Market Bulletin (11/10/2016)
Workshop of the world
Politicians like to deal in symbols, and last week Theresa May appeared to bid for a particularly large one: the city of Birmingham. The prime minister is known to admire Joseph Chamberlain, whose late-19th century reforms as Mayor of Birmingham helped to cement the city’s reputation as ‘workshop of the world’. Birmingham also encapsulates national divisions on Europe, having voted to leave the European Union by an even narrower margin than the broader UK. More than most cities, Birmingham presents a picture of Brexit Britain writ small.
Party conferences and markets in Britain rarely cross paths, but in the current global environment, and in the UK in particular, the two are more closely connected than they have been for decades. May’s opening speech to the conference promised the triggering of Article 50 by the end of March and spelt out her vision for a Brexit that prioritised border controls. The prices of gilts and sterling dropped in response, and the latter experienced a ‘flash crash’ later in the week, striking a 31-year low against the dollar. Exporters generally view this as a positive, but sterling is now the worst-performing currency of the developed world this year, having dipped almost 15% against the dollar. Its slide means that (in currency terms) the size of the UK economy has slipped below that of France, according to IMF figures.
Other indicators told a growth tale. The FTSE 100 rose 2.1% over the week, helped by the currency and a buoyant oil price. Halfway through the week, it came close to an all-time high and it ended the five-day period comfortably above 7,000 points, a level it has not reached since May 2015. The more domestically focused FTSE 250 reached a new all-time high on Tuesday, continuing a strong run begun in the last week of June. UK manufacturing saw its strongest gains in two years, and the UK services sector beat forecasts for its September reading, suggesting third-quarter growth will be stronger than expected. The IMF forecast that the UK economy will grow faster than all its G7 peers in 2016.
Despite the currency dip, the trade deficit widened to £12.1 billion in August, up from £9.5 billion in July, and the UK chancellor, abandoning his predecessor’s 2020 fiscal surplus target, warned that Britain faces two or more years of economic uncertainty and some “fiscal uncertainty”. His fellow Cabinet ministers appeared eager to promote a ‘hard Brexit’ last week,
and European leaders hardened their own rhetoric in response: Angela Merkel warned that “comfortable” UK deals would not be possible. The French president was more forthright.
“Britain wants to leave, but not to pay for it – that is not possible,” said François Hollande. “The UK has decided on Brexit, it seems a hard Brexit, and that must be followed through. We must be firm on it. Otherwise we put under threat the principles of the EU… There must be a threat, a risk, a price, otherwise we will be in a negotiation that cannot work well.”
The FTSEurofirst dropped 0.88% last week, as it was pushed down by weak automotive stocks, sterling’s ‘flash crash’, and disappointing US payroll figures, which left the S&P 500 down 0.92% for the week. Around 156,000 jobs were added in September, far below the 2016 monthly average of 178,000, taking pressure off the Fed to raise rates in December.
The European Central Bank, meanwhile, was forced to deny reports that it was planning to taper its own buying programme (worth €80 million a month) in the immediate future. As things stand, the UK, Europe and Japan are expected to spend a combined $506 billion on assets in the last quarter, the largest figure since 2009, according to figures from J.P. Morgan Asset Management. In Japan, where the Nikkei 225 rose 2.5% last week, the scale of central bank intervention is particularly extreme. Thanks to a spending spree that began in October 2010, the Bank of Japan is already a top-ten shareholder in 90% of the country’s 225 biggest companies.
But there are growing expectations that the global era of central bank support is closer to its end than its beginning. “With interest rates at their current level we are close to the end of central bank stimulus, which may present a headwind for equity markets over the next 12 months,” said George Luckraft of AXA Investment Managers. “I would be surprised if UK rates were cut any further.”
Indeed, to judge by her words in Birmingham last week, Theresa May probably is nervous about the dislocations that central bank policy has caused. “While monetary policy – with super-low interest rates and quantitative easing – provided the necessary emergency medicine after the financial crash, we have to acknowledge there have been some bad side effects,” said May. “People with assets have got richer. People without them have suffered. People with mortgages have found their debts cheaper. People with savings have found themselves poorer… A change has got to come.”
Anyone watching their annuity or savings rates will know very well what the prime minister is talking about, and in comments made to the IMF last week Mark Carney, Governor of the Bank of England, appeared to agree. Reports suggested that the Treasury was planning new incentives to help savers, and the work and pensions secretary confirmed that the ‘triple lock’ on the State Pension would be protected, while there were warnings that millions of employees must double or triple their defined contribution payments to compensate for the loss of income created by low interest rates. Britain’s 100 biggest companies now face a pensions shortfall of £73 billion, up from £25 billion a year ago. Given that the Bank of England said rates could be as low as 0.2% in 2020, there is more pressure than ever on workers to increase contributions – and to do so as early as possible.
Although Philip Hammond appeared to brush aside suggestions of large-scale fiscal stimulus last week, Theresa May’s closing speech in Birmingham signalled a monumental policy shift away from the laissez-faire economics of the Thatcher, Blair and Cameron years, and towards state interventionism.
“Theresa May’s speech showed that the UK is embarking on an entirely different economic policy agenda under the new administration,” said John Wood of J O Hambro. “What she made clear at Conservative Party Conference was that she wanted to step away from free market capitalism towards the state-led development policies of Joseph Chamberlain. As a result, there is a real risk that capital is inefficiently deployed. But it also means that UK-focused investors need to be more aware of political developments than ever.”
AXA Investment Managers and J O Hambro Capital Management are fund managers for St. James’s Place.
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