The Weekly- Is it safe to relax

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06/08/2018
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This is a question that many an investor is asking as they venture to the beach and switch off.  August has traditionally been the month of market snooze but can we really relax and expect little to happen? 

Unfortunately, the answer is probably no - those days are long gone in this world of 24/7 news.  It is also becoming more difficult to decipher real news from fake news, or more accurately, relevant stories which qualify as news and headlines created for clicks which really aren’t worthy of the accolade.  The best non-story of the last two weeks was whether Donald Trump offended the Queen or not and who kept who waiting?  If Trump could refrain from responding on Twitter, or in this case, on a hustings platform at his own instigation, then the media wouldn’t feel so compelled to bait him.  The sport of irking Trump into a reactionary tweet has become mainstream with the media and unfortunately it only serves to undermine their own credibility as they come up with evermore far-fetched headlines.  It could be argued that this is the whole point behind Trump’s tweeting strategy. 

One thing we do know is that one day, Trump will fall on his sword and step down and for many, that day cannot come soon enough.  However, as with many ambitions and dreams, think very carefully what you wish for because all may not be as it appears.  There are some who are wishing that he gets a bloody nose at the November mid-term elections and loses the Senate.  However, when you examine the US economic numbers since his inauguration and his foreign policy executive orders, no US voter could question that he hasn’t been true to his word whilst on the campaign trail.  Very few politicians follow through so vehemently with their campaign pledges once elected, especially the really difficult parts which are going to upset so many international allies along the way.  He has certainly stood by his words and pledges.

We should also thank our lucky stars that he isn’t approaching his relationship with Putin in the same way that he initially did with Kim Jong-un otherwise, we could be in a very dark place.  However, his policy of making friends out of foes (and vice versa) could be storing up trouble for a future US President as those supposedly new friends are now able to exploit the new US position of tolerance.  It would appear that the US is redefining its position in the world under Trump and that is to be an unrivalled economic superpower once more because from that, all other positions of power naturally follow.  This is showing itself in stock market returns for the year-to-date but especially since June when the S&P 500 has outpaced all major markets whilst Asia-Pacific and Emerging Markets, including China, have fallen back.  Meanwhile, the UK has been directionless in its Brexit-induced stranglehold.

As usual, there are plenty of harbingers of doom around, calling the end of one of the longest bull markets in history, simply because it is one of the longest bull markets in history.  There are also articles on the increasing odds of economic recession in the US in 2019, grasping at early signs of sentiment surveys and confidence polls which could be showing the beginnings of a slowdown.  Whilst Trump’s trade tariffs are a real threat, the worst forecasts we have seen suggest a 0.5% reduction in global GDP.  We take the purist economic view that history has shown there will be no winners, and at some point, Trump will realise that his policies serve to increase prices and, reduce demand, US growth and jobs, and he will be forced to engage reverse.  The question is how long will this take?  His recent jibe at the Fed regarding interest rate increases may be his insurance policy if US growth dips – he will blame the Fed and not his tariffs and will relent on the latter to save the US economy from the Fed.  Whatever you may think of Trump he implements policy like an American Football coach, always having an offensive and defensive strategy irrespective of the outcome.

Outside of the ongoing robust US growth, the only other relevant news from last week was the unsurprising increase in UK interest rates.  In some ways this was a surprise, bearing in mind the building no-deal Brexit scenario and Mark Carney’s known views on the potential risk of economic damage.  Still, at least there is more potential to now cut rates, should a chaotic outcome ensue, we view this as unlikely due to the EU stepping up at the last minute and pulling a rabbit out of their hat with a grand fudge.  We have been here before with Greece and one would hope that lessons from that debacle have been learnt which will avoid overnight discussions in the last week of March 2019.  Most of the key players are now in Tuscany or France with Theresa May now trying to pick off other key EU leaders during the holiday period.  The intensive media speculation will only build from here but we, and the markets, are betting on some grand compromise which all can hail as victorious.

