Market Bulletin (28/02/2017)
Happiness, according to Charles Dickens’ character Wilkins Micawber, is to be found in achieving a surplus. Or, as the fictional debtor himself put it: “Annual income twenty pounds, annual expenditure nineteen [pounds], nineteen [shillings] and six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
By that logic, Mr Micawber might judge the UK to be an unhappy place just now. Last week, the Office for National Statistics (ONS) published figures that showed consumption, that bellwether of UK economic health, was buoyant in the fourth quarter of 2016, as household spending rose 5% year-on-year. In itself, that might be cause for celebration, not least because headline growth in the fourth quarter was revised upwards to 0.7%, providing further proof that the UK economy has not missed a beat since the referendum.
Yet the figures also showed that wages rose just 4% in the quarter, meaning that households have been increasing their spending more quickly than they have managed to increase their earnings. The savings ratio has been falling and consumers have become increasingly reliant on credit – last week the TUC reported that the average UK family owes a record £12,887 before mortgages are taken into account. In a country already known for its high levels of private indebtedness, this is a worrying trend, one which suggests that many are sacrificing future financial security rather than investing for it.
“The UK consumer is important to how things shape up this year,” said Luke Chappell of BlackRock. “Will employers react to the short-term inflation pressures and push up wage inflation or hold their nerve? The savings ratio is falling as debt increases – credit is building, particularly in high-ticket items like cars. Meanwhile, lenders are focusing on unsecured debt as an opportunity – thus Lloyds’ purchase of MBNA in December. These are worrying hallmarks, if they mean a return to a credit-fuelled economy.”
Indeed, the ONS figures show that more than 90% of UK growth in 2016 was due to consumption, while net exports and investment both lagged. In fact, there were anecdotal signs even last week that investment trends remain strong: perhaps most notably, Amazon announced that it would create 5,000 new UK jobs in the coming year, an increase of almost 25%. Such announcements will need to gather momentum if investment is to become a driver of growth once more.
The UK chancellor made clear last week that he intends to stick rigorously to Mr Micawber’s rule, warning that any extra money from his surplus would not be made available for government departments in the forthcoming Budget. “There is no pot of money under my desk,” he warned. He may yet face pressure from the prime minister, however, who appeared to suggest she might yet relent slightly on the planned revaluation of commercial property due in April, the first since 2010, which has the potential to make business rates all but unaffordable for many small businesses.
Last week three of the four biggest banks on the FTSE 100 announced their results, and provided plenty of evidence that balance sheets in the UK banking sector are finally moving into the black, as bad loans are unwound, the era of post-crisis fines draws ever nearer its end, and inflation offers the hope of interest rate rises. The government will doubtless be most pleased at the exceptionally strong results posted by Lloyds, in which it still owns a 5% stake. Pre-tax profits at the bank were £4.2 billion, up from £1.6 billion a year earlier, the bank’s best results since the global financial crisis. Lloyds announced a special dividend, as well as increasing its ordinary dividend – its 2016 net dividend pay-out was a sizeable £2.2 billion.
“Lloyds reported solid numbers, helped by a low level of UK impairments,” said George Luckraft of AXA Investment Managers. “Their dividend is starting to become meaningful and, as long as the UK economy remains on track, we should continue to see good dividend growth, with the stock returning to its pre-financial crisis position of being a boring high-yield stock.”
It was a less joyful results season for the largest bank listing on the FTSE 100. Although the slide in sterling has pushed HSBC’s dividend up 14%, pre-tax profits fell by a whopping 62% last year, reflecting currency woes and a write-off in its European banking division. The bank had rallied on markets in recent weeks, thanks to its emerging markets exposure and to expectations of rising interest rates, which should help the industry as a whole.
“HSBC reported dull numbers but confirmed their dividend, while reducing revenue guidance for 2017,” said AXA’s Luckraft. “Their sensitivity to higher interest rates increased, so they should be a beneficiary if the Fed tightens monetary policy more aggressively than expected.”
Meanwhile, Barclays finally entered the black for the first time since the crisis, going from a net loss of £394 million in 2015 to a net profit of £1.6 billion last year. Jes Staley, the American appointed to reorganise the bank, said last week that the restructuring process was now close to completion, with some 15,000 staff already gone, an increased focus on investment banking, and a halving of the dividend. Although revenues slipped, a drop in charges offered support to the balance sheet. Now that banks appear to be moving on from the crisis, investors are faced with a somewhat different set of questions.
“The question is – are they good investments from here?” said Neil Woodford of Woodford Investment Management. “When you know the banks are solvent and they have adequate capital, you then have a question about whether they can grow profits and deliver returns and attractive dividends. [But they are] now more investable than they’ve been in a long time.”
Last week, figures for the German state finances showed that the country had posted its largest budget surplus since reunification back in 1991, ending 2016 €23.7 billion in the black, helped by low unemployment and cheap debt financing. Figures also showed that Germany was the fastest-growing G7 economy last year. German bond yields struck a record low last week; but equity investors were apparently less enamoured, as the Eurofirst 300 dropped 0.11% and the FTSE 100 fell by 0.77%.
At least some of the reason for the sluggish week on markets came from growing nerves that investors have been overly exuberant in their response to Donald Trump’s electoral victory – the S&P 500 rose just 0.37% and the uncertainty hit the value of the dollar too, which helped push Japanese stocks down on Friday: the Nikkei 225 ended the week up a mere 0.25%.
As it happens, there were notes of political comfort to be heard last week, not least when Mike Pence, on a visit to Europe, reassured EU leaders of America’s strong and ongoing commitment to the transatlantic alliance. Moreover, Steven Mnuchin, the commerce secretary, said last week that China would not be imminently labelled a currency manipulator, despite the president’s campaign pledges, but that the usual process of bureaucratic scrutiny would lead decision-making.
Finally, minutes of the Federal Reserve’s latest meeting were released last week and showed that a majority of the rate-setting committee’s members expect to make a rate hike “fairly soon”. Such plans reflect positive momentum in the economy. They will also make it all the easier for the banking sector, whose margins have been squeezed by the low rates regime of recent years, to boost profits and keep balance sheets in the black. Mr Micawber would surely be delighted.
BlackRock, AXA Investment Managers and Woodford Investment Management are fund managers for St. James’s Place.
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