The Weekly - The macro and the micro

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17/09/2019
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Macro-economics remain volatile, but the bottom-up micro-economic realities are what really moves share prices over the medium term. Some businesses are doing very well indeed.

The focus on macro-economics, or the big picture, has been intense over the last year. Over the weekend, the Middle East has reminded us of the impact that terrorist activity can have on the markets. Targeting Saudi Arabian oil installations ahead of the planned Aramco listing shows an organised strategy to hit where it hurts, whilst using armed drones brings a new and worrying weapon which the authorities now have to combat. Not surprisingly, the oil price has moved significantly higher and, although reserves can apparently be used instead, it does show an increased risk to the lifeblood of western capitalism, namely oil. The share prices of BP and Royal Dutch Shell have risen as they stand to benefit from a price rise in their principle asset, expanding profit margins.

This is clearly the last thing the global economy needs as it increases input costs and is a further drain on profitability. If such activity persists, it could lead to price rises over and above those being mooted from the latest round of tariffs imposed by the US. This will be why the Federal Reserve Bank is reluctant to succumb to pressure from the White House to subsidise trade policy by aggressively cutting rates. Control of inflation is their primary objective, not pump-priming the economy. The Federal Open Market Committee (FOMC) meets this week with its conclusions to be announced on Wednesday along with an economic summary. Most analysts are expecting a cut, but it will be the outlook statement from Chairman Jerome Powell which will potentially move the markets, with President Donald Trump likely to provide approval or disapproval on the side-lines.

The decision by the European Central Bank to restart its Quantitative Easing programme last week was a surprise, accompanied by a cut in the ECB bank deposit interest rate to -0.5% to encourage lending. This feels like a trip back in time but is perhaps illustrative of the economic weakness in the eurozone, especially Germany. This attracted immediate comment from President Trump, who accused the ECB of deliberately depreciating the Euro compared to the US Dollar, which has continued to strengthen, offsetting some of the tariff impact on US imports. As the US Dollar has been the global reserve currency ever since the link to the Gold standard was severed in 1971, at times of heightened tension, investors flock to the US Dollar. This creates a virtuous circle whereby the more the US puts pressure on global trade through tariffs, in its quest to reduce US imports and reduce its trade deficit, the more the US Dollar appreciates. This makes those very same imports cheaper and still affordable.

The forthcoming trade discussions with China later this month and the planned high-level talks in October have encouraged the markets. There have also been tariff concessions from both sides in the last two weeks with the suspension of planned increases as gestures of goodwill. The tariffs are hurting the Chinese economy and there could be an irresistible attraction to present some sort of agreement in part. This has been the main overhang for the market for over a year and any relaxing of the aggressive tactics would land well.

Moving on from the macro to the micro-economic reality of what defines a share price, namely profits and dividends, last week saw reports from Bovis Homes, Ashtead, JD Sports, Morrisons and JD Wetherspoon, amongst others.

The housebuilding sector is one of the most sensitive to Brexit and has been weak as investors worry about the impact. Bovis Homes would be one of the stocks, along with others within the sector, which would respond strongly if a Brexit deal is suddenly pulled out of the hat. And therein lies the problem – it is currently a binary outcome and nobody knows. A further announcement from Bovis that they are considering buying the housebuilding business of Galliford Try caused a frenzy of consolidation talk which will be an interesting development to watch.

Ashtead is involved with the provision of construction equipment rental solutions in the US, Canada and the UK where it trades as A-Plant. Overall, it is a solid set of results with an upbeat outlook and no hint of any Brexit of US tariff influence, which is very welcome and evidence that not all revolves around politics. JD Sports really did impress on its announcement with a 12% rise in like-for-like sales in the first half, figures from the high street that many retailers would die for. The share price advanced by 15% over the week revealing that not everything is doom and gloom on the high street.

