Market Bulletin (13/09/2016)
Zero sum
In 1484 a French mathematician called Nicolas Chuquet made the earliest surviving written reference to the word ‘tryllion’ (as he spelt it). Chuquet wrote that one followed by six zeros could be called “million, the second mark byllion, the third mark tryllion, the fourth quadrillion… the ninth nonyllion, and so on with others as far as you wish to go.”
Six centuries later, central bankers, companies and investors appear united in their wish to go very far indeed. Last week, purchases of government bonds by the European Central Bank (ECB) passed the €1 trillion mark. US corporate issuance has already passed $1.1 trillion in 2016 – close to last year’s record. And dividends paid out by UK companies since the start of the millennium reached £1 trillion last Tuesday, according to Capita.
Through its recent purchase programme, the ECB has already swallowed around a seventh of all available eurozone government and agency bonds. As a result, one of its greatest challenges today is simply finding bonds to buy up with its monthly spending allowance of €80 billion – besides, its own rules stipulate that the ECB cannot buy bonds with a yield of less than -0.4%.
Subdued growth and inflation rates, however, point more towards a need for stimulus than to a softer touch. When the ECB met last week, it chose to leave both interest rates and the pace of its asset purchases unchanged – and said it wasn’t planning on new measures this year.
Nevertheless, Mario Draghi admitted that the ECB faces a scarcity of bonds to buy. One answer is for the rules governing its purchases to be relaxed, but any slack which allows it to buy government debt from peripheral Europe risks angering Germany and thus fomenting divisions, not only in the currency union but also on the board of the ECB.
Figures released last week showed eurozone business growth in August at its weakest since the start of 2015, although retail sales reached their highest point for the year. The FTSEurofirst dropped 1.4%. Germany’s services industry suffered its weakest showing for more than three years. More positively, Bayer, a German agribusiness giant, raised its offer for Monsanto, a leading US seeds company – it would be the largest overseas takeover by a German company.
“Whilst we have no issue with the strategic logic of Bayer bidding for Monsanto, the price being paid leaves us, and the market, sceptical of the value side of the argument,” said Adrian Frost of Artemis Investment Management. “Undoubtedly the long-term trends in crop protection and seeds are favourable and the market is consolidating as a result of recent mergers. The fact that these doubts are largely captured in the recent underperformance of the shares means that we tend towards the view that this chapter in Bayer’s progress provides an opportunity to buy.”
Numbers game
As UK plc dividend payments for the millennium passed £1 trillion, there were signs that the short-term economic response to the Brexit vote has been positive. The Markit services sentiment indicator jumped to the largest single-month rise in its 20-year history, after July witnessed its largest single-month dip. In response to the economic news, the pound struck a seven-week high against the dollar and five-week high against the euro. The trade deficit narrowed in July thanks to the cheaper pound, but August’s fall in food prices and retail spending (also reported last week) is expected to be short-lived for the same reasons. The FTSE had dropped 1.7% by close on Friday.
David Davis, Secretary of State for Exiting the European Union, told the Commons last week that the economy was in “a position of strength”, but the prime minister publicly countered his conviction that single market access was “improbable”.
Meanwhile, Japan’s foreign ministry chose the closing day of the G20 summit in China to publish a formal request for the UK to pursue a soft Brexit that safeguards the UK’s membership of the single market – Japanese companies account for 140,000 jobs in the UK. (The Nikkei 225 rose just 0.2% over the week.) Barack Obama made clear that US trade negotiations with the EU would come before negotiations with the UK – and warned that a badly handled Brexit could cause US–UK trade ties to “unravel”.
The government was quiet on its Brexit plans, but reports suggested Philip Hammond had ruled out George Osborne’s proposed corporate tax break. However, on the Lifetime ISA, another of Osborne’s policy proposals, Hammond confirmed his predecessor’s plans – the government has issued draft legislation to introduce the scheme next April. This would allow UK residents aged 18 to 40 to open a LISA and pay in up to £4,000 a year – the government would make a 25% top-up on contributions until the holder is 50 years old. Withdrawals can only be made, without losing the government bonus, for a deposit on a first home worth up to £450,000; or once the holder turns 60; or if the holder develops a terminal illness.
The overall ISA allowance will rise to £20,000 from next tax year, and the LISA will contribute towards that limit. The industry does not yet universally share the government’s enthusiasm about the LISA, citing concerns about complexity and potentially penal exit charges.
There was confirmation last week that Micro Focus, a UK technology firm that last week acceded to the FTSE 100, will buy Hewlett-Packard’s software business for £6.6 billion. Neil Woodford of Woodford Investment Management described it as a “transformational deal”.
“We are not surprised that its share price has responded well – we believe the shares were already undervaluing the company’s cash-generative capabilities and its strong long-term growth prospects,” said Woodford. “This new deal, however, significantly enhances the scale and breadth of the business and provides a substantial opportunity to improve profitability across an enlarged revenue base. We rate the Micro Focus management team very highly – if history is any guide, this deal should create a huge amount of value for the company’s shareholders in the future.”
Tax axe
In the US, services data showed the lowest reading in six years, pushing down the dollar. Combined with the disappointing recent payrolls report, this has lowered expectations of a US interest rate rise this week. The S&P 500 ended the week down 0.8%, but US stocks have had a strangely quiet second half to the summer. In August, the VIX, which measures volatility on the S&P 500, registered its lowest monthly average in at least 16 years.
The presidential election in November has the potential to end the quiet. Firstly, Moody’s warned last week that whoever wins the November election will face a significant challenge in sufficiently taming US national debt to prevent the country suffering a credit rating downgrade.
Moreover, the recent press focus on tax evasion has helped turn corporation tax into an election issue. Running as it does to an upper limit of 39%, the US has one of the highest top rates of corporation tax in the developed world, which is in great part why companies such as Apple have sought low-tax alternatives in Ireland. Last week Tim Cook, Apple’s CEO, promised to repatriate more of Apple’s earnings if the US corporate tax rate becomes “reasonable”.
As yet, Hillary Clinton has not suggested any cuts to the rate, while Donald Trump has promised to make a headline-grabbing cut to 15%, a neater figure than the 5–7% proposed by one of his economic advisors. But well-wishers might heed the advice of Samuel Johnson: never trust a round number.
Artemis Investment Management and Woodford Investment Management are fund managers for St. James’s Place.
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