Market Bulletin (29/11/2016)
Mists and mellow fruitfulness
Aside of when he made a couple of quips about Boris Johnson and George Osborne, there was not much spring in his step as Philip Hammond delivered his inaugural Autumn Statement. Instead, the chancellor offered up revised assessments from the Office for Budget Responsibility (OBR): growth in 2016–20 would be lower than thought last March; debt would be higher. Several prominent MPs and newspapers quickly denounced the forecasts as overly pessimistic.
Pity the OBR. The independent advisory body is mandated to provide forecasts for the Treasury based in part on government policies, but the only policy plans it received in advance were two paragraphs from Theresa May’s speeches – their content amounted to little more than ‘Brexit means Brexit’. EU exit plans remain foggy for the moment, and the chancellor clearly felt constrained, whether by the OBR projections or by his boss, to make only the most modest of promises – an apt Statement, perhaps, for what John Keats called the “season of mists and mellow fruitfulness”.
Yet slower growth is still growth and the gloomier pre-vote forecasts have been confounded. Moreover, on Friday the Office for National Statistics announced that UK business investment actually rose 0.9% in the third quarter.
“The OBR’s current view is that the referendum decision reduces the UK’s potential growth by only 2.4 percentage points more than would otherwise have been the case – allowing the chancellor a little more policy wriggle room than he might have feared,” said Aberdeen Asset Management.
Beyond the OBR forecasts, three of the chancellor’s biggest announcements were that there would henceforth be no more Autumn Statements; that George Osborne’s 2020 ‘budget surplus’ target would be axed; and that Osborne’s plan to cut Corporation Tax to 17% in 2020 would remain in place. None of these seemed to move markets.
Yet headline figures were more influential. The OBR had calculated that UK growth in 2017 would be 1.4% – down from its March forecast of 2.2%. It predicted that government debt would rise by £122 billion in 2016–20, including £58.7 billion due to the Brexit vote and £23 billion for a new infrastructure fund which targets housing, productivity and regional growth.
Ten-year gilt yields rose following the Statement, reflecting in part the fact that the UK debt office will now need to sell £15 billion more bonds in the current fiscal year than previously planned – an increase of more than 10%. Nevertheless, it is worth noting that, unlike sterling, the ten-year gilt yield has largely recovered since the Brexit vote.
The chancellor also chose the Autumn Statement to roll out a new government bond through NS&I, offering a 2.2% return. Given that the OBR expects consumer price inflation to rise at 2.3% in 2017, savers might need some convincing. Yet inflation and growth were not the only concerns last week. The Institute for Fiscal Studies reported that UK workers now face the worst period of pay increase for at least 70 years – and will earn the same in 2021 as they did in 2008, despite inflation. The Resolution Foundation, meanwhile, warned that the poorest third of households will see incomes decline until 2021, and for three reasons: poor productivity, George Osborne’s working-age benefit cuts, and Brexit-induced inflation. The FTSE 100 enjoyed a third straight week of gains, ending up 0.96%, thanks in part to energy and mining companies.
Energy stocks also featured among the risers on US markets. On Monday of last week, four leading US indices struck record highs, a feat not achieved on the same day since 1999: the tech-heavy NASDAQ, the Dow Jones Industrial Index, and the small cap-dominated Russell 2000, and the S&P 500 (which rose 1.3% over the five-day period). Remarkably, all four indices then achieved the same feat again later in the week.
US banks had already begun to perform better over the summer, thanks in part to making far greater progress in cleaning up their balance sheets than their European counterparts. Their rise continued last week, and they were joined by US small caps, which benefited from a rising dollar – the greenback struck a 13-year high against a basket of peers, helping Japan’s Nikkei 225 up 2.3%. The yield on the ten-year US Treasury struck a one-year high on expectations of infrastructure spending and rising inflation. By Friday, markets were pricing in a December rate rise at the Federal Reserve with a likelihood of 100%.
“The reality is that one name – Trump – has had a massive impact on financial markets just in the last week alone,” said Nigel Ridge of BlackRock last week. “We have this extra risk arising, which is geopolitics. Now what that means is that equities will become more volatile than we have experienced in the recent past.” Investors would do well to remember the virtues of sitting tight in such periods, should volatility indeed materialise.
While Donald Trump’s campaign promises of tax cuts, infrastructure spending, bank deregulation and an energy free-for-all have excited investors, other promises added to nerves. Among these were pledges to expel undocumented immigrants, build a wall along the Mexican border, jail Hillary Clinton, slap tariffs on Chinese and Mexican imports, end the Affordable Care Act (the ACA is a major boon for some healthcare providers), annul the imminent Transatlantic Trade and Investment Partnership and Trans-Pacific Partnership, and possibly leave the long-standing North American Free Trade Agreement.
Yet since his victory Trump has appeared to soften. He has not mentioned the wall, has cut projections for immigrant expulsions, has declined to pursue Hillary Clinton in the courts, and has offered partial support for the ACA. Establishment appointments, notably Reince Priebus as chief of staff, have gladdened those eager for professionalism and moderation.
“Broadly speaking, Mr. Trump has recently struck a more conciliatory tone compared to his campaign rhetoric,” said Wasatch Advisors in a note last week. “At the same time, many investors have focused on his pledges to improve the country’s infrastructure, lower taxes, reduce regulations, and renegotiate international trade agreements. Markets have interpreted Mr. Trump’s prospective policies as being good for U.S. companies in the industrials and materials sectors, which should benefit from infrastructure spending, and [for] financial-services stocks because of potentially lighter regulations, and because a higher interest-rate environment is expected to be good for U.S. financial companies, which should be able to earn better returns on business loans, personal loans and mortgages.”
Nevertheless, Trump has confirmed that he will pull out of the TPP immediately and was quick to appoint Steve Bannon (the chief executive of his election campaign) as chief strategist and senior counsellor – Bannon is the former executive chair of Breitbart News, an ‘alt-right’ American news provider associated with extreme right-wing views. Moreover, Trump’s determination to borrow and spend, while cutting taxes, has focused attention on the bond market. Yields on the policy-sensitive two-year US Treasury last week struck 1.13% – their highest since 2010. In Trump’s favour are positive economic indicators, of which there were more last week – US durable goods orders rose 4.8% in October, far above expectations.
Politics continued to loom large in Europe too, where the FTSEurofirst 300 rose 1% and the lead Purchasing Managers’ Index for the eurozone struck an 11-month high. Angela Merkel confirmed she would stand for a fourth term as German chancellor and free-marketeer François Fillon secured the Republicans presidential nomination in France – both figures are expected to hold extremist alternatives at bay in elections next year. December the fourth looms large for investors: Italy will vote in a constitutional referendum proposed by President Matteo Renzi (who has promised to resign if he loses); and Austria will see a rerun of its presidential election, with the far-right and Eurosceptic leader Norbert Hofer currently 1/2 favourite.
Aberdeen Asset Management, BlackRock and Wasatch Advisors are fund managers for St. James’s Place.
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