Market Bulletin (08/11/2016)
“Nearly all men can stand adversity, but if you want to test a man’s character, give him power,” said Abraham Lincoln. Last week, however, as US election polls signalled a shift in sentiment, markets made clear that they would prefer not to put this year’s Republican nominee to the test.
On Friday 28 October James Comey, director of the FBI, publicly reopened the inquiry into the case of Hillary Clinton’s private email server. Clinton’s accession to the Oval Office had been looking increasingly secure but, following the announcement, one tracking poll even placed Donald Trump marginally ahead. The forecaster Nate Silver, who is perhaps best known for correctly predicting 49 out of 50 states in the 2008 US election, had been giving Hillary Clinton an 85% chance of winning the week before last – by last Friday that number had fallen below 68%.
Reactions came thick and fast, as indicated by VIX, which measures volatility on the S&P 500; and calm was only restored on Sunday when Comey confirmed that the emails had highlighted no criminal behaviour – case closed. In recent weeks the VIX has spiked significantly on only two occasions. The first rise came after Hillary Clinton collapsed on the campaign trail due to a bout of pneumonia; last week it jumped again after Comey’s announcement sparked a shift in the polls.
The second event has mattered more on markets. As of late last week, the S&P 500 had suffered its longest sell-off since the financial crisis. The world’s leading index dipped 1.4% last week, while the dollar dropped against major currencies such as the euro, the Japanese yen and the Chinese yuan. Markets were making strong recoveries at the start of this week, however, after Sunday’s news that no charges would be levelled against Clinton.
In a report published on 21 October, the 100-year-old Brookings Institution, a leading US think tank, said a Trump victory would have a much bigger impact on stock, energy and currency prices than previous elections. Meanwhile, 10-year US Treasuries and gold, both viewed as havens of safety, experienced significant inflows last week – until the weekend news reduced panic.
Broader economic news last week offered a less volatile narrative. After encouraging signs in US third-quarter corporate earnings, new jobs in October remained at stable levels and unemployment dropped back to a long-term low of 4.9%. Moreover, global activity in mergers and acquisitions (which is dominated by the US) enjoyed a stellar October, reaching its seventh-highest monthly total ever after General Electric agreed the takeover of Baker Hughes, an oilfield service company.
Despite these encouragements, global markets were hypersensitive to election news last week – the Nikkei 225 and FTSEurofirst fell 3.1% and 2.9% respectively. The US stock market usually rallies in the weeks before a US election; this year it has done the reverse. That is not the only trend being bucked; an August-to-October S&P 500 decline in election year has typically been a bad signal for the incumbent party – yet polls through that period have generally favoured Hillary Clinton.
Like the UK referendum campaign, the US presidential campaign has been exceptional for the public criticism levelled at the country’s central bank – in the Fed’s case, by Donald Trump. Last week the Federal Reserve chose to remain quiet, leaving rates on hold, an approach matched by the Bank of Japan. Nevertheless, Janet Yellen implied that improving economic indicators made a rise possible in December. Inevitably, much will hang on how markets react to the outcome of the election.
Political risk is expected to remain at large in the US, whoever wins. Both candidates are reviled by such a large proportion of Americans that the election has been dubbed an ‘unpopularity contest’. A divided Congress – or a Congress dominated by the president’s opponents – would presage the usual risks of policy deadlock, and of brinkmanship over the debt ceiling. Yet it seems that this is Wall Street’s preferred outcome, given the radical policy promises made during campaign season.
For those investors who fear the economic impact of a Trump presidency, there is at least recent political precedent. The outcome of the UK referendum vote was neither expected nor desired on markets. Stocks and the currency both fell in the immediate aftermath; the same might happen in the US. The Bank of England took strong accommodative action; the Fed could do so at its December meeting. Initial panic began to subside as a new administration took over and the slow-burn nature of Brexit became clear; in the US, the presidential inauguration is not until 20 January and focus could turn to the checks on presidential power, not least Congress. In the UK, exporters quickly benefited from a falling pound as, in time, did multinationals, leading to a significant broader rally on markets; buoyed by a cheaper dollar, a similar dynamic could play out on US markets.
Investment decisions should never be made on the basis of conjecture (or precedent), but the principle applies to the pessimists as well as the optimists. The Brexit example shows that it can be a grave mistake to sell when prices fall (or in anticipation that they are about to). The FTSE 100 may have just suffered its worst week since January, falling by a weighty 4.2%, but despite that it ended Friday up 9% since 24 June – and that is before accounting for its sharp rise at the start of this trading week.
Brexit vote #2
The benchmark UK index’s fall last week was spurred by a sharp rise in sterling, which may have owed a little to a Trump-induced sell-off for the dollar early in the week (just as the FTSE’s Monday rise may have reflected the FBI news), but its timing indicated it owed more to a High Court ruling that Article 50 could not be triggered without a vote in parliament.
The decision ultimately rested on the definition of ‘royal prerogative’, and thus on the words of Sir Edward Coke, the dominant jurist of the Elizabethan period, who said in 1610: “The king hath no prerogative, but that which the law of the land allows him.” MPs are thought unlikely to vote against the popular will, but sterling’s rise probably reflected expectation that parliament would prevent the more radical forms of Brexit. Theresa May said her government would appeal the decision, and that Article 50 would still be triggered in March, while the front pages of pro-Brexit newspapers depicted the judges as enemies of Brexit. May also suffered the resignation of a Tory MP last week, making another by-election unavoidable. Political risk in the UK remains elevated.
Yet key indicators painted a cheery picture of the British economy. Services activity in October grew at its fastest rate since January; manufacturing also grew. There were suggestions from the Treasury that the Autumn Statement would not attempt anything especially radical, although the Chancellor hinted at a more flexible approach to the deficit; and the Association of British Insurers recommended that employees should be obliged to save for retirement, if significant numbers forgo company pension schemes in favour of alternative products, specifically Lifetime ISAs.
In the week, UK premium bonds reached their 60th anniversary; 10-year gilts were sensitive to political and central bank developments, but yields ended the week down. Mark Carney left rates on hold, but forecast strong growth and stronger inflation – he said the latter would reach a 2.8% peak in early 2018, its highest since 1997. He added that the BoE would allow an inflation overshoot (its usual target ceiling is 2%), but within limits. In other words, it may ultimately feel the need to raise rates before he steps down in 2019, the year the government has set for Brexit to take place.
Politics has undoubtedly reached a new fever pitch in recent weeks, and markets around the world have been heavily buffeted as a result. Yet for patient investors, a cursory look at the careers of Hillary Clinton and Theresa May serves as a reminder that it is all too easy to forget the value of playing the long game.
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