners is now at a level which would have surprised even the initial bears. His lack of diplomacy and blatant hard-nosed statements on twitter are still causing ructions in the polite circles of the political elite. He is willing to tread where others wouldn’t dream and will leverage US economic clout to get what he wants with little concern for protocol or who he may offend. His current trade crusade may end with the US having more of the global manufacturing pie but if he shrinks the pie in the process, that is nothing but a pyrrhic victory for him alone and everyone else is poorer.
Setting politics to one side, the fundamentals for fresh investment are looking somewhat tired. The main cause of investor hesitation is the likely trajectory of global interest rates as central banks multi-laterally withdraw their Quantitative Easing programmes. What will the effect be in terms of economic growth and will inflation continue in a subdued and controlled fashion? It feels like there is considerable risk and uncertainty but investors are sanguine for now as the alternatives remain sufficiently unattractive for any major shifts in allocation.
That said, as the political environment becomes more intense, it is inevitable that Trump’s aggression is going to meet something similar from both China and the EU, possibly involving the World Trade Organisation. Historic reference to 2002 is useful. The Bush administration of the time imposed steel tariffs for politically motivated reasons but this was during the economic slowdown and Technology bust of the period. Eventually, other countries of the world complained to the WTO who ruled against the US and imposed sanctions and the US backed down. The basis of these latest tariffs is supposedly in pursuit of national security which should not hold any water with the WTO. It is blatant protectionism and so one would hope that eventually they will be ruled illegal but there is some way to go with little sign of WTO interest to date.
Meanwhile, markets are going nowhere. Up one week and down the next with the first half of 2018 delivering the worst returns since 2010 and barely covering inflation. Earnings and dividends appear robust and there are no reasons to doubt their future but if the trade spat intensifies and Brexit disagreement develops into crisis, sentiment could easily collapse and deliver a correction of more substantive proportions. The outlook is as uncertain as the outcome of the World Cup – we will be watching both with keen interest.
Volatility continues as equities close lower
Global trade war concerns again weighed on equity markets early in the week and most were unable to claw back a positive return by Friday’s close. The UK’s FTSE 100 index succumbed to a weekly decline of -0.6%.
The White House made toned down rhetoric this week as plans to limit Chinese investment in US-based technology companies were scrapped in favour of more rigorous reviews by the Committee on Foreign Investment. However, roughly $35bn in tariffs on select Chinese exports are set to come in this Friday, plus Canada introduced $19bn of tariffs on American imports yesterday in retaliation for US steel and aluminium levies.
First quarter US Gross Domestic Product was revised lower on Thursday, the annualised quarter-on-quarter reading down to 2% from 2.2%. Weaker consumer spending data was the main driver of the revision, though most US economic indicators remain more resilient than other developed economies this year. Whilst second quarter growth is expected to be stronger, in part due to a narrower trade deficit, forecasts are being reined in somewhat on recent weakness. The S&P 500 recouped some heavier early-week losses to close just -1.3% lower.
UK first quarter GDP was also subject to a revision; the construction sectors woes during a weather-hit March were less severe than initial estimates suggested which led to a 10 basis point increase in the quarterly growth rate to 0.2%.
European markets also suffered as German retail sales dropped sharply last month according to Friday’s data. Germany’s DAX 30 closed the week down -2.2% and the French CAC 40 finished -1.2% lower. The European Central Bank has already confirmed its plans to end its quantitative easing programme at the end of the year and the bank is now taking a leaf out of the US Federal Reserve’s “Operation Twist” procedures. The ECB will look to lengthen the duration of its portfolio by swapping shorter-dated maturities for longer-dated ones, in an effort to keep long-term interest rates lower and boost economic growth. Meanwhile, the summit of European Union leaders appeared to have little bearing on Brexit negotiations, but did reach an agreement on migration and treatment of asylum seekers.
The Week Ahead
Production indices come back into focus this week with major releases from the UK, US and Eurozone. Little change is expected to the steady growth reported in the UK last month with the US data also expected to have remained strong. In the US, the biggest release of the week arrives on Friday in the form of the labour market report for June. The unemployment rate is forecast to have remained unchanged at 3.8% last month with new additions to the workforce likely to be around the 200,000 mark once again. Alongside the PMI releases, it’s a busy week of Eurozone data with unemployment, retail sales and industrial production all due before the close of play on Friday. In China, media company Caixin releases its PMI equivalents for the private sector following on from the official government data last week. Japanese data is in short supply.