The Weekly - Are we nearly there yet?

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08/10/2018
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On Brexit, it feels like we should be there by now but when you don’t know the destination, it’s a bit difficult to determine.

One of our roles as investment advisers is to interpret the political landscape and determine whether there is instability and potential for a change in influence.  Investing is often said to be part science (the numbers) and part art (human behavioural bias).  Turmoil on the political front falls firmly in the latter and the problem right now is that we can’t forecast the science until we have some clarity on the political outlook, hence the discount being applied to sterling and the UK equity market.  It is entirely logical that the market has gone nowhere as no-one can base any tactical view without some clarity on the fundamentals going forward.  This is similar to discussions taking place in every UK Boardroom with many having already put in place operational contingency plans.  However, with investment, you can’t formulate an investment strategy around a binary outcome which is one of deal, no-deal or no-Brexit.  If you get the wrong side of that call, you stand to look very silly, if not irresponsible.

As investors, we have to remain bi-partisan in our views and as political as possible.  At outset, we capture the risk appetite of our clients and try our best to deliver their objectives in terms of growth or income, through thick and thin but we don’t ask about their political beliefs and whether we should allow this to affect where we invest.  A starting point would be to assume that, on average, 50% of our client base is in favour of Brexit and 50% against, as for the national vote.  However, much of the reason why we are where we are is because many have not seen an increase in wealth over the last ten years.  Quantitative Easing is to blame here which has boosted equity markets and the property markets whilst doing little to increase wages as the economy has recovered.  So the wealthy have become wealthier whilst those without investible assets have gained little.  Our average client has benefited handsomely from Quantitative Easing but it doesn’t necessarily follow that they are a Remainer or a Brexiteer.  It is far more complicated than that with the four main reasons why people voted, one way or the other, being their views on immigration, bureaucracy, financial contribution or sovereignty.  Those that voted Remain, on the whole, didn’t feel strongly enough on any to want to take the leap into Brexit.  Those that voted for Brexit, had a strong enough view on at least one if not all of those issues and perhaps a few more besides.

The whole debate has exposed the limitations of democracy as we know it and it is small wonder that populist political parties have made so much progress over the last few years.  Our western version of democracy is in crisis and whether those currently in power realise it is a moot point.  The voters certainly realise it by no longer sufficiently supporting the established choices of centre left socialism and centre right capitalism by voting for parties with more radical views for change.  Some voters are politically apathetic, fed-up with a succession of self-interested, career-focused politicians, who are increasingly perceived to have delivered little to help the vast majority, focusing instead on furthering their own career.  You don’t have to ponder for very long to come up with some names in Westminster who fit the bill.

You will have seen the rumours over the last few days that there would now appear to be some increased hope that a Brexit deal can be reached with the EU.  That will be a cause for celebration indeed!  Whatever this looks like and however it solves the Irish Border problem, we already know that the SNP, the Labour party and hard-line Brexiteer Tory rebels are likely to vote it down which means any initial relief rally in sterling could be short-lived.  If parliament do vote whatever deal down, then what happens next?  The clamour for a second Brexit vote is building but again, there is little agreement as to what this vote would be on, deal or no-deal, or indeed Brexit itself, once more.  There is a point at which democracy becomes impotent because it fails to deliver a decision and this is where we are headed.  The most unfortunate thing is that if parliament does fail to ratify a deal, the vast majority of the population will be dismayed that the people we elect to govern and make decisions on our behalf have failed to do so, regardless of political persuasion.  Many MPs will be voting for strategically political reasons rather than for what is best for the people and the country.  This is why we are where we are – many Brexiteers have a desire for change and freedom from self-interested power-junkies who, in their view, have forgotten who they serve.  However, in parliament this is presenting itself as exactly that!

This is the state of modern day democracy throughout much of the developed world.  An apparent dislocation between the incumbent parties and voters which is leading to more radical outcomes such as Brexit, Donald Trump and the rise of nationalism throughout Europe, most recently in Italy and Germany.  Quite where it will lead us is anyone’s guess but one would hope that a new era of political ideology will appear in time, as suggested by Tony Blair, like him or loath him.  One ray of hope is that Theresa May managed to hold it together reasonably well at her Party Conference last week and showed some renewed vigour and leadership.  Her role is the ultimate hospital pass and whilst many are waiting to administer the dagger, none wants to take over right now.  Perhaps there is more strategic planning here than we may think.  Let us suppose there is a deal in the next few weeks which she can present to parliament.  Let us also suppose this deal ensures the free movement of trade such that all the issues with the likes of Jaguar Land Rover, Toyota and Airbus are solved in terms of job security.  The Labour Party and the SNP are going to look irresponsible if they prioritise their six impossible tests or Scottish Remain at all costs, vote it down and then guarantee multiple job losses throughout the UK, many of whom will be union and Labour members.

