Produced by St. James's Place Wealth Management


Courtship display

Posted on Monday 24th July 2017

Earnings season offered reasonable signs of economic momentum, while central banks largely chose to sit on their hands.

When the male frigatebird is trying to attract a partner, he spends almost half an hour inflating his red gular pouch until it reaches close to half the size of his body. Companies courting investors ahead of earnings season aim to do the reverse, deflating expectations far enough to be sure of subsequently beating them.

The current season looks little different. Last week, a number of technology companies announced strong quarterly results. The headline exception was IBM, which reported its 21stconsecutive quarter of declining revenue, but Microsoft beat earnings expectations, thanks to the success of its cloud computing division, while Netflix (recently 100 million members strong) added a stronger quarter as its investment in new series continues to bear fruit; a fact reflected in a glowing share price performance in 2017.

In fact, US technology stocks had their own frigatebird moment back in 2000, reaching a stock market peak on 27 March of that year. Last week, the S&P 500 Technology index, having risen 20% this year, finally topped that high for the first time.

Yet there is a key difference between 2000 and 2017. The tech bubble of 2000 was based on anticipated earnings – hubris, many later called it – whereas the tech sector now boasts some of the most impressive earners listed anywhere in the world. Moreover, the outperformers of that bubble have been far from prominent in the recent surge. Neither Alphabet nor Facebook were publicly listed in 2000, yet today they are the largest two technology stocks in the world.

Since their own crisis back in 2007-9, banks have also been enjoying a recovery, albeit only much more recently – earnings news last week was positive, investor reactions more muted. Morgan Stanley was a particular highlight, beating previous earnings across all divisions. Goldman Sachs was the big disappointment, recording its worst ever quarter in commodities, and a 40% slide in overall trading revenue. Bank of America actually topped profit and revenue forecasts, but worries over net income interest meant that its stock stuttered.

Some of the caution over banks derived from politics, amid growing signs that Donald Trump may not be able to deliver on policy pledges. Yet such concerns didn’t prevent the S&P 500 from rising 0.5% last week. The Nikkei 225 saw a fall in steelmakers’ shares at the end of the week, which offset positive corporate earnings – it ended the week fractionally                    down -0.1%, buoyed also by a Bank of Japan announcement that monetary policy (notably QE) would remain on hold for the moment. Its inflation forecast for the coming months dropped to 1.1%.

Woman of note

It was a quieter few days for the Bank of England, which chose last week to launch its new £10 note. The note features a portrait of Jane Austen, the late eighteenth-century novelist, and a line on the subject of reading from one of her books. Given the context, they might have chosen another: “Money is the best recipe for happiness”.

The money on which Austen appears, however, is continuing to lose its value at a rate that wage increases are unable to cover. Last week’s headline news was that UK inflation fell to 2.6% in June, still above target but significantly below the May rate of 2.9%. The Bank of England had forecast a drop to around that level, but the number has spurred questions over whether the latest figure was a blip or the start of a trend. Either way, markets appeared to all but rule out the possibility of a UK interest rate hike in August.

“Inflation has picked up only because of Brexit, only because we had a significant fall in the currency,” said Neil Woodford of Woodford Investment Management. “Once that washes through, and it is washing through right now because we have annualised the impact of Brexit, UK inflation in my view will fall back to about the 0.5% from whence it came.”

For the time being, however, it is important to remember that inflation remains high, and continues to eat away at the value of savings. Research published last week by Aegon found that 80% of people in the UK are now worried that they will not be able to maintain their current lifestyle – and 28% are redirecting money away from saving to meet the rising cost of living. Yet more than two thirds said they had not taken steps to review their savings and investments in order to help protect themselves against inflation.

And yet it is clear that, in this area at least, ignorance is not bliss, and all the more so when it comes to pensions. A report published last week by the UK-based International Longevity Centre advised that workers should put away 18% of their salary in order to ensure “adequate retirement income” (reckoned at two thirds of current income) – or 20% if they wanted the lifestyle enjoyed by today’s pensioners. Yet its figures showed that only 12.4% of people are saving 15% or more of their salary. No wonder the UK government announced on Wednesday that it would bring the planned retirement age increase (to 68) forward seven years to 2037.

