Market Bulletin (29/02/2016)
Sound as a pound?
Last week the world’s oldest surviving currency suffered its worst beating against the dollar in seven years. Sterling, the 1,200-year-old Anglo-Saxon currency, has shown itself to be highly vulnerable to developments in the UK’s relationship with Europe, at least in the short term.
The cause of the dip was generally acknowledged to be the confirmation of a date for the referendum on Britain’s EU membership, and the ensuing procession of political heavyweights who came out in favour of an exit. Meanwhile, an updated HSBC report released last week predicted that sterling could reach parity with the euro if the UK voted to leave the EU.
Furthermore, figures released by the Office for National Statistics last week showed that business investment in the UK sank 2.1% in the fourth quarter, its biggest fall since 2014 – some commentators saw the dip as the result of pre-referendum caution.
A cheaper pound might have its advantages, even if this particular drop had been driven by fear. Yet equally intriguing was the fact that the FTSE 100 seemed unbothered by the prospect of a possible British exit. The S&P 500 (up 1.9%) and Nikkei 225 (up 1.4%) enjoyed strong weeks too, but the FTSE 100’s 2.5% rise was especially notable, given the obvious headwinds.
In great part, the currency-stocks disparity arises from the FTSE 100’s close correlation with the oil and mining sectors, and from its more international flavour. Yet even that does not explain everything – the FTSE All-Share, with its far greater UK weighting, also enjoyed a positive week. In terms of the broader British economy, positive signs persist: figures released last week showed UK growth in the fourth quarter at 0.5%.
Sterling can offer a picture of how markets feel about the UK’s outlook, but its fluctuations are probably less important for Britain than global economic trends. After peace and security, oil and finance are perhaps the most important facilitators of global growth. Last week, a barrel of Brent crude rose from around $33 to above $35, amid hopes that the problem of oversupply would fizzle out.
There was also a rise in the price of leading metals, notably steel, iron ore and copper, which helped the FTSEurofirst 300 to clock up a 1.6% rise over the course of the week, although positive quarterly GDP growth figures for Germany, France and the UK probably helped too.
Despite the commodity price bounce, the world’s leading miners did not enjoy a strong share performance last week, as corporate earnings and dividend decisions hit market prices. BHP Billiton reduced its dividend by 74% last week (its first cut in 15 years), and Rio Tinto saw its credit rating cut by Moody’s, having announced a dividend cut earlier in February.
If markets were bullish on oil, they were far more questioning on banks, which continue to unnerve many investors. Last week RBS announced a £2 billion loss for 2015, raising fears that its much-touted recovery may not materialise. Yet there was good news too, as Lloyds paid out a £2 billion dividend on the back of strong results – the stock price rose over the five-day period. In fact, Lloyds’ headline 2015 profit of £1.76 billion left out various so called ‘one-offs’ that in fact turned the figure into a pre-tax loss of £507 million. But, crucially, bank capital ratios tell a positive tale.
“All in all, the results point to a very healthy and well-capitalised banking sector in the UK,” said Eoin Walsh of TwentyFour Asset Management.
Inevitably, attention now turns to the sustainability of Lloyds’ dividend payment. Even here, long-term investors think the payment was in line with the bank’s fundamental growth trajectory and profitability – not just an attempt to bribe the market.
“The company does look well placed to sustain better-than-expected growth – the increase announced today is three times the 2014 total,” said Chris Reid of Majedie Asset Management. “All in all, this is one of the more confident sets of results for a bank in recent times. The conclusion from the results and our call with the management is that this is a stock all income fund managers need to own. Given the very limited dividends available elsewhere, the shares continue to look well supported.”
Majedie was not alone in its analysis that banks have cleaned up their balance sheets and that this is not yet reflected in their share prices. In the case of Lloyds, there may even be potential for the dividend payment to grow.
“Headline profitability should continue to improve and we anticipate a further increase in dividends to shareholders,” said Hamish Douglass of Magellan Asset Management. “Lloyds remains well placed in the concentrated UK retail banking market, controlling approximately a quarter of system loans and deposits and delivering attractive returns on capital.”
Inevitably, there was less good news from banks heavily exposed to emerging markets; shares in Standard Chartered fell on Thursday after the bank reported its first annual net loss for many years. But in Europe and the US, an enormous clean-up operation, combined with an increase in regulation, has helped to deliver banks that are better-capitalised (and therefore less highly leveraged) and often undervalued on markets. Forthcoming EU bank stress tests may offer further reason for optimism.
On Friday, world leaders arrived in Shanghai for the Group of 20 (G20) meeting of governments and central bank leaders. The economies represented in Shanghai account for almost four fifths of global trade. The assembled leaders could take heart that US GDP growth in the fourth quarter had come in better than first reported at 1.0% – even core inflation in the US (which strips out energy and commodities) offered positive news. However, figures released last week show a major contraction in the value of goods crossing international borders in 2015. As ever, investors held out little hope that such issues would be meaningfully addressed, even though there had been talk of potential coordinated monetary and fiscal easing.
Nevertheless, the draft communiqué did go so far as recommending the use of all policy tools necessary to address sluggish global growth – not the kind of statement that the German administration (with its aversion to easing) might have wished for. George Osborne, on the other hand, was gratified that it warned of “the shock of a potential UK exit from the European Union”. The UK Chancellor said that finance leaders and central bankers at the meeting had “raised serious concerns” about the fallout from a British departure.
The focus on a possible British exit has been largely seen as a reason for companies to hold back from committing increased funds to their UK operations. Last week, Deutsche Börse took the opposite view, figuring that political uncertainty made it less likely to face competition for its proposed acquisition of – it says “merger with” – the London Stock Exchange (LSE). The deal would create a European exchange operation large enough to head off US acquisitions – deep and liquid markets are key to London’s appeal as a financial centre. Deutsche Börse has since said that a British exit would have an adverse impact on the deal – but not dissolve it.
It could not be much more symbolic if it tried. The deal strikes at the heart of Britain’s greatest wealth generator – the financial sector. It offers the LSE the advantages of European scale, and of competition with the US; but the prospect of compromise with a German owner. More Saxon than Anglo-Saxon, the Brexit lobby might complain.
Magellan, Majedie and TwentyFour are fund managers for St. James’s Place.
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