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Market Bulletin (10/07/2018)

Market Bulletin (10/07/2018)

Plausible deniability?

“Never believe anything in politics until it has been officially denied,” warned Otto von Bismarck, the old Prussian statesman. Does the Iron Chancellor’s old rule still apply?

Last week, Donald Trump denied that he plans to pull the US out of the World Trade Organization, and denied that his tariff moves were to blame for Harley-Davidson’s recent decision to shift some production overseas. Theresa May, meanwhile, denied that she was “climbing down” on plans to leave the EU’s customs union. Russia denied any involvement in either of the two recent cases of Novichok poisoning in the UK. And the People’s Bank of China denied that it was pursuing a policy of weakening the renminbi against the dollar.

Whatever your take on the denials, it was clear last week that the current US administration is serious about dismantling the postwar nexus of trade relationships and treaties that it once pioneered – and within which it is the major player. Washington’s imposition of $34 billion of tariffs on Chinese imports went live on Friday, prompting China to impose $34 billion of retaliatory tariffs. Meanwhile, the US president warned he was serious about imposing fresh tariffs on cars coming from Europe (a blow to Germany in particular), while the EU, Mexico and Canada have imposed tariffs on US products ranging from Bourbon to ketchup. The Corn Belt states Donald Trump relies on for votes will be significantly affected, among them Nebraska, Indiana, Iowa and even as far north as North Dakota. (How times have changed: the state capital of North Dakota, Bismarck, received its name in 1873 in a bid to attract immigration and investment from Europe.)

Figures released last week suggest that global trade is already slackening. Business surveys published a few days before tariffs were activated on Friday showed that, after a strong 2017, global export growth barely shifted in the first half of 2018. Indeed, the growth figures were the lowest in two years. Last week’s round of actions is hardly likely to reverse the slowdown. Beijing accused the US of “launching the largest trade war in economic history” while the EU rebuked the US president for his threat to impose tariffs on imported European cars. Further retaliation is widely expected, and there are several routes that affected countries might choose to follow. China, for example, could allow its currency to fall further, increase regulations on US goods or wage media campaigns to encourage Chinese consumers to shun US products (a policy that has been used in China in the past). Mixed messages over trade drove US Treasury yields up and down over the course of the week, adding to volatility on markets.

The S&P 500, however, had a positive week, aided by a number of sectors, among them energy and technology. On Thursday, hopes for a transatlantic trade compromise helped push Volkswagen, BMW and Daimler higher. US markets are also feeling the effects of a surge in initial public offerings (IPOs) this year – the sum raised in US IPOs in the first half of the year was the second-highest so far this century. The most buoying news for markets came on Friday: the June employment report. It showed that, while unemployment rose marginally, it came in the context of much-increased hiring by US companies. Moreover, United States Department of Labor figures show that the number of Americans who voluntarily quit their jobs has been rising, implying a far greater supply of options for workers. Market expectations are that, following its June rate rise, the Federal Reserve will next raise rates in September.

Other worries

Protectionist actions in Washington undoubtedly come as a concern for Beijing, which is already managing the impact of a slight decline in China’s rate of economic growth. Although the decline in Chinese industrial production of recent years has been arrested since 2016, the decline in retail sales in China shows few signs of abating. Consumers tightening their purses is arguably a far more important for investors in Chinese shares than trade tussles.

Chequers strategy

The FTSE 100 rose over the week, but neither markets nor growth is likely to have received much attention from the UK prime minister last week. On Friday, Theresa May invited her Cabinet to Chequers, the prime minister’s official country residence, to sell them on her vision for Brexit. While official negotiations will be between the UK and EU, it has long been a truism of British politics that achieving unity over Europe within the Tory party is probably a greater challenge than forging any UK–EU deal. Her solution offers a halfway house between the ‘maximum facilitation’ preferred by Cabinet Leavers and the ‘new customs partnership’ desired by Remainers. It would involve a “facilitated customs arrangement” and “free trade area for goods”, but would mean sticking with EU rules on goods and agricultural foods (although no longer enjoying a vote when they are drafted). Initial signs were that she had corralled the Cabinet into accepting the deal – until David Davis, the Brexit secretary, resigned on Monday morning. (He has since been replaced by Dominic Raab, the Minister for Housing.) Sterling and stocks have thus far brushed off the news, but further resignations – and worse – remain possible.

While the Electoral Commission reported its initial findings that Vote Leave had broken campaign finance rules during the referendum, the governor of the Bank of England focused on drawing out lessons. Speaking in Newcastle, Mark Carney warned that a global trade war is now plausible, and that the dip in UK business confidence following the Brexit referendum serves as a warning to would-be protectionist politicians. Yet some see the referendum outcome differently.

“The economy is much stronger than the [pre-referendum] Treasury forecasts had shown,” said Roger Bootle of Capital Economics. “Relative growth has deteriorated, albeit not by a lot. You can argue the data both ways, but we don’t think this period of underperformance will last.”

In the retail sector, Tesco and Carrefour confirmed a tie-up supply deal on own-brand and some other products in order to make savings. The initial phase of the partnership will last three years, but the union is expected to be for the longer term. Tesco has been revitalised following an accounting scandal and dip in its competitiveness.

“If you look at the relative pricing of Tesco versus the industry more widely, they had allowed their prices to drift too high, principally compared to Asda – but now that competitiveness has been restored,” said Nick Purves of RWC Partners. “Tesco has the largest market share and even the proposed Asda–Sainsbury’s merger won’t give Sainsbury’s significantly more buying clout. What has worked so far under Dave Lewis, the Tesco CEO, is that the company has been focusing on core competencies and pulling back from areas that are outside that, like Tesco Direct. It’s also been pulling out of competitive markets. Removing brands from its shelves – as it is now doing – is part of the simplification process too, as reduced complexity has economic benefits and increases buying clout with the brands that are left.”

Long-term thinking

A report last week by the Pensions and Lifetime Savings Association (PLSA) found that some 30 million people are at risk of running out of money during retirement because they don’t know how much to save into their pension. The new research found that 23% believed they knew how much they would need when their careers came to an end, and around half of those surveyed reckoned the government’s minimum mandated automatic enrolment contribution of 5% would be enough to see them through. The PLSA noted the government’s failure to provide clear targets and guidelines for workers in planning for the future; it is an advice gap that workers would be wise to plug.

RWC Partners is a fund manager for St. James’s Place.

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