Market Bulletin (11/07/2016)
After a fortnight of jumpy trading, markets were eager for good news last week. On Friday, it duly materialised in the form of the important US payrolls report. Figures for both April and May had fallen far short of expectations; Janet Yellen, chair of the US Federal Reserve, said earlier last week that the Fed would be watching to see whether April and May had been exceptions to the broader trend, or instead pointed to a US slowdown.
Markets had expected that the payrolls report would announce that 175,000 jobs had been created in June: in fact, the monthly figure was 287,000. This was aided in part by the end of a strike conducted by some 36,000 employees of Verizon, a US telecoms company. There was also a drop in the number of would-be full-time employees having to work part-time. The report offered a late boost to the S&P 500, which ended its week up 1%.
The Federal Reserve is due to meet on 26–27 July, when it will make its next decision on interest rates. In ordinary times, unemployment at 4.8% combined with a positive payrolls report might be enough to encourage it to move interest rates off their current floor of 0.5%. But the UK’s decision to leave the EU has reduced risk appetite on financial markets, and lowered expectations of any swift rate rises.
After the revolution
Last Monday US markets took the day off as the nation celebrated Independence Day. It was perhaps appropriate that the break enabled US investors to take their eyes off British politics, which had so dominated markets over the previous week. It may yet continue to dominate, however, not least because an EU exit lacks any precedent, and there is as yet no exit plan.
There were more tangible signs of trouble last week, too. Initial indicators showed that consumer sentiment, job openings and residential property auctions dropped significantly following the referendum result. Moreover, data for the second quarter showed activity in the services sector (which accounts for almost 80% of the UK economy) at a three-year low. Construction in the same month fell to its lowest level since 2009. GfK’s Consumer Confidence Index, a leading gauge of retail sentiment, showed its biggest fall since 1994. Gilt yields suggest a recession is possible, and the UK has received downgrades from each of the three major rating agencies. Last week the price of gold, traditional haven of the fearful, hit a two-year high.
Corporate indicators of the post-vote outlook offer a slightly more varied tale, albeit one still skewed to the negative. Total UK sales for M&S stores dropped 4.3% in the first quarter, and the trade gap with the rest of the world widened to £2.3 billion in May – better than expected, but worse than the previous month. Despite George Osborne’s meeting with senior bank chiefs last week, Goldman Sachs and JP Morgan both said that the loss of their EU ‘passporting’ arrangements – which currently appears unavoidable if the UK refuses EU freedom of movement rules – would lead their respective banks to shift staff elsewhere. On the other hand, the CBI said that the falling pound would help to cushion exporters from economic and trade headwinds. Leaders from several leading economies expressed an appetite for signing bilateral trade deals with the UK. Finally, manufacturing output in May dipped slightly, but beat expectations.
Yet stock markets told a more upbeat tale. The FTSE 100 ended the week almost unchanged, but its 0.19% rise took it still close to a one-year high; it has been Europe’s best-performing major index since the UK referendum result. The FTSE 250, which is more sensitive to domestic developments, rose marginally more, but remains down since 23 June. Both markets have received a boost from the prospect of lower interest rates and a weakening currency – as of last week, sterling is the weakest of the world’s 31 major currencies this year – and the prospect of lower interest rates. The Nikkei 225 fell 3.7%, partly due to a strong yen, and the FTSEurofirst 300 slipped 1.3%.
Now that the UK referendum is over, investors are expected to turn their attention to the US presidential election in November – not least because of some of the more extreme claims and policy ideas floated during campaigning. But campaign promises may offer a poor guide to policies to come, and investors would be unwise to fret.
“This is the most contentious presidential campaign I have seen,” said Jim Henderson of Aristotle Capital Management. “We are seeing extreme rhetoric in a bid to get elected. But whoever wins will come back into the centre; and many of the more extreme plans won’t see the light of day. Presidents can change mindsets but not the nuts and bolts of the economy.”
But if the US election provides the next major headline event for markets, it is likely that the British vote to leave the EU will remain at the forefront of investors’ minds in the immediate future. Indeed, while the UK is expected to see the most pronounced consequences, the vote’s effects are inevitably being felt elsewhere in Europe too, whether in terms of offering a boost to non-centrist parties, or in terms of the risk they pose to European growth – and to the outlook for some of Continental Europe’s leading exporters.
Minutes of the May meeting of the European Central Bank released last week showed that panel members had spoken about the “significant” potential shock of a UK vote to leave the EU, leading to a negative spillover to the euro area. Hungarian and Italian referendums due in October provide potential flashpoints. The first concerns much-resented EU refugee resettlement policies, the second, the Italian constitution – an anti-government vote is possible in Italy, even as the current administration seeks to solve the problems of its banking sector. Those reforms may be most urgent in Italy, but Europe also faces a wider challenge – last week the EURO STOXX bank index slipped close to the record low it struck in 2012.
On Friday, the International Monetary Fund cut its growth forecast for the eurozone to 1.6% this year and just 1.4% for 2017, citing fallout from the UK’s referendum result. The fund had formerly forecast growth of 1.7% in both years. Nevertheless, recent eurozone indicators have been positive and the currency area has enjoyed 12 consecutive quarters of positive GDP growth since the end of 2013. Moreover, some political and business leaders in Continental Europe are already expressing enthusiasm at the chance to attract companies formerly committed to London. Last week, easyJet opened inquiries into the process of moving its headquarters to Continental Europe.
While such moves may be a concern for the UK itself, they also reflect the fact that companies currently based in the UK need not suffer from a British exit from the EU. While some can profit from a cheaper pound, others may simply take the opportunity to reorient their business – or even to move abroad.
“A good company yesterday will remain a good company tomorrow,” said Jim Henderson.
Aristotle Capital Management is a fund manager for St. James’s Place.
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