Standing back from all the noise and the disaster scenarios, the reality is that global growth is robust and strong and whilst the US economy is firing on all cylinders, that provides a very strong foundation for the rest of the world.  Yes, there are specific areas of concern influenced by Brexit, including the onward march of Amazon on the high street and US tariffs, but the media profile these are given is out of all proportion to the size relative to global output.  The current US earnings season has seen 80% of earnings reports beat forecasts which is the highest figure since the credit crisis.  This means that whilst US valuations were looking expensive, they were behind the economic curve building in an element of caution which has been proved wrong.

Whilst it is very sensible to build in some caution and, as an investor, you have to be cognisant of all risks, for now, most known fears appear to be priced into the markets.  Even a no deal Brexit scenario, which will affect sterling, doesn’t necessarily mean UK equities will fall, as 75% of FTSE-100 earnings benefit as sterling falls.  Gold has just hit its lowest price for 18 months and volatility is at the lows for 2018, having spiked dramatically in February.  It always seems to surprise how the initial shock and concern tempers over time as earnings continue onwards, unabated.  It is always the unknown unknowns that cause the damage.  What don’t we know?

So for now, we would relax as any Brexit agreement or tariff tempering will please markets.  However, we wouldn’t shout about this too much, because something new is always around the corner.  The risk today is that something is initially dismissed as fake news through habit and complacency but becomes real news once the ramifications are fully understood.  A so-called Black Swan and by definition, they cannot be foreseen.

FTSE edges higher whilst Carney moves on rates

Equity markets inched higher in what was a busy week of central bank meetings and macroeconomic data. The FTSE 100 made a weekly gain of +0.3% as the Bank of England raised interest rate to 0.75%, a level not seen since the Global Financial Crisis.

The Bank of England's Monetary Policy Committee unanimously voted in favour of raising base rates by 25 basis points, at its meeting on Thursday.  The decision was widely anticipated so the move in Gilt yields was very modest, the UK 10-year climbing four basis points over the course of the week to 1.33%. The committee last tightened policy back in November, though this effectively just unwound a 25bp cut brought in to force in the aftermath of the Brexit referendum.  Governor Mark Carney said the Bank expects to continue raising but at a gradual rate going forward. The Governor though noted that the chance of the UK dropping out of the EU without a deal was "uncomfortably high."  This was a theme that ran through the Bank’s latest Inflation Report, also published Thursday, as most commentators found little to take from the report given the amount of uncertainty. 

The US Federal Reserve also met but refrained from any change to policy on this occasion.  In its statement, the Fed described the US economy as strong and tightening is expected to continue in-line with existing projections.  Friday’s US Labour Report was mixed but gave little reason to change the course of policy.  Nonfarm payrolls rose 157,000 in July, a little below expectations, but upward revisions to previous months more than offset July's shortfall. The unemployment rate dropped back to 3.9% whilst wage growth was in-line with forecasts. The S&P 500 closed with a weekly gain of +0.6%.

European markets made gains last week; Germany’s DAX 30 climbing +2.4% whilst the French CAC 40 posted a +2.1% gain. This came in spite of second quarter economic growth data that marginally undershot consensus forecasts.  A quarterly rate of 0.3% versus a forecast of 0.4% reflected overhanging trade tariff concerns throughout much of the quarter.

Week Ahead

Following a busy week of data and central bank activity, this week sees a much quieter schedule heading into August.  The highlight of the week will be UK Gross Domestic Product (GDP) data, now released monthly, which is due to be published on Friday. Official second quarter estimates are also expected and forecast to show a quarterly rate of 0.4%, up from the 0.2% recorded in weather-hit Q1. Retail Sales ticked lower as the quarter came to a close in June, taking the shine off an otherwise relatively strong period for the Services sector as the UK basked in sunshine.

Overseas, an estimate of Japanese GDP for Q2 is also due in the early hours of Friday morning whilst the latest Consumer Price index (CPI) figures will gauge inflation in China and the US, published on Thursday and Friday respectively.