Market Bulletin (26/06/2018)
Financial alchemy
One of the leading trends on financial markets in recent years has been the rise of passive investing. Exchange-traded funds (ETFs), a type of passive investment traded on a stock market, have added increasing complexity to the breadth of investment options for investors. A company chaired by Jim Rogers, a veteran US investor, last week became the latest to launch an ETF of an ETF; the new fund’s weightings will be determined by artificial intelligence. The set-up leaves humans several places removed from the action.
Investors can be tempted to buy into such ventures early, confident that technology is likely to continue its rise and that machines will, in the end, always beat the rest of us. Indeed, without its leading technology stocks, the S&P 500 would have remained roughly flat this year. While the index has risen more than 3% this year, the S&P 500 Information Technology Index (which includes only the technology stocks listed on the S&P 500) is up some 14%. Last week, despite global trade fears, technology stocks continued their run, as did major US banks, although trade fears left the S&P 500 down for the week.
The stellar run the S&P has enjoyed in recent years has led some investors to assume it’s overvalued; yet prudent investors should beware of drawing major conclusions from broad index moves alone. Indeed, non-technology sectors have remained effectively flat on the S&P this year, despite US corporate profits rising by some 25% in the first quarter. The recent earnings run means that the S&P 500’s forward price/earnings ratio – which measures the stock market price against expected earnings – is in fact lower than its five-year average.
“While the index has risen, the reality is that the US market is now looking significantly less expensive relative to earnings than it was at the start of the year,” said Chris Ralph, Chief Investment Officer at St. James’s Place. “In fact, the S&P has risen by 10% a year since the end of 2014 and yet, on this measure, it is cheaper today than it was back then.”
News came last week that, in 2017, US investment banks had returned to profitability levels last seen before the financial crisis. The growth trend appears to be continuing through the second quarter (Q2) too – Capital Economics is expecting annualised Q2 growth in the US of 4.2%, given recent business growth pointers and a strong labour market.
Closing doors
Yet challenges were also apparent, as Washington continued to make its presence heavily felt on markets. Last week, having already imposed $50 billion in tariffs on Chinese imports, Donald Trump warned that retaliatory measures from China would spark a further $200 billion of tariffs on Chinese goods. China quickly responded, saying that the US was employing “blackmailing” tactics. The S&P 500 suffered as a result, as did the Shanghai Composite and Hong Kong’s Hang Seng: all three ended the week significantly lower. Over the weekend, the US administration further announced it would restrict Chinese investment in a range of US sectors, such as robotics and aerospace.
Recent commentary suggests the president remains insensitive to the cajoling of US business leaders, choosing to focus instead on the fact that China exports more than $500 billion in merchandise to the US annually, against just $130 billion going the other way. The first round of tariffs will mostly impact capital goods like industrial machinery – industrial stocks have underperformed in recent weeks. However, the second round is expected to impact more mainstream consumer items such as clothes, mobile phones and TVs. If so, at least one of two groups will feel the pain: consumers, and the companies themselves.
Concerns persist in Europe, too, and a number of companies reliant on EU–US trade continuity have suffered on markets in recent weeks, among them Boeing, Caterpillar, Volkswagen and thyssenkrupp. Yet Trump’s intransigence may also be pushing old European partners that little bit closer together. Last week, Angela Merkel agreed to Emmanuel Macron’s broad idea of a eurozone budget – such a shift had until recently been relatively unthinkable for Germany. Yet Merkel faced significant pressure from her coalition partners, the Bavarian Christian Social Union, over the deal; only the week before, those same partners threatened to pull out of the government over her migration policy.
Inevitably, much of the focus remained on Italy, where Matteo Salvini, head of the Northern League, has managed to claim the political limelight with his hard line against migrants. Italian debt yields remained relatively manageable over the period, while Italian stocks ended the week down. The MSCI Europe ex UK fell substantially, although perhaps mostly on trade fears; losses were pared a little late in the week on improving eurozone business activity figures.
This week, EU leaders will gather for the (roughly) quarterly meeting of the European Council, and the Italian prime minister has already warned that EU migration policy needs an overhaul. There is also the small matter of Brexit. Last week, the EU began formally making plans for a no-deal Brexit, citing the lack of progress in negotiations. Nevertheless, the UK prime minister chalked up a significant victory when she managed to get the Brexit bill through its third and final reading in the House of Commons – an offer of a meaningful parliamentary debate on the final deal placated key Europhile Tory rebels. She also told Andrew Marr of a ‘Brexit dividend’ to come. Less positive was news that asset managers in the City of London have halved their hiring rate since the referendum (while rapidly increasing hiring in Luxembourg and Paris); and that Airbus is considering cutting thousands of UK jobs due to Brexit uncertainties.
The Bank of England left interest rates on hold but the counter-vote of its chief economist, who wanted a 0.25% rise, was felt on markets. A July rise is now priced in. Nevertheless, recent data for the UK economy is varied at best. The UK has traditionally grown faster than the eurozone average, but has lagged the eurozone growth rate for the past five quarters, and wages are barely rising against inflation. Retail sales have risen – an encouraging sign given the composition of the UK economy – but confidence remains subdued and growth in household spending has slowed. As the two-year anniversary of the referendum passed over the weekend, a Financial Times survey found that, on average, forecasters believe the economy is now 1.2% smaller than it would otherwise have been – a forfeit of £450 million a week.
Nevertheless, the government’s finances have been improving materially, aided by low interest rates and rising tax receipts. As a result, the prime minister saw fit to raise spending on the NHS; speculation now centres on whether she will annul manifesto pledges on business rates, the personal allowance, and not increasing VAT. Yet despite the health funding rise, a government green paper on care – which had been due to be published by the summer – was kicked into the long grass, offering a reminder that making one’s own arrangements for long-term care is as important as ever. Kicking the can down the road appeared to be the order of the day in the world of pensions, too, as the pensions minister said no decisions on auto-enrolment for the self-employed would be imminent. The lack of government intervention in this area serves to underscore the importance of financial planning to those working for themselves.
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