The Weekly - The Perfect Storm

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07/01/2019
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This week sees the official end of the holiday period and some economic reality in the form of various data reports.  Many of these will be from retailers which will reveal Christmas trading from the high street, alongside internet sales.  General investor sentiment feels very bearish as it has done so ever since October last year.  Behavioural science teaches us that recent performance has a significant influence over investor sentiment.  You only have to think about how you feel when an investment turns sour and you are staring at a 20% loss.  You regret the decision to invest and form a negative view about that particular investment.  Sticking with it can sometimes be the worst thing to do when the company concerned is suddenly really struggling – think Debenhams or Carillion.  However, many a hold decision is driven by procrastination and not wanting to crystallise the loss, rather than a rational view on whether you would buy the stock today if it wasn’t held.

This is different when it comes to the entire market.  Investors’ appetite for risk increases the more money they make and vice versa.  This is the classical flipping between greed and fear and this causes sentiment to overshoot on the upside, ignoring any bad news and discounting this as noise and nothing to worry about.  This then flips to overly negative sentiment such that all news is negative, and everything is something to worry about.  The list of political worries is very long and, depending on your particular negative disposition, we will see either a slow Brexit car crash in the UK, or an ever present disruptive series of combative, short-term tweets from the presidential personality occupying the White House.  The media always reports the negative and so it is very easy to get overly bearish in this environment following a correction.


The real catalyst that did the damage before Christmas was the perception that Trump was trying to interfere with the Federal Reserve Bank’s independence.  No politician ever wants to increase interest rates as this is only ever perceived as an electoral negative.  This is precisely why Central Banks have to be independent of political influence.  Difficult decisions which involve slowing an economy will not be taken when they should be and then inflation will get out of control as the inevitable bubble inflates.  Trump is one of the most openly politically self-motivated presidents there has ever been and appears to have a single-minded determination to deliver on his campaign promises in the belief that this will lead to his re-election for a second term.  This applies to his border wall and his trade tariffs, despite the fact that the Government shutdown has caused 800,000 workers to go without pay over Christmas and there are indications that the trade tariffs are starting to seriously impair earnings from companies like Apple.


Economists have always criticised his policy on tariffs, referring to history and economic logic which show that the only result is higher costs for global trade as retaliatory tariffs are put in place.  The Chinese economy would appear to be slowing for a variety of reasons, partly cyclical and partly induced by tariffs.  There could also be early signs that the Chinese consumer is starting to boycott US firms operating in China due to the aggressive strategy of Trump.  Western consumers are insensitive to where a product is manufactured, concerned mainly with price.   This is not a luxury enjoyed by US exporters, who tend to be more expensive whilst the Chinese will willingly buy Chinese and do without the brand.  Trump fails to understand this, believing that US industries that wound down many years ago will be rejuvenated, such as steel mills and coal mines.  This is very unlikely due to the investment required and productivity lead time and will be wasted expenditure if Trump fails to be re-elected and the tariffs are reversed.

Many corporate businesses are having to navigate a highly uncertain trading environment influenced by politicians and this is probably the most rational concern facing investors.  Real damage is being caused by the uncertainty despite the current strong earnings, full employment and relatively buoyant economies of today.  There are some weak spots in terms of car sales, but these would probably have happened anyway as the consumer is reticent about replacing their fossil fuelled vehicles.  Some bearish economists are referring to the yield curve where there is an ‘inversion’.  This is where short-term rates are higher than long-term, and this has always preceded a recession for as long as historic comparison is relevant.  Right now, parts of the yield curve are inverted but not all and this can change if the Federal Reserve Bank decides to pause on its interest rate increases.  However, this would appear to be caving into pressure from Trump and Jerome Powell, the Fed Chairman, will not want to give that impression.  It should also not be forgotten that although economists are useful for pointing out likely scenarios, the old joke still applies that they have successfully predicted 8 of the last 3 recessions!


In a nutshell, Christmas has seen massive volatility with equity indices gyrating in thin markets on very little news.  As most investors return to their desks, hopefully we will get more sensible market behaviour.  The recent market nadir was seen on Christmas Eve – so much for the Santa rally!  Interestingly, this dip was most pronounced in the US and Japan, less so in Europe and the UK, whilst Asia and Emerging Markets barely registered.  We will leave religious comparatives to other commentators, but these movements are very odd and random.  What we can say, is that western markets are in correction territory and have fallen by between 8-12% since 30th September, in Sterling terms.  Emerging Markets and Asia are down by around 5% but had been significantly weaker earlier in the year as the US trade tariffs were imposed – Chinese stock markets are down by over 20%, all in Sterling terms.  Valuations are no longer expensive on some measures if you believe the earnings forecasts.


