Market Bulletin (27/09/2016)
Political fractures
“Things fall apart; the centre cannot hold,” wrote W. B. Yeats in 1919, describing a Europe that was turning away from old beliefs, and taking new and radical turns. The line has often been quoted by commentators in recent months, as the centrist political consensus that has held sway in developed countries for more than two decades suffers a series of knocks – the Brexit vote, the growing success of far-right nationalist parties across Europe, and the rise of Donald Trump in the US.
In the UK last week, attention continued to focus on when the government would begin to release details of its Brexit negotiating position and timetable. What signs there were appeared to say more about the government than its negotiating aims. Boris Johnson told a US audience that Article 50 would be invoked in early 2017 and that a British exit could then be completed within two years, only for 10 Downing Street to counter that the timetable was not yet decided.
Meanwhile, Philip Hammond was asked by a business leader to tell him who was in charge of Brexit, and reportedly answered that it is “all very difficult at the moment”. Business leaders expressed unease at Theresa May’s decision to disband David Cameron’s Business Advisory Group, a gathering of 20 top UK senior leaders that used to meet quarterly at Downing Street. Whatever negotiating approach is eventually adopted, however, the negotiations do not promise to be easy.
“The negotiations, once they begin, will be long and complicated,” said Simon Walker, director general at the Institute of Directors. “David Davis has said these may be the most complicated negotiations ever. The business community won’t be able to tell for many years how the negotiations are actually going.”
Among the most important issues for business leaders is companies’ ability to ‘passport’ into any EU country simply by virtue of having being approved to operate in the UK. Figures published by the UK regulator last week showed that 5,500 UK companies rely on these passports to do business in other European countries, while more than 8,000 financial services companies based in the EU or EEA rely on single-market passports to do business in Britain.
“The single market is still the best attempt to bring services into a single trade bloc that anyone’s tried and passporting is an important part of that,” said the IOD’s Walker. “I fear that restrictions on immigration are inevitable. This will become the biggest bone of contention between business and Theresa May’s government, as employers can’t simply substitute foreign workers with domestic ones.”
Earnings policy
Despite ongoing concerns, however, markets continued to strengthen last week, and the FTSE 100 gained 3%, buoyed as it was by banks and miners. Indeed, with the benefit of hindsight, pre-vote fears about an immediate hit to stock prices now look overdone. Indeed, for some fund managers, market dynamics in the aftermath of the vote have been surprisingly benign.
“We were neither expecting the result nor well-positioned for it,” said European equity manager Stuart Mitchell of S. W. Mitchell Capital. “With the vote uncertainty behind us, markets are now able to recognise that our domestically-oriented companies still trade at historically unprecedented discounts to the higher-growth international staples which have been so in favour. There is quite some irony in this. Earlier this year we thought we needed to get past the spectre of Brexit for our portfolios to perform well. That is exactly what we are seeing – just after the result we weren’t expecting!”
Brexit negotiations are not the only area in which the government is under pressure from both sides. Last week, it was reported that the government is also being pushed to defer its decision on increasing workplace pension contribution rates – as it is, contributions are slated to rise from 2% today to 8% by 2019. A spokesman for the Pensions and Lifetime Savings Association said it would be better to hold off until roll-out of the auto-enrolment programme is completed in 2019. But Steve Webb, former pensions minister, warned that current contributions are “woefully inadequate”, and that not delaying decisions remains “essential”.
Whichever side is correct, Webb is right to be concerned over a problem that is in urgent need of solutions, not least because it is getting worse. For the moment, the impetus remains firmly on workers themselves to start saving earlier, and to ensure that their contributions really can provide for the retirement they expect.
No moves
Last week economic indicators for the eurozone told a more troubled story than they have in recent months. France’s second-quarter growth figure was revised downwards to show a slight contraction of -0.1%. More importantly, however, the eurozone economy appears to have slowed at the end of the third quarter, and the September Purchasing Managers’ Index reading for the currency area slipped to its lowest level in 18 months.
The FTSEurofirst 300 still ended the week up 2.3% and the Nikkei 225 ended up by an almost identical 1.4%, but central banks in both countries faced growing scrutiny last week over the effectiveness – and side-effects – of their venture into negative rates.
Shock factor
Yet among the major markets, the greatest potential for political ructions would appear to be in the US, despite the S&P 500 rising 1.4% last week. Although Donald Trump remains slightly behind Hillary Clinton in the polls, some senior Democrats fear that pollsters are missing the ‘Shy Trumpers’ and that many Democrats won’t bother turning up to vote.
“The big worry politically right now is Donald Trump,” said Jim Pickard, chief political correspondent at the Financial Times. “The mood has turned against centrism, but running a country involves dozens of compromises each day – and a good deal of prioritisation. Trump is happy to leave Putin to do as he wishes in Europe, just as the UK is pulling away from the EU. All that post-World War II push towards countries finding common cause is at risk at the moment.”
As it is, global trade already faces many challenges. Last week, the World Trade Organization ruled that Airbus had profited from years of effective subsidies. The ruling gives Washington the power to impose subsidies on European imports – worth up to $10 billion. Recent fines were also announced for Apple and Deutsche Bank – trans-Atlantic trade tensions appear to be rising.
For investors, such trends are potentially concerning, but some are equally worried about Donald Trump’s unpredictability, not least because markets dislike uncertainty. In this light, even though they cannot predict their exact nature or timing, investors would be wise to prepare themselves for the possibility of macroeconomic shocks by investing in quality companies and maintaining a well-diversified portfolio strategy.
“Whilst it is unrealistic to think we can simply take macro risk out of the portfolio altogether, we have a preference for finding stocks where the micro considerations are likely to have a greater influence on their future,” said Adrian Frost of Artemis Investment Management. “So, to speak in earthquake terms, if a macro event impact rating might ordinarily be level 8 or 9, we want companies for which it would only be level 2 or 3 – a shake but not a disaster.”
“Stable defensive stocks are justifiably regarded to be at the low end; however, of late, their very strong performance has been closely correlated with falling bond yields,” said Frost. “Given how well these bond proxies have done, they would suffer if the support of falling bond yields were to fall away. Notwithstanding that, the longer-term prognosis remains favourable.”
Artemis Investment Management and S. W. Mitchell Capital are fund managers for St. James’s Place.
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