Market Bulletin (06/02/2018)
Last Friday, the US celebrated Groundhog Day, in which the North American marmot is consulted for the seasonal outlook. Punxsutawney Phil – Pennsylvania’s (and America’s) lead marmot – warned of six more weeks of cold ahead. Other indicators released the same day told a happier tale, although they contributed to expectations of rising inflation, unnerving some investors.
Friday’s jobs report showed that the US had added 200,000 new jobs in December, far exceeding expectations, while wage growth struck an eight-year high. Meanwhile, it was Janet Yellen’s final day as governor of the Federal Reserve. By almost any of the leading measures, she departs her role as one of the most successful Fed governors in history. Employment sits at an extended high, the economy is growing at 2.6% a year, inflation has been hovering close to the Fed’s target, stocks have been on the rise – and the Fed has successfully introduced five rate rises under her tenure. Donald Trump also linked himself to a few of these numbers in his State of the Union address, which he delivered to a joint session of the US Congress on Tuesday.
The hike in wage growth stoked fears of rising inflation and an uptick in the speed of interest rate rises, worries already evident in the 10-year Treasury yield, the world’s most important bond yield. By close of business on Friday, the 10-year yield was around 2.84%, its highest close since 2013. Stocks in the US had a bad week: the S&P 500 began the week with its worst two days since May 2017 and dropped 2.9% over the five-day period; its biggest weekly fall since February 2016. Last Monday’s slip capped a 99-day streak without a single-day fall of 0.6% or more, marking a postwar record.
Amazon reported the largest profit in its history, with its North America revenue up 42% last quarter, helped by a strong holiday season. It was, however, just one among many earnings highlights. Reuters made a midweek forecast that S&P companies’ earnings would see an average annualised increase of 13.7%. Apple reported record revenues, despite a 1% dip in sales of its latest iPhone. Nintendo, one of the world’s largest video games companies, reported a big jump in operating profits.
While Chevron suffered on refining weakness, other oil majors posted strong numbers, among them ConocoPhillips and Shell. The price of a barrel of Brent crude has been rising in recent months, and last week it even crested above $70, its highest since November 2014, before falling back to around $68. Buoyed by the recent price recovery, production of shale oil in the US last week reached a record high, 47 years after the last Texas oil boom.
Despite its high energy weighting, the FTSE 100 suffered its biggest weekly loss in nine months, falling 2.9%. Although in post-referendum terms, the pound remains strong against the dollar, it ended last week much where it began. The bigger issue came in the form of corporate challenges. Carillion’s slide had already hit the FTSE hard, but last week it was the turn of Capita to set pulses racing (for the wrong reasons). The outsourcing business, which has received numerous government commissions, delivered a profit warning and suspended its dividend. The CEO, who has only been in the job a few weeks, said that the company had spread its net far too widely, and promised an overhaul. The share price quickly fell 47% and has not recovered.
“Capita has been undergoing a complete reset,” said Neil Woodford of Woodford Investment Management. “The new chief executive, Jonathan Lewis, has mapped out a clear new direction of travel for the business and it is one with which I completely agree. More focus, better leadership, better cost control, and a stronger balance sheet – through a combination of disposals, dividend cuts and a future capital raise – will lead to more investment in the business, an enhanced competitive position and a brighter future for its shareholders and customers.”
Stocks in the eurozone had a similarly disappointing week, as the Eurofirst 300 fell 3.2%, pushed down by both negative news (such as poor results from Deutsche Bank) and a strong euro. Growth in the eurozone was reported at 2.5% in 2017, a ten-year high. The euro remained strong against the dollar (which often hurts stock prices in the short term). It has risen by 7% against the greenback in the last three months.
“The European economy is booming and, notably, the December eurozone manufacturing PMI reached its highest level since the survey began over 20 years ago,” said Stuart Mitchell of S. W. Mitchell Capital. “Our company visiting programme tells of corporate sector recovery that continues to significantly outpace more cautious market expectations. After a number of years of austerity, a highly competitive eurozone is gaining market share in export markets, experiencing a recovery in consumer spending and seeing investment spending beginning to pick up. The election of President Macron in France, furthermore, has given a boost to the European project but, more importantly, heralded controversial economy-boosting labour market reforms. These ‘revolutionary’ changes… will especially benefit businesses with fewer than 50 employees [95% of all French businesses].”
Faced with buoyant trends, the eyes of investors are increasingly trained on the ECB. Last week, it warned that markets were unprepared for inflation (although single-currency area inflation fell to 1.3% last month). Meanwhile, some 42% of the €7 trillion of eurozone government bonds still carries yields below zero – in other words, lending to the central bank actually costs you money. Policy normalisation still lies some way off. There are other worries too – a member of the bank’s rate-setting committee warned last week that the ECB would fight back if the US started a currency war.
In Brussels, the EU appeared to play hardball over Brexit. First it ruled out a special trade deal for financial services (insisting instead on equivalence) and then it published a paper warning that it would impose sanctions if needs be to prevent the UK trying to undercut its major trading partner in such areas as tax, regulation and state support.
Yet the liveliest Brexit disagreements were in Westminster and Whitehall. A leaked Treasury analysis forecast a major hit to UK GDP in all mainstream ‘hard Brexit’ scenarios. Falling back on WTO rules would, it said, cost the UK 8 percentage points of growth; higher than the Remain campaign’s 7.5% estimate. A free trade agreement would reduce that figure to 6.2 points, and a Norway-style single market deal would cut it to 3.8. In short, going by the leaked report, the Treasury is more negative on the economic impact of a hard Brexit now than it was prior to the referendum. A second leak warned that the cost of a strict immigration policy would far overshadow the economic benefits of a new trade deal with the US.
In response to a question in the House of Commons, Steve Baker, the Brexit minister, warned that Treasury officials were allowing their anti-Brexit views to colour their judgements. Theresa May chose not to reprimand him publicly, let alone push for his resignation. Moreover, on the weekend, she quashed rumours she was softening on customs union membership, by once again ruling it out. Meanwhile, the Labour MP Chuka Umunna launched a new coalition of groups opposed to a hard Brexit, adding new definition to the existing Brexit divisions in Westminster.
While Theresa May was visiting Beijing, and her ministers were bickering over Brexit, the UK chancellor was writing to the Office of Tax Simplification to request a review of Inheritance Tax in order to simplify the regime. The announcement coincided with news that around 400 estates inherited last year could be liable for unexpected IHT bills of hundreds of thousands of pounds after relatives made gifts which they continued to benefit from before they died. The complications of Inheritance Tax rules mean taking advice is crucial to navigating the nuances. If Phil Hammond thinks it’s hard to understand, that surely says something.
S. W. Mitchell Capital and Woodford Investment Management are fund managers for St. James’s Place.
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