Market Bulletin (18/04/2017)
Last week’s events were quickly overshadowed by Theresa May’s announcement on Tuesday that she planned to call a general election, to be held on 8 June, subject to parliamentary approval. This completes the picture of a European summer dominated by national elections in its three largest economies: the French presidential election in April and May; the UK general election and French parliamentary election in June; and the German federal election in September. Politics remains to the fore.
Ahead of the UK announcement, investors last week appeared cautious, as earnings season kicked off in the US and geopolitics held the headlines. The S&P 500 slipped 0.75%, while the FTSE 100 and Eurofirst 300 fell 2.8% and 2.7% respectively. The VIX, which measures volatility on the S&P 500, tracked upwards to a level not seen since the US election.
At least some of the cause lay in self-doubt. Since the election of Donald Trump, a swelling number of investors have assumed that the new president will cut regulation and tax as promised, while ultimately shying away from the headline protectionist and isolationist pledges he made during his election campaign. Strong global economic growth and improving US company earnings simply added to expectations that a corporate renaissance was in the offing.
Yet politics in general, and Trump in particular, has proved far more unpredictable than anticipated. The new president used his campaign to attack China over trade and praise Vladimir Putin as a strong leader. Last week, however, he appeared to complete a volte-face; he said that US-Russia relations had reached an “all-time low” due to disagreements over Syria, while Trump had already recast China as a close ally. For all the apparent realignments, however, global politics last week was dominated by an old problem. North Korea’s nuclear programme was a running sore for the Obama administration, and with the prospect of Pyongyang’s nuclear reach extending in the near future, the Trump administration has adopted a far more strident tone – sending warships to the region. Japan’s Nikkei 225 probably owed some of its 1.1% slip last week to geopolitical fears centred on East Asia.
The president also complained last week that the dollar was overvalued, which led traders to devalue it themselves on markets – sterling was among the currencies to rise against the greenback last week. Yet a little hesitation from markets is very different from a wholesale change of perspective, and pricing continues to reflect investor hopes. All eyes will now be on earnings season, which began last week with results from three major US banks. JPMorgan Chase and Citigroup both reported a strong first quarter with revenues significantly above expectations, while Wells Fargo suffered a share price dip after a sales scandal ate into profits.
There are strong economic tailwinds. Last week Christine Lagarde, managing director of the IMF, said that both developed and developing economies were performing well, and highlighted the benefits of robust US manufacturing data, improved growth in the emerging world, and the knock-on benefits of higher commodity prices. The IMF expects global growth of 3.4% this year, an improvement on 2016.
The UK is on a similar economic trajectory, but figures released last week suggested that prices are still rising faster than wages. Real wages grew at their slowest rate in three years in the three months to the end of February, while inflation in March rose 2.3% (annualised), the same rate as in February, when it struck a three-year high. Inflation was held in check last month by a fall in air fares and petrol costs, but food prices rose by 0.3% for the first time in three years. There was happier news on jobs, as figures showed that unemployment remained at 4.7%, the lowest level since records began in 1971. But the Institute for Fiscal Studies warned that Britons face more than a decade of low or non-existent wage growth, meaning they will earn no more in 2021 (in real terms) than they did in 2008 – the worst period of wage stagnation in the UK since the Great Depression.
The inflation numbers are of particular concern to retailers. Figures published by the British Retail Consortium last week showed that non-food retail sales in the first quarter fell by the greatest margin in almost six years. That suggests consumers are focusing instead on core purchases, notably food and fuel.
Last week Tesco published full-year results which showed that same-store sales have risen for four quarters in a row, with sales in the UK and Asia especially strong. It was the company’s first full year of UK sales growth in seven years, after the supermarket chain suffered from passing rising costs onto customers in the wake of the financial crisis – as its rivals took the chance to undercut prices. Yet even for Tesco, rising costs have pared back gains. The share price actually dipped more than 4% last week, reflecting investor concerns that Tesco should have got further with its recovery before spending £3.7 billion to buy Booker, which it acquired earlier this year – and possibly nerves over how Tesco manages inflationary pressures.
“The results were slightly better than expected, with the mix showing the UK margin expanding and a variable performance overseas,” said James de Uphaugh of Majedie Asset Management. “The overall business is on track to meet its medium-term targets. The UK performance was driven by a high-quality volume performance with particular outperformance in fresh [foods] – the key battle ground for any food retailer. The uncertainty relates to how much of the input cost inflation will feed through to shelf edge pricing… logic dictates that with the profit pool low, a good degree of pass-through will occur [leading to higher consumer prices]. We continue to think that the shares offer an attractive opportunity, at a time when inflation is set to become a tailwind.”
The banking sector in the UK received unwanted attention last week over the Barclays CEO’s attempts to uncover the identity of a whistle-blower at the bank. RBS, HSBC and Barclays all saw their share prices slip last week, as investors eyed forthcoming results from their US counterparts.
No crystal ball
If political unpredictability made itself felt on markets last week, Donald Trump could not take all the credit. This Sunday, France will go to the polls in the first round of its presidential election. There have already been unprecedented developments – the incumbent will not stand; and neither of the two mainstream parties is expected to get to the second round. Last week, fresh developments unnerved markets further, pushing French 10-year bond yields to hit a six-week peak against German Bunds – a key measure of perceived political risk.
It had been assumed that the Eurosceptic Marine Le Pen would face centrist Emmanuel Macron in the second round or, failing that, centre-right candidate François Fillon, who has been hit by a ‘fake jobs’ scandal. Last week, however, a poll showed Jean-Luc Mélenchon winning 19% of the vote, putting him within reach of second place – and the second round.
Mélenchon is a hard-left independent candidate who favours 100% for the top rate of income tax, opposes globalisation, plans to cut the French working week (currently 35 hours), is a Eurosceptic, and wishes to replace De Gaulle’s Fifth Republic with a new setup. Thus a new possibility has emerged for the second round: Marine Le Pen of the far right against Jean-Luc Mélenchon of the far left. Markets dislike both possibilities since, for all their differences, they are both deeply protectionist and Eurosceptic. Investors prefer to ignore politics. The past few days serve as a reminder that they cannot afford to do so.
Majedie Asset Management is a fund manager for St. James’s Place.
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