WeekWatch (04/03/2019)

Stock

“To be alive at all involves some risk,” said Harold Macmillan. When it comes to premium bonds, launched under his chancellorship in 1956, the former prime minister appears to have taken the maxim too far. Last week saw the launch of the fifth generation of ‘Ernie’, the computer that chooses the winning numbers. As things stand, with an ‘investment’ of £1, you have a 1 in 10,457,501 chance of winning £500. And good luck with anything above that.

Fortunately, the first two months of 2019 have shown that the risk-reward relationship need not be so unequal. No major equity market has enjoyed a stronger New Year recovery than China. Granted, growth has slowed and last week a disappointing round of official purchasing managers’ indices data hit energy and mining stocks. But mainland trading was boosted at either end of the week; on Monday, by Donald Trump’s decision to postpone the next round of US trade tariffs indefinitely, and on Friday by signs of stabilisation in the mining sector.

Monday mattered more. Chinese stocks rose almost 6%, their best single-day gain in three years. Indeed, US-China trade talks have become a strong driver for investor sentiment on global markets; Japan’s TOPIX index was among the week’s beneficiaries. As for the outlook for trade talks, the rise in the yuan is likely to have helped China’s case in Washington. (Conversely, however, it was notable that US companies are planning their lowest level of expansion in China since 2016.) But investors should also remember that China’s reliance on trade is not what it was.

“To be sure, the current trade tariffs are creating some notable headwinds in China, but they pale in comparison to what the effect could have been a decade ago,” said Henry H. McVey of KKR, which manages the St. James’s Place Diversified Assets Fund. “Exports as a percentage of the Chinese economy have already shrunk from 36% in 2008 to 18% today, a nearly 50% decline in only a decade.”

There was technical support for Chinese equities, too. The MSCI Emerging Markets index is the benchmark for around $1.9 trillion of global funds; last week, MSCI announced it would quadruple the weighting of Chinese shares within the index. That could draw some $100 billion of investor inflows to China in 2019. Yet the Shanghai Composite is already up more than 20% this year alone.

The S&P 500, on the other hand, had a mediocre week, struggling to find a leading story to hang its hat on. One sour point was Kraft Heinz, which fell 27% after the food company booked a $14.5 billion write-down and said it was subject to an investigation by the US financial regulator.

Yet US GDP growth for 2018 came in at around 3%, in line with what the president had pledged, and consumer confidence rebounded in February from its contraction the previous month. (Even the oil price appeared ready to bow to the president. Its price rose; he tweeted his disapproval to OPEC; it duly fell.)

Wage growth came in positive, if not quite as robust as it has been, and business investment rose as a proportion of GDP in the final quarter.

Not that global politics was entirely benign for markets. Talks between the US and North Korea ended in failure, and Pakistan shot down an Indian plane in Kashmir – both weighed on markets.
But the China news was more important for stocks, perhaps particularly in Europe, where Germany and other Northern European countries are especially reliant on Chinese demand. Carmakers and luxury goods companies were among the most significant risers. The Euro Stoxx 50 ended up for the week. Sentiment was also buoyed by improved manufacturing figures in Germany. There were also signs that the worst of the French president’s political crisis may have passed – polls show a majority of French people now want the ‘gilets jaunes’ to end their protests.

In the UK, politics underwent some significant shifts over the course of the week, with both the Labour party and the government changing their position on Brexit. In the process, sterling struck a four-week high; that, in turn, pushed down the FTSE 100, reliant as it is on international earnings.

The Labour party, having seen its own Brexit proposal defeated in parliament, formally swung in behind a second referendum; it will only agree not to oppose the prime minister’s deal (thus facilitating its passage through parliament) if she then holds a national vote on it. Meanwhile, the prime minister acquiesced to allowing MPs to vote for an extension to the Brexit deadline should her deal be rejected on 12 March.

This has left the European Research Group in a tricky position: vote against Theresa May’s deal and risk a delay – perhaps even no Brexit at all. Or vote for it and swallow the elements it has long opposed, notably the Irish backstop and its associated customs union tie-in.
KKR is a fund manager for St. James’s Place.

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