Market Bulletin (12/12/2017)
Diplomatic capital
“The view of Jerusalem is the history of the world,” said Benjamin Disraeli, Britain’s first Jewish prime minister. Last week that history took a new turn, as Donald Trump announced that the US would shift its Israeli embassy from Tel Aviv to the ancient capital. One hundred years after the UK’s foreign secretary sent the decisive ‘Balfour Declaration’ to Walter Rothschild, the US president has made his own mark on the world’s most intractable conflict. In so doing, he also added to the growing divergence between US and European foreign policy. The shekel and Israeli stocks both fell on the news – although the Tel Aviv index had recovered by the end of the week.
The S&P 500 ended the week up just 0.21%, and the causes of its own five-day trajectory lay much closer to home. Although volatility remained subdued, much of the movement related to the passage of the US tax-cuts bill. A late provision added to the bill would retain the corporate ‘alternative minimum tax’, thereby negating some of the expected gains. Technology stocks suffered midweek as a result, as did energy stocks. Yet both sectors had recovered later in the week. Positive US payrolls figures also added to momentum, and raised expectations of a Fed rate rise later this week.
The tax reform package has multiple implications beyond making it cheaper to do business in America. Perhaps most significantly of all, according to the non-partisan Congressional Budget Office’s analysis of the Senate tax bill, the cuts would add $1.4 trillion to the deficit over the next decade. Congress’s bipartisan tax referee estimated that lower-income Americans would experience tax rises by 2021 as a result of the bill, whereas the top 20% of the population would benefit.
Stephanie Kelton, professor of public policy and economics at the University of Missouri–Kansas City, argued last week that the bill would particularly benefit the top 0.1%. She concluded that, since the very wealthiest are unlikely to increase personal spending as a result of the extra income, it may well be channelled into assets such as property and stocks. To some onlookers, stocks appear fairly popular already; by one measure, the ratio of US equity prices to earnings is at double its long-term average. Not that any simple formula can tell you when to buy or sell; had you loaded up on equities when that same index (the Shiller) fell below its long-term average and sold when it rose above it, you would have only been in the market for eight months of the last 30 years – and missed out on most of the returns.
It was also noticeable last week that 30-day data showed the US Treasury yield curve flattening at its fastest pace since 2008 – in other words, bond investors are increasingly not being compensated for holding longer-dated debt. Traditionally, this has implied a recession to come, but these are not traditional times on markets. Even though the Fed has finally stopped pumping extra money into global markets, its peers are far from done – the ECB, for one, will continue buying bonds at a rate of €30 billion a month, until at least autumn 2018. The combined assets of the Fed, Bank of Japan, People’s Bank of China and ECB reached a record $19.6 trillion in October, 10% higher than in October 2016. The Eurofirst 300 rose 1.5% last week.
Keeping the peace
In fact, European investors were responding to new policies surrounding another of the world’s more finely-balanced political arrangements, this time in Northern Ireland. After the Democratic Unionist Party had stymied Theresa May’s hope for agreement on the status of Northern Ireland’s post-Brexit borders a few days earlier, negotiations were returned to in earnest later in the week. In the end, Theresa May secured a deal that will – barring any 11th hour complications – enable the UK to move to phase two of negotiations. Those will include discussions over the future of UK–EU trade.
Opinion varied on how good a deal she had secured. On the one hand, she agreed to pay the UK’s dues and to ensure some kind of regulatory continuity (in line with the EU); on the other, she had largely removed the practical oversight of the European Court of Justice and managed to secure a deal just in time. Yet Northern Ireland was arguably her thorniest problem, given the delicate arrangements already in place under the Good Friday Agreement. After a tough few months, many of her erstwhile critics on the backbenches seemed ready to congratulate her for successfully navigating such dangerous waters. The FTSE ended up 1.28% and the Eurofirst 300 was up 1.62%.
Although there were broad smiles and hearty handshakes aplenty in Brussels on Friday, the EU quickly clarified that there could be no discussions on trade until February, subject to “more clarity” from the UK prime minister. As Theresa May will recall from her visit just a few days earlier – when she ironed out a Northern Ireland deal over lunch with Jean-Claude Juncker – there’s many a slip ’twixt cup and lip.
There was less good news for the government at home, as General Electric announced it would cut 1,100 UK-based jobs as part of planned cuts across the group of $3.5 billion; 1,400 jobs would also go in Switzerland. The CEO said in October that the company’s disappointing third-quarter earnings were “completely unacceptable”. GE’s share price fell almost 15% the day the results were announced – and has not recovered since.
“GE’s reduction of 12,000 jobs in its global power division is part of a push to reduce expenses by $1 billion,” said Jim Henderson of Aristotle Capital Management. “The action is driven by systemic changes in the global power-production marketplace. Rival Siemens recently noted that global demand for high-capacity gas turbines has declined to around a quarter of market capacity. This action, while painful in the short run, is a long-term necessity given current global demand.”
While Theresa May was in Brussels, the UK’s actual first lady was launching a new £3 billion aircraft carrier in Portsmouth, the HMS Queen Elizabeth. Yet not all military investment appears to be making it through to the end user. Last week, a freedom of information request made by Royal London elicited data showing that spouses and partners of those in the armed forces who have served abroad were missing out on considerable pension payments due to failing to claim them. Royal London claimed such payments could be worth up to £30,000 per person. As so often for pensions, eligibility does not necessarily translate into utilisation. It is worth taking advice to ensure you are securing the best income available.
Chinese debt
Stock markets in Asia were more volatile than most over the course of the week, due largely to warnings over the scale of debt in China. In its first report on China’s financial system since 2011, the IMF warned that Chinese banks needed to raise capital buffers further in order to protect themselves against any financial shock. The fund warned of “unresolved tensions” between pro-growth policies and de-risking policies. Although 27 of the 33 banks it stress-tested were under-capitalised, all of the ‘Big Four’ state banks passed the test.
The assessment hit Chinese stocks midweek and took Japanese stocks down with them, despite Shinzo Abe’s balance-sheet-friendly decision to recategorise the start of ‘old age’ as 75, not 65 – a potentially significant marker, given the country’s ageing challenge. After their downward spiral in the first half of the week, Asian stocks recovered on Thursday and Friday. Although the Hang Seng still finished down, the Nikkei 225 ended the period essentially flat (down 0.03%). Moreover, the IMF report noted that China’s ‘zombie’ debt problem had been widely overstated, while others pointed out that China’s saving ratio remains very high at 48% – making China’s total debt ratio less meaningful. The debt-crisis doubters might have turned to Benjamin Disraeli’s old line: “There are three kinds of lies: lies, damned lies and statistics.”
Aristotle Capital Management is a fund manager for St. James’s Place.
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