The Weekly - Keeping the Faith

Newer
17/12/2018
Older

For some, this is a religious time of year, for others it is also the time for family, friends and festivity.  For politicians, Theresa May is probably hoping it is a time for reflection ahead of the future commons Brexit vote, whenever that may be.  Most of us will be glad of the break from all the Brexit hysteria, analysis and strategizing which has provided very little in the way of clarity on the way forward.  A break from Brexit is as welcome as a break from many things at this time of year.

 

There have been some noteworthy company specific announcements this week which may be evidence that the future uncertainty is starting to take its toll on the British consumer. The profit warnings from Dixons Carphone, online retailer ASOS and planned job losses from Jaguar Land Rover (JLR) illustrate a sense of nervousness within the British consumer. The last of these is more specific to diesel guzzling cars and future consumer demand, but JLR is also a company supposedly exposed to Brexit inspired supply chain disruption in its UK business. No doubt there will be no shortage of Brexiteers saying these developments are not connected to Brexit and would have happened regardless.

There will also be others who will say that if the negotiations had been left to them, , by now we would have had an agreement and any connected uncertainty would be gone. Retailing difficulty is exposed to the onward march of Amazon and digital retailing more generally. ASOS may have suffered from the fickle nature of fashion and misjudging Black Friday and so may be company specific rather than a broader bellwether message.  That said, it has raised many eyebrows about the confidence of the consumer ahead of Christmas and has hit the sector hard in terms of other retailer share prices.

Right now, we are in the Brexit sweet spot, or should we say, sour, where, one way or another, the day of parliamentary reckoning lies ahead to welcome in 2019. To us, it seems highly unlikely that the EU will agree to any concessions on the imposition of the backstop. Those demanded by hard-liners and cabinet resignees would mean that its value as an EU insurance policy would be rendered worthless.  A backstop which can be unilaterally terminated by the UK would not have any value to the EU and would remove the default position for the maintenance of a border free Irish trading relationship.  So, even if a form of words is agreed, unless it has any legal status or is an addendum to the unchangeable withdrawal agreement, then it will satisfy few of those who feel it unacceptably compromises our sovereignty.  This would mean that the parliamentary vote in the new year will fail and we really will be facing a constitutional crisis.

Looking back, with perfect hindsight, this was always inevitable when we agreed to separate the withdrawal agreement from the trade negotiations. From that moment, there was always going to have to be a fall-back position if the trade negotiations floundered that wouldn’t be Brexit and would merely serve to maintain the current customs union and trade arrangements until an agreement was hammered out. Accepting the May Plan because there is no other on the table is too much to swallow for many and has unacceptable sovereignty risk.  It could actually be judged illegal by the WTO, although that could take years to determine. With any acrimonious divorce, the matrimonial court judge is the independent arbiter that treats both sides on an equal basis, applies the law as prescribed and makes a judgement call having listened to all the supporting evidence. The problem with the Brexit Withdrawal Agreement as tabled is that we have 27 nations against one and those 27 nations would be judge, jury and executioner if the backstop came into play. If there was a role for the WTO to be the arbiter, then this is it, but unfortunately that is not in place and the EU potentially holds all the cards.

No wonder investors are getting skittish.  However, history and the revered Warren Buffett, tells us that buying opportunities present themselves during times of crisis and this has been repeatedly illustrated over the years whether at the nadir of the Credit Crunch, the bursting of the Technology Bubble or any other time of impending doom. So far, equity markets have fallen by no more than 10-20% which qualifies as a correction or entering a bear market for the academics.  Neither really matters as what we do know is most investors are poorer at the end of 2018 than they were at the start, where 2017 was a strong year after global equities rose by 11.8%, as measured by the MSCI World Index in sterling.  This followed 2016 where the same index rose by 28.2%, a remarkable return. The mere fact that returns by the same measure are currently 1.3% for 2018 is hardly disastrous but most will feel disappointed, especially as this figure was 9.4% at the end of September. This year, October has lived up to its reputation as being a dangerous month and will serve to support the historical reference books.

