Market Bulletin (25/10/2016)
“When I was a boy, the most trusted man in America was the newscaster, Walter Cronkite, who once said, ‘If you’re not confused, you don’t know what’s going on.’ I would apply that to the current monetary picture – we’ve never had an experience like this.” Such were the reflections of Howard Marks, legendary bond investor and co-founder of Oaktree Capital, in a week that saw UK inflation reach its highest level in two years, central bank policies under scrutiny, and the US presidential election campaign enter the long home straight.
The Consumer Prices Index in the UK rose sharply to 1% in September from 0.6% in August, driven by the costs of fuel, clothing and hotel accommodation. The gathering upward pressures on prices is one of the most visible effects of Britain’s decision to leave the EU. Economists forecast that inflation will climb to 2.2% by mid-2017 and peak at 3–4% in 2018, as sterling’s weakness begins to show up in higher prices across the board.
In the game of trying to second-guess the Bank of England, markets have abandoned expectations of a further rate cut in November, but still forecast that rates will not rise before 2020. Faced with the fundamental need to maintain the spending power of their money, the prospect of rising inflation looks set to pose an increasing challenge to savers holding excess funds in bank and building society deposits.
A report by the EY ITEM Club forecasts a “prolonged period” of weaker growth for the UK economy, as consumer spending slows and business curbs investment. The think tank predicts GDP growth of 1.9% this year, but claimed that the economy’s stability since the Brexit vote was “deceptive”, and that growth will drop sharply to 0.8% next year as inflation rises, before expanding to 1.4% in 2018. Meanwhile, UK employment figures showed that the UK referendum still hasn’t provided much of a hit to the jobs recovery. The FTSE 100 Index ended the week virtually unchanged, up just 0.1%.
Retailers saw their strongest quarter of growth since the end of 2014, allaying fears that consumer confidence would be hurt after the Brexit vote. However, September saw spending on clothes and footwear drop to its lowest level in seven years, with the blame being put on warmer weather and Brexit. “Conditions on the high street for UK retailers were already tough, as they battled against too much capacity, competition from online retailers and a general slowdown in consumer spending,” observed Nick Purves of RWC Partners. “The recent fall in the level of sterling has undoubtedly made the situation worse, both because inflation is likely to rise in the near term, putting further pressure on consumer spending, but also because many of the UK retailers source their goods from overseas and hence their cost of sales will rise.”
“We would be concerned about the impact on those retailers with a large high street presence and with excessive amounts of financial leverage, which will limit their ability to respond to changing conditions,” says Purves.
The uncertainty created by the Brexit vote revealed itself in news from a number of leading companies. Following a similar warning from rival easyJet earlier in the month, budget airline Ryanair blamed the drop in the pound when it reduced its full-year profit forecasts by 5%, explaining that the currency impact would cut revenues from fares by 13–15% in the second half. However, Majedie Asset Management believes the company is still in good shape. “Underlying progress is very strong, with unit costs expected to fall a further 3% and passenger numbers expected to grow from 106 million to 119 million this year, and with the load factor better at 94%.”
Travis Perkins, the UK’s biggest builders merchant cited “an uncertain UK outlook” when it announced it was closing 30 branches, putting 600 jobs at risk. “Travis Perkins relentlessly sets its strategy to gradually gain share against its competition across its many formats, but it cannot buck toughening markets,” commented Majedie Asset Management. “That said, we expect Travis to emerge from this uncertain period of demand over the next 18 months or so in an even stronger relative market position; corporate Darwinism in action.”
At a summit in Brussels, Prime Minister Theresa May predicted “difficult moments” ahead in Brexit negotiations, but she was optimistic she could get a deal “that is right for the UK”. Earlier in the week came reports that the government was considering continuing to pay billions into the EU budget to maintain single market access for sectors such as finance and car manufacturing.
On Thursday, the European Central Bank made its expected decision to leave interest rates unchanged and maintain its asset-purchase programme. President Mario Draghi confirmed that the bank’s December meeting would decide whether, as markets hope, it prolongs QE beyond March to keep the fragile recovery on track. The FTSEurofirst 300 Index ended the week up 1.3%.
At the weekend US telecoms giant AT&T announced plans to buy entertainment group Time Warner for nearly $85 billion, in what would be one of the biggest deals of the year. Donald Trump said that, if elected, he will block the deal; although the final US presidential debate on Wednesday appeared to have done little to improve the odds of the Republican candidate winning the day. The S&P 500 index ended the week down, fractionally, by 0.3%.
The Treasury confirmed its expectations for take-up of the new Lifetime ISA (LISA), to be introduced in April next year and available to UK residents aged between 18 and 40. It anticipates that 200,000 people will contribute to a LISA in the first year, rising to more than 800,000 in the 2020/21 tax year, and says it does not believe that people will reduce their savings into workplace pension schemes in favour of the LISA. It does, though, acknowledge that personal pensions may take a hit as individuals, attracted by the scope for earlier access, decide to switch their savings. However, whether this is necessarily the right thing to do is one of the concerns about the government’s possible future direction on pension policy.
While speculation continued over whether next month’s Autumn Statement will include an overhaul to the current system of tax relief on pensions, a very clear line was drawn through the government’s plans to allow pensioners to raise money by selling their annuities to insurance companies. The idea was first mooted by the then-Chancellor George Osborne in the Budget of March 2015, and only last December the government decided the plan would go ahead; but it has now changed its mind given justifiable fears that consumers could not be guaranteed good value for money.
“The second-hand annuity market was always going to be a difficult one to get to operate,” observed Ian Price of St. James’s Place. “An efficient market needs a willing seller and a willing buyer and it’s clear that not many providers were keen on these plans. In reality the government had no alternative but to change its mind.”
Uncertainties lie ahead for investors, but the prospect of rising inflation and continuing low interest rates makes it even more important to invest where your money has the best chance of maintaining its spending power. As Howard Marks remarks “If you have bought an asset which is appropriate for you, if you understand it, and if you can hold on through the rough spots, then invariably you can do fine despite the inevitable fluctuations. It’s the person who loses faith and sells out at the bottom who endures the most pain.”
Majedie Asset Management, Oaktree Capital and RWC Partners are fund managers for St. James’s Place.
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