Market Bulletin (25/09/2018)
Auf Wiedersehen
The Felsenreitschule theatre in Salzburg is used to goodbyes. It was where, in the 1965 film, The Sound of Music, the extensive von Trapp family sang for their wartime audience before fleeing across the border: “So long, farewell, auf Wiedersehen, good night.”
Theresa May faced her own farewell moment in the same theatre last week when the 27 other EU national leaders informed her that her ‘Chequers plan’ was essentially dead, short of some root-and-branch changes on plans for the new economic relationship. Donald Tusk added in a press conference that, unless the UK government presents an acceptable solution to the Irish border question by the time of the mid-October summit, there will be no November gathering to finalise the deal. (No wonder there is talk of bringing the Budget forward a few weeks, so as to keep it relatively insulated from the politics of exit deals.)
Given how carefully planned such summits tend to be – leaders rarely turn up without a fair idea of the kind of deal they might then sign up to – it was a strangely polarised outcome. One EU official reportedly said that May and her team had been wrong to put all their eggs in the Chequers basket. The prime minister later told Leo Varadkar, the Irish taoiseach, that an Irish border plan wouldn’t be feasible before mid-October.
In short, the gathering supplied more questions than answers, just weeks before the UK and EU need to agree a withdrawal deal, ahead of votes in national parliaments and the formal withdrawal on 29 March next year. Whichever side was guilty of wrongful expectations, a no-deal Brexit was looking more likely by the end of the week than it had been at the start. “We are at an impasse,” May said later, in combative mood; her comments pushed the pound to its biggest fall versus the dollar in 11 months. The bond market also recoiled, while the odds on a no-deal Brexit shortened to around 5/4. The Labour leadership’s decision to back its members, should they vote for a second referendum this week, only added to the pressure, as several Cabinet members started to argue for ditching the Chequers plan in favour of a Canada-style deal (which would mean the removal of most tariffs but only full market access in certain industries and probably no passporting for services).
News back at home didn’t offer the prime minister much respite. Employer federations for the haulage, hospitality and housebuilding sectors all complained at a new government immigration plan that favours high-skilled migrants at the expense of lower-skilled foreign workers. Moreover, more than 80% of UK manufacturers said they were unprepared for a no-deal Brexit, according to a new survey published by EEF, an industry body. There were also reports that some multinationals have begun stockpiling products and parts in the UK; among them Mondelez, a US food company, and Airbus, Europe’s leading aerospace company.
“Fears of a no-deal Brexit are rising,” said a report published by Loomis Sayles, manager of the St. James’s Place Investment Grade Corporate Bond fund, early last week. “We believe an agreement will be needed by January 2019 at latest … [and] the UK’s economy would likely take a bigger hit from a no-deal Brexit than the EU.”
Long way to run?
The FTSE 100 enjoyed a stronger week, reflecting both the falling pound and exposure to energy companies and banks – the latter also buoyed European stock markets.
It was, moreover, a good week for Japanese stocks, which struck a four-month high on Friday, following on from Wall Street’s own successful run the day before. Banks and insurers led the rally, among them Sumitomo Mitsui Trust Holdings and Mizuho Financial Group.
“The recent interest rate rise isn’t yet priced into the stock prices of Japanese banks,” said Yoshi Ito of Nippon Value Investors, manager of the St. James’s Place Japan fund. “In our own portfolio, the valuations of Sumitomo Mitsui Holdings and Mizuho Financial Group remain attractive in terms of price-to-book and earnings, while they still offer a good dividend yield of 3%.”
It could have been a tougher week in China, given the White House’s decision to impose a further $200 billion in tariffs on Chinese imports. Beijing retaliated by imposing its own tariffs on $60 billion of US imports and cancelled the next round of talks. The renminbi and Chinese stocks dipped on Thursday, but the Shanghai Composite index ended the week higher; and the currency even recovered most of its losses on Friday, in part because the US tariffs had been set at a lower level than initially feared.
“Financial markets have shrugged off the widely-expected announcement of additional US tariffs on China, and China’s response, so far this week,” Capital Economics said in a report last week. “But we suspect that this will just prove a lull in the storm… There is a good chance that the trade war will continue to escalate.”
Investors in the US clearly weren’t too bothered by developments last week, as the S&P 500 struck another all-time high, boosted by energy and technology companies. It’s also notable that investment by S&P 500 companies increased to $341 billion in the first half of the year; should that rate persist throughout 2018, it will mark the highest level of corporate capital expenditure in 25 years.
Nevertheless, ten years on from the last financial crisis, some are concerned that markets risk overheating and that indebtedness worldwide remains at elevated levels. The latter has all sorts of ramifications, not least in emerging markets, where companies have been encouraged for years to borrow in dollars – a much stronger dollar has since increased their debt burden in local currency terms.
“The total global debt stock now stands at $175 trillion (or 325% of [global] GDP),” read a report published last week by Llewellyn Consulting. “In the US alone, outstanding car loans – mostly sub-prime – total $1.2 trillion, close to the $1.3 trillion-odd of outstanding prime mortgages in 2007, while outstanding student loans total $1.4 trillion.”
Cash poor
Among the fears looming on markets is inflation, which has only gradually begun to reappear since the financial crisis. Last week, data showed that inflation in the UK rose to 2.7% in August, which was above expectations. Prices of theatre tickets, ferry trips and new autumn clothing ranges were among the most heavily affected. While the rise makes the Bank of England’s August rate rise look prescient, it comes amid lacklustre growth and hits stricken cash savers still harder.
A report released by Moneyfacts last week showed that few providers have passed the full August rate rise onto savers – increases fell far short of the 0.25% increase introduced by the Bank of England. In fact, the average no-notice rate has risen by a mere 0.06% over the past month and now sits at 0.58%. The notice equivalent now sits at 0.94%, meaning a rise of 0.10%. It is a similar story for no-notice and notice Cash ISAs, up to 0.87% and 1.09%, respectively. “Despite there being two base rate rises in the last year, the market has barely recovered from the rate cut two years ago,” said the report. In this light, savers might want to consider their options.
Loomis Sayles and Nippon Value Investors are fund managers for St. James’s Place.
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