The UK equity market has been weakening as sterling has strengthened off the back of this, but more generally, global markets have fallen by around 2% since the end of the third quarter.  Fund managers often reposition their portfolios for the final quarter of the investment year, either battening down the hatches to secure their outperformance or making quite a few last-ditch positions to attempt to claw back their underperformance. The so-called year-end rally is statistically proven to influence what is often a reasonable period for markets and as 2018 has been so dismal so far, becoming bearish now is probably the wrong call, especially when there is so much negativity around.  Contrarian investors will tell you to buy when there is blood on the streets and sell when all looks rosy – it feels like we are nearer the first scenario than the second.

Of greater global influence is the US equity market and what is going on there.  The British media is all-consumed with Brexit and Trump-bashing which makes for good headlines but little else.  Whenever the noise becomes overwhelming, it is sensible to think back to what we are invested in, namely, company balance sheets, profits, dividends and interest payments.  The world continues to go round and people continue to work for a better standard of living.  Elected politicians are transitory, they come, they meddle and they go.  History either remembers them, occasionally with a statue or, exceptionally, a banknote, or forgets them.  Try to keep calm and try to keep focused on the intrinsic value of what we invest in and refrain from overloading on the media frenzy.  We may not have got there yet, but wherever we are headed, we are nearly there.  Some of the guesswork is about to be removed and with it, the uncertainty discount.

US Bond Yields Spike On Positive Economic Data

US Treasury yields pushed higher last week as the latest Labour Market Report revealed unemployment at its lowest for nearly 50 years. Whilst only 134,000 new jobs were added during the month, the jobless rate surprisingly dropped by 20 basis points (bps) to just 3.7% during September, a level not seen since 1969. The latest production indices from the Institute for Supply Management (ISM) also showed the economy in rude health with both manufacturing and services sectors continuing to power ahead. The US 10-year yield closed the week 16 basis points higher at 3.23%.

This lead to some concerns of higher than expected future interest rates and Equity markets were firmly in retreat mode last week. Domestically, the FTSE100 declined by -2.6% and the mid cap focused FTSE250 by -1.9% as 10-year Gilt yields rallied by 23bps to 1.71%. It was a similar story elsewhere with the S&P500 shedding -1.0% and the Nikkei 225 by -1.4%. European markets also had to content with Italian government budget concerns which resulted in the Euro STOXX 600 falling by -1.8%.

With regards to currencies, Sterling crept higher against both the Dollar and the Euro, rising by +0.3% and +1.2% to finish the week at $1.308 and €1.136 respectively. Despite its modest weakness against Sterling, the Dollar continued to climb last week amid the rise in bond yields and nervousness in equity markets.

In the commodities market, oil continued its march upwards with Brent crude rallying by another +2.6% to close the week just below the $85.00 a barrel threshold. Gold meanwhile ignored the increase in the Dollar to record a weekly gain of +0.9% to conclude the week at $1,202 an ounce.

Data sources: Thompson Reuters DataStream; Forex factory; Guardian; Institute for Supply Management

The Week Ahead

Domestically, the ONS releases its monthly calculation of GDP on Wednesday, this time covering off September. A modest +0.1% increase is expected on this occasion, 20 basis points slower than the level recorded back in August. Other items to keep an eye on include manufacturing production (also Wednesday) and well as the latest Bank of England Credit Conditions survey which is due later in the week. In the US, the standout data this week is CPI inflation which is forecast to have declined slightly to 2.5% at the headline level. UoM consumer sentiment due on Friday is expected to be particularly strong once again. Industrial production is the main figure out of the Eurozone with the ECB releasing the minutes from its last policy meeting. In Asia, trade data for China is released in the early hours of Friday morning with its significant surplus with the US likely to come back into focus once again. Japanese data is in short supply.

Source: Forex Factory