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WeekWatch (01/04/2019)

WeekWatch (01/04/2019)

The three-year face-off between executive, legislature and voters has reached its endgame. In terms of who will ultimately win the war, we now all but know it won’t be the executive or, at least, not without a change of personnel. Thankfully, the Royal Mint had the sense to hold off on stamping its commemorative Brexit coins with ‘29 March 2019’.

As for those coins already in circulation, their value was changeable over the course of last week; as sterling rose and fell in proportion to the success and failure of executive and legislature’s respective attempts to chart a course out of the current impasse. Yet for some investors, blaming supposedly feckless MPs for the impasse risks missing the point.

“If Brexit was demonstrably advantageous economically, I would have thought they’d have found out a way to do it in the last 24 months,” said Howard Marks of Oaktree, co-manager of the St. James’s Place International Corporate Bond fund. “But all they have done is said what they don’t like. Nobody has found an approach that the majority of legislators liked – and maybe there isn’t one. It’s not one of these deals where people vote for it and the implementation is smooth and easy because it makes so much sense.”

The first hit for the pound came early in the week, when the DUP made clear that it wouldn’t back the prime minister’s deal at the third time of asking. The ensuing round of ‘indicative votes’ was not expected to deliver a majority for any one result, and nor did it. Nevertheless, the votes were significant in indicating parliament’s preferred direction of travel; namely, towards a softer form of Brexit involving customs union membership at the least. Sterling duly began journeying back towards where it had begun the week.

The pound also slipped last week when Theresa May lost a third vote on her deal (albeit only the first part of it) by 344 votes to 268 – a loss suffered despite the prime minister’s pledge to tender her resignation should the deal pass. But the pound soon started making up ground once again, on hopes that the second round of indicative votes, due today (Monday), would plough a furrow down which progress could then be made. This week may prove decisive for both Brexit and sterling, not least given the growing rupture in the Cabinet, although some believe that at least one option is already off the table.

“By removing the hard deadline for Brexit negotiations, the EU has avoided the disaster of a 2008-style sudden stop in business with its second-largest trading partner,” said Anatole Kaletsky at Gavekal Research. “The threat was not a deal on WTO terms. It was the lack of a transition period – a sudden stop. That is the qualitative difference between no-deal and all the other options. But in my view, the probability of a no-deal outcome is now zero, which is good for UK assets – just not for gilts.”

In this context, it is worth remembering that UK shares have seen almost unbroken investor outflows since that day in June 2016 – that could yet reverse. The FTSE 100 ended up for the week; and that January GDP showed a robust increase from weak December levels. While Brexit developments undoubtedly made themselves felt on markets last week, both in the UK and across Europe more broadly, other themes may have mattered more at a global level.

The US and China, increasingly the two lynchpins of the global economy, both reported positive economic news. Initial US jobless claims are now at multi-year lows for this season, despite weak consumer spending trends. China, meanwhile, is enjoying a golden period of capital inflows.

With regard to US–China relations, there was further grist for the bulls in the form of comments by Larry Kudlow, Donald Trump’s chief economic adviser. Kudlow told reporters that US–China trade negotiations could stretch out for “months”, indicating less urgency to impose sanctions and perhaps a new eagerness to reach a deal, too. Markets responded positively on Friday, both in equities and US government bonds. The S&P 500 and Shanghai Composite indices both ended up for the week. (Japan’s TOPIX finished flat.)

“Whether we get a sanctions resolution in the US–China dispute is a key theme for 2019,” said Nigel Ridge of BlackRock, manager of the St. James’s Place UK Absolute Return fund. “The rhetoric has been more constructive of late and has been a contributing factor to US equities going up this year. Other key themes for the year are the impact of Brexit on the UK stock market and the outlook for interest rate rises in the US. It could be a tough year and I’m convinced that there will be volatility.”

However, not a few investors were unnerved by the inversion of the US yield curve – an event in which long-term debt yields fall below short-term debt yields. Historically, such an event has been a reliable indicator of a recession, although some economists believe quantitative easing has skewed the numbers.

Oaktree Capital Management and BlackRock are fund managers for St. James’s Place.

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