Morrisons gave an insight into the state of the supermarket wars and the price discounters of Aldi and Lidl. The results were received well by the market where they appear to be trading well in a very hostile environment. The same could not be said of John Lewis, historically seen as the top-end bellwether of the sector. They are barely profitable and reported the most promotional market they had seen in a decade with their Never Knowingly Undersold Pledge squeezing their margins. Similar challenges are being felt at Marks & Spencer, another fashion, homewares and food combination, with the latter shortly due to leave the FTSE-100. The transformation of the high street under Amazon continues relentlessly and is an unstoppable secular story which continues to play out.

JD Wetherspoon reported a solid set of results with an increase in profits and like-for-like sales but slightly below forecast. The shares have been strong recently, so a little weakness was to be expected. Tim Martin, the CEO, is an outspoken Brexiteer and often uses results announcements to express his views. Interestingly, in the case of a Hard Brexit, beer prices would be lower as there is no WTO tariff on beer, if we revert to those terms.

This week sees reports from Kingfisher, owner of B&Q, and Pendragon, the car dealership owner and Next, which may report more pain from the high street. As ever, we will be watching intently to gauge the strength of the consumer as the Brexit journey intensifies over the next few weeks. Short term market gyrations are being driven by the top-down macro-economic picture whilst the bottom-up micro-economic realities are what really moves share prices over the medium term. There are some obvious vulnerable areas to avoid in this market, but there are always those that benefit within a harsh environment and buck the trend. Focussing on the micro picture shows that some businesses are doing very well indeed.

 

Value stocks rise as the ECB cuts rates and resumes QE

Most major equity markets made gains during a week that saw quantitative easing return in Europe, improving trade sentiment between the US and China, and a shift in momentum towards value sectors.  The FTSE 100 recorded its third consecutive week of gains with a +1.2% gain, whilst the US S&P 500 index climbed +1.0%.

In a fairly clear rotation of market leadership on both sides of the Atlantic, small and mid-cap indices outperformed their large-cap peers whilst highly-valued defensives gave way to embattled value sectors like Financials and Materials.

Gestures of goodwill came from both the White House and Chinese state officials as their trade war saga took a turn for the better last week, accounting for a large amount of the market gains.  On Wednesday, Chinese officials gave tariff exemptions to a list of US made products that were scheduled to carry additional duty this week. President Trump responded in kind by postponing a 5% tariff increase on $250bn worth of imports from China.

European markets also rose as the European Central Bank (ECB) announced a fresh quantitative easing package to stimulate the economy and raise inflation, which remains subdued below target.  Fears of a no-deal Brexit in the immediate future also subsided as the UK parliament pushed forward measures to avoid the scenario.  The German DAX 30 gained +2.3% whilst the French CAC 40 made a weekly return of +0.9%.  Departing ECB President Mario Draghi confirmed the bank’s deposit rate would be cut further into negative territory, from -0.4% to -0.5%, and announced they would purchase €20bn of assets every month from November.

Sterling rose to its highest level against the US Dollar since July as Parliament passed a law effectively forcing the UK government to seek a Brexit extension from the European Union in order to avoid a no-deal Brexit on October 31st. The Pound, which also benefitted from improved UK economic growth data last Monday, gained +0.5% versus the Euro and +1.4% against the US Dollar over the course of the week.

 

The week ahead

The Bank of England hosts its latest policy meeting on Thursday and whilst no changes are expected to interest rates this time, it will be interesting to see the rhetoric that comes from the central bank given the policy easing being seen around the world. In terms of data, the latest CPI statistics are due on Wednesday with headline inflation forecast to have fallen during August. Meanwhile, retail sales also covering August are expected to show a monthly decline in volumes when reported on Thursday morning.

In the US, the Federal Reserve looks poised to deliver another rate cut at its own policy meeting later in the week, which would be the second such move since July. The main data from the world’s largest economy this week focuses on the housing sector, with building permits, housing starts and existing home sales all due before the close of play on Friday. Sticking with the Central Bank theme, the Bank of Japan holds its monthly policy meeting during the early hours of Thursday morning although no changes are expected on this occasion. Elsewhere, it’s a busy week for Chinese statistics, the most notable being fixed asset investment, industrial production, retail sales and unemployment. Data from the Eurozone is in short supply on this occasion.

 

 

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Source: FE Analytics (information is correct as at 16th September 2019) 

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