It should not be forgotten that a typical medium risk portfolio may only have around 25% exposure to UK equities. For the brave, now, and the coming weeks present an attractive entry point for those fortunate enough to have cash, but it requires a strong constitution when the newswires are full of political uncertainty and impending doom.  Many will recall the rejoicing over the rare achievement of globally synchronised economic growth in 2017 which now appears a distant memory.  We now appear to have globally synchronised economic weakness whether that be Chinese output, US tariffs, Brexit uncertainty or a general crisis in investor confidence.  It has always been correct to buy the rumour and sell the story which means look forward to weaker times as this will be as good as it gets or conversely, look forward to stronger times as this will be as bad as it gets, depending on what you believe.  Most investors want to enjoy a discount on purchase, but when this presents itself, there is always a reason which leaves a bad taste in the mouth.  Good and bad reasons come and go whilst the underlying fundamentals remain - profits, balance sheets and dividends. These may be reducing, but the point of maximum pessimism will come and go before the markets will enjoy a relief rally. 

The holy grail is identifying the nadir of the buying opportunity as closely as possible, as there are no prizes for being too early or too late, only short-term losses to tolerate or historic profits foregone forever.

Market volatility continues whilst Draghi calls time on QE

Another tumultuous week for British prime minister Theresa May led to a mixed and volatile week for UK stocks, whilst the European Central Bank (ECB) formally brought an end to its Quantitative Easing program.

Sterling ultimately lost ground as May’s government abandoned a parliamentary vote on Brexit at the eleventh hour. The Pound fell -0.7% against Euro and -1.6% against the US Dollar during the week.  Both inter-party and cross-party squabbling has increased and, if possible, there is even less clarity on the path of Brexit now than ever before. The UK’s FTSE 100 index, which benefits from a fall in Sterling given its heavy overseas revenue, climbed +1.0% over the course of the week. Meanwhile, the more domestically orientated FTSE 250 retreated by an equal and opposite -1.0%. 

ECB President Mario Draghi confirmed the Bank’s asset purchases will come to an end this month, as expected.  The European economy has been supported by the program since its initial launch in March 2015. Having peaked at €80 billion a month, the value of purchases has been winding down over the last 18 months.  Draghi also reiterated that rate rises will not come until at least the summer of 2019. Given recent softness in economic indicators across Europe as well as political uncertainty, market expectations are that rates will not rise until 2020.  French Purchasing Managers Index (PMI) readings for Services and Manufacturing both dropped below 50 last week having been on a downward trend throughout 2018.  European equities were able to secure modest gains during the week; Germany’s DAX 30 climbing +0.7% whilst the French CAC 40 index rose +0.8%.

US markets remain sensitive to the ongoing trade dispute with China which weighed on sentiment early in the week. However, markets appeared to be boosted later in the week as reports surfaced on Wednesday that China had resumed buying US soybeans, having blocked purchases several months earlier in response to new tariffs, and were also considering redrafting their ‘Made In China 2025’ plan that drew criticism from Trump’s administration.  The S&P 500 ended the week -1.3% lower.

Brent crude oil slipped to $60.28 per barrel at Friday’s close, a weekly fall of -2.3%. The American focussed West Texas Intermediate (WTI) benchmark dropped -1.8% to $51.19 per barrel.

Source: Datastream 2018
Source: Forex Factory 2018

Week Ahead

The last full week ahead of Christmas is particularly busy with numerous headline releases from around the world. Domestically, inflation data is due on Wednesday with retail sales a day later, both covering November. Headline CPI is expected to have pulled back slightly from the 2.4% reported previously whilst retail sales are forecast to have rebounded after a weak October. We also have the final Bank of England MPC meeting of the year although no changes to interest rates are expected on this occasion. US focus will also revolve around its central bank as the Federal Reserve hosts its FOMC meeting. Interest are expected to be lifted to a range of 2.25-2.50% whilst further guidance on the outlook for the economy will also be provided. In terms of data, the final revision of Q3’18 GDP is expected to be unchanged from the +3.5% figure recorded last time. Eurozone activity is limited with this morning inflation data the only figure of note. Headline CPI missed expectations, coming in 10bps below forecasts at 1.9% whilst the core number was unchanged at just 1.0%. Asian data is also in short supply with no major releases from either Japan or China. 

Source:  Forex Factory 2018