Possible positive catalysts are clarity with the Chinese and Brexit, with hopes regarding the former causing positive volatility after Christmas now that a US delegation is visiting China to further negotiate.  Hopes are not high as the two sides appear to be digging in but Trump would love the political kudos of announcing the greatest deal in history.  We know that Brexit is likely to get worse before it gets better which means that bottom-fishing in bombed out Brexit sensitive sectors such as UK property and exporters is simply gambling and probably foolhardy.  With hindsight, this could be a possible missed opportunity when the clouds lift but a highly risky strategy right now which feels like gambling with a binary outcome.


We take comfort that the global economy is still growing, and most consumers are employed.  Recessions usually come about following a period of overly strong expansion where interest rates have to rise, and weak and over-extended businesses go bust, not because it’s time we had one.  There is no sign of this at the moment with corporate retrenchment limited and employment markets still tight, as evidenced by the US payroll figures last week.  The first take on US GDP is due on 30th January with forecasters expecting 2019 to deliver 2.4% from 3.1% in 2018, which will have been the strongest figure for a decade, if confirmed.  Aluminium producer Alcoa will kick off the Q4 US earnings season on 16th January which will give some hard data and global outlook commentary.


Most of us are feeling bruised after a dreadful Q4 of 2018.  One golden rule applies - investment decisions should always be based on long-term fundamental analysis and never on short-term emotion.

US Jobs Data Impressive Easing Recession Concerns


The final US Labour Market Report of the year was a blockbuster with an impressive 312,000 new jobs created during December. That was some 133,000 ahead of expectation with wage growth continuing to accelerate. In addition, some 400,000 people re-commenced the search for work and whilst that did lift the overall unemployment rate slightly, it should be viewed in a positive light (1).

After a prolonged period of weakness, global equity markets started 2019 on the front foot with the vast majority of the major indices ending the week in positive territory. Domestically, The FTSE100 rose by+1.5% with the mid-cap focussed FTSE250 rising by +1.9% (2). After enduring a torrid few months, AIM shares jumped by +2.8% although the junior market has some way to go after falling by nearly -20.0%over the last quarter(2).


Overseas, the S&P500 posted a +1.9% weekly rise, benefitting from the good jobs numbers on Friday. Meanwhile in Europe both the German DAX30 and French CAC40 enjoyed a positive week rising by +2.0% and +1.3% respectively(2). It was only the Nikkei 225 that bucked the positive trend with the Japanese market falling sharply on Friday (-2.3%), its only trading day of the week following the New Year celebrations.


Despite the rebound in equities, sovereign debt markets were little changed. The yield on UK 10-year Gilts was flat at 1.27% with the US Treasury equivalent 6 basis points lower at 2.66%(2). After several weeks of lost ground, Sterling rallied although remains just above its post Referendum lows against both the Dollar ($1.272) and the Euro (€1.115).


In the commodity markets, oil prices rose sharply from 18 months lows as OPEC production cuts started to take effect. Brent crude closed the week +9.3% higher after it was revealed that OPEC supply fell by 460,000 barrels per day during December (2). Gold also continued to inch higher with the precious metal rising by +0.4% to finish the week at $1,283 an ounce (3).


Source: Washington Post (1), DataStream (2), CNBC (3)

 

The Week Ahead


This week is busy one for domestic data with the National Institute for Economic and Social Research releasing it Q4’18 GDP estimate on Wednesday followed closely by the Bank of England’s monthly GDP data on Friday. It’s also worth keeping an eye on industrial production and retail sales (from the British Retail Consortium) which are due later in the week. However, attention is likely to be firmly on Parliament which is finally expected to host its vote on Tuesday although it has been delayed before.


In the US, the Federal Reserve releases the minutes from its final FOMC meeting of 2018 on Wednesday with Chairman Jerome Powell presenting the following day. In terms of data, Friday’s inflation numbers are the standout alongside tomorrow’s trade figures. Meanwhile in Frankfurt, the ECB also releases minutes from its most recent policy meeting whilst unemployment, retail sales and industrial production numbers are also likely to receive plenty of attention. Asian data activity is in short supply with inflation the only number of note from China whilst there is nothing of note expected from Japan on this occasion(1).


Source: Forex Factory (1)