Market Bulletin (25/04/2017)
It has become a commonplace of the past ten months that, when politics pushes sterling rapidly in one direction, so the FTSE 100 travels a similar distance, but the opposite way. Last week was no different but, even by recent standards, both moves were unusually pronounced.
In a vote on Wednesday afternoon, MPs delivered a huge majority in favour of Theresa May holding an early general election on 8 June, despite earlier protestations she would do no such thing. The pound rose more than 2% against the dollar over the course of the week, striking a five-month high, while the FTSE 100 fell by 2.9%, erasing its gains for the year. Although this might hurt a few short-term speculators, the rise in the value of sterling suggests that investors were pleased at the election news for the broader UK outlook. The fall in the FTSE 100 simply reflects the fact that non-UK earnings (which dominate the index) have effectively lost value in sterling terms – not that the companies themselves are struggling.
There are several reasons why markets might have reacted positively. The most obvious is that Theresa May’s Conservatives are expected to win a landslide – polls currently predict that the Tory majority in the Commons will rise from 17 seats to around 130. This would release her from David Cameron’s election manifesto promises, but its principal benefits may be more party-political.
The Conservative Party’s Eurosceptic lobby has a grand and decades-old tradition of causing problems for Tory prime ministers – a vastly increased electoral majority would reduce the lobby’s influence on Mrs May, as it would the influence of the Europhile wing of the party, giving her more room to manoeuvre. Given the expected Tory acquisition of seats currently belonging to Labour and, in smaller number, the SNP, it would also weaken the hand of opposing parties. In short, investors may be assuming that Mrs May would then head into Brexit negotiations with a gusty following wind. Moreover, although the latest UK retail sales figures showed the first quarter-on-quarter slip since 2013, economic growth remains buoyant, and was last week upgraded still further by the IMF. Mrs May could be weeks away from becoming one of the most powerful prime ministers since World War II.
“We have been more optimistic about the outlook for the UK economy than the market consensus and the snap election does nothing to change our view – in fact, it is a positive, as it should give us, as investors in the UK economy, much greater clarity and stability on domestic monetary and fiscal policy over the years ahead,” said Neil Woodford of Woodford Investment Management. “It removes much of the political risk that could otherwise have been present in the Brexit negotiations. I see a lengthy period of improving economic stability in the UK – one which is now much less likely to be derailed by politics.”
In light of the forthcoming election, the government could perhaps be expected to quietly drop a few of its plans. One early casualty last week was its controversial plan to hike probate fees – an initiative that would have seen the costs rise from £155 to £20,000 for estates worth more than £2 million. The Ministry of Justice said there is no time to complete the change before the election. It is the government’s second significant policy U-turn of the year, after the Budget change to National Insurance contributions was reversed within a week.
Yet a looming election and Brexit negotiation process did not prevent the prime minister and chancellor from commenting on major tax issues in interviews last week. Theresa May said that aid spending would not be cut and indicated that the triple lock on pensions was no longer secure. Meanwhile, Aegon published research which showed that women in the UK have (on average) only a third of the pensions savings that men do. Although the combination of automatic enrolment, pension freedoms, and fears over the future of pension tax relief has led to some improvement, a lack of engagement in retirement planning lies at the root of the problem. Worryingly, 42% of women have never reviewed their retirement plans, and a third don’t know how much they have saved into their pension. Another significant development came in the form of a suggestion by Philip Hammond that the 2015 manifesto pledge not to raise Income Tax, National Insurance or VAT might not make it into this year’s Tory election manifesto. Significant tax changes could therefore be in the offing.
Moreover, the chancellor decided to push ahead with the government’s Finance Bill 2017, which goes to parliament this week, despite the Chartered Institute of Taxation warning last week that much of the detail should be shelved for the moment as it remained inappropriate. At 762 pages, it is reportedly the longest bill in parliamentary history.
Despite heightened activity in Westminster, even UK politicians had their eyes trained on France last week, as the country went to the polls in the first round of the presidential election. Indeed, there are reasons to believe that the French election will have far greater consequences for Brexit negotiations than the UK’s own general election, given the importance of France to the EU’s positioning on Brexit, and the continued significance of the EU to the UK’s future – reports at the weekend said that the White House now favours concluding a new US–EU trade deal before any US–UK deal.
Markets would have been best pleased had Emmanuel Macron and François Fillon made it through to the second round, and might have despaired if the selection had been Marine Le Pen and Jean-Luc Mélenchon, both protectionists and Eurosceptics. Moreover, uncertainty was heightened by a terrorist attack in Paris last week. In the event, the result delivered the expected mix: Emmanuel Macron and Marine Le Pen. Bond spreads narrowed in relative relief; and, at the time of writing on Monday morning, the FTSE 100 was within sight of a 2% single-day rise. The surge reflected the market’s favourable view of Macron, a globalist and centrist, who is expected to comfortably beat Le Pen, a protectionist and Eurosceptic.
For the first time in the history of the Fifth Republic, candidates from neither of the two main political parties will be on the ballot paper for the second round. But volatility has dipped significantly since the result was announced, after nerves jangled in the run-up – the Eurofirst 300 dropped 0.75% last week. All the same, a survey of fund managers published last week showed that investors have in fact been carrying out a major rotation away from the US and towards Europe in recent weeks – the fifth-largest such shift since the euro was established.
There was good news last week from Europe’s fourth-largest company too, as Volkswagen reported much higher earnings than expected for the first quarter – profits rose 28% (annualised). Tweaks to existing models (notably the Tiguan) together with cost cutting appear to have helped, as do signs that the black mark of the emissions scandal fallout is beginning to fade. On Friday, a US federal judge ordered VW to pay a hefty £2.8 billion in criminal fines and face three years’ probation – potentially another step on the road to restitution.
Beyond European politics, there were plenty of signs of continued momentum for global growth. Major US banks posted strong results last week, with the significant exception of Goldman Sachs, among them Bank of America Merrill Lynch and Morgan Stanley. Stock markets in the US and Japan both enjoyed a buoyant week: the S&P 500 rose 0.97% and the Nikkei 225 finished the five-day period up 1.6%. Meanwhile, the IMF upgraded its global growth forecast for the year to 3.5%, citing improving trends in trade, investment and manufacturing.
Woodford Investment Management is a fund manager for St. James’s Place.
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