Meanwhile, EU exit negotiations pressed ahead last week, and the UK government formally conceded that it would have to pay an exit bill after all. Senior voices continued to diverge publicly over the outlook for the exit process. John Kerr, a former diplomat and the author of Article 50, said in an open letter signed by a number of political veterans that the “disastrous consequences are now becoming ever clearer”. Liam Fox, on the other hand, said that a UK-EU trade deal would be “one of the easiest in human history”, although at the weekend he suggested that any transitional arrangement with the EU after Brexit must end by the time of the next election, scheduled for 2022.

Theresa May, meanwhile, appeared to strike out for the middle ground. She held a first meeting with business leaders in Downing Street, at which she said she would not allow companies to fall off a “cliff edge” when Brexit occurred, but would instead ensure an “implementation phase” (or transition period) after the formal departure in 2019. The FTSE 100 rose 1.0% over the week.

Frankfurt focus

Mario Draghi made clear at a press conference of the European Central Bank in Frankfurt that there were no plans in place to reduce the ECB’s current asset purchase programme – and that the relevant group had not even been tasked with thinking about it as yet. Although he offered a positive outlook on eurozone growth, Draghi said he was less convinced that inflation would be sustained. This was a central bank governor in holding mode above all. The Eurofirst 300 slipped 1.8% over the week as the euro hit a near two-year high following Draghi’s comments. Earnings season in the eurozone looked set for a relatively positive set of results, according to Reuters forecasts.

Yet if the ECB refrained from bold statements, Frankfurt was in the news for other reasons last week too, as both Deutsche Bank and Citigroup announced plans to increase their operations in the German financial hub following the UK vote to leave the EU. John Cryan, the CEO of Deutsche Bank, said the bank would move the “vast majority” of the assets in its UK global markets to Frankfurt. In an email to staff, Cryan said he couldn’t wait on negotiation outcomes and was assuming they wouldn’t be good anyway.

 

Woodford Investment Management is a fund manager for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.


Calendar creep

Posted on Monday 17th July 2017

Major indices rose, as US earnings season began, and leading central banks continued to express caution.

One hundred months, and still it goes on. The starting gates were opened on the current bull run on 9 March, 2009 and, as yet, it shows few signs of running out of puff. After rising another 1.3% last week, the S&P 500 began the weekend at yet another all-time high – the Dow Jones Industrial Average hit its own all-time high earlier in the same week.  Count it however you like in terms of time – 8.3 years, or 3,052 days – the real lesson has been in the equity market gains.

Nor has the UK been excluded from the party. The FTSE 100 (up just 0.4% last week) has been on the same path – and has risen by more than 20% in the mere 55 weeks since the referendum result was announced. Historically, the average US bull market has lasted for 8.1 years and yielded a total return of 387%, according to a study by Newfound Thinking.  At the upper end, the postwar bull market lasted 14 years (1947-61) and returned 913%.

In short, it is no wonder that some investors are nervous, and others have already taken flight. But it is also true that the only obvious lesson from recent experience is that it would have been damagingly expensive to stay out of the market in the days, months and years since March, 2009 – the mid-crisis low point. Time in the market has paid off, and royally so. With dividends reinvested, the S&P 500 has returned more than 300% over that period, according to Financial Express figures. Even allowing for a correction (which some investors fear), that’s a hard number to beat. Other indices have followed suit, of course, and last week was no different: the Eurofirst 300 gained 1.7% and the Nikkei 225 rose by 0.95%.

The longer a bull run continues, the more good news it needs to sustain it, or so goes the old wisdom. Yet the current run has already weathered quite a few wildcard shocks in the past year, among them the UK referendum result and the Trump election victory. Moreover, the S&P 500 set another record this year too: the highest number of hours an American has to work to buy a unit of the index.  For almost 50 years it would have taken the average American worker around 26 hours – today that number is above 100.

In this light, the market’s particularly intent focus on central bank policy is understandable, since central banks have played an outsized role in boosting asset prices since the crisis. Last week, the inscrutable Janet Yellen, Chair of the Federal Reserve, offered no major clues on the likely timing of interest rate rises, but she did warn that the recent slowdown in US inflation was only “partly the result of a few unusual reductions” in elements of the consumer price index. In short, she is not certain that inflation will pick up once again – and figures released on Friday did show inflation in the year to June unchanged from a month earlier. Yellen added that she would watch “very closely” for signs of an economic slowdown. Markets took her words to mean that the Fed had turned a shade more dovish. The yield on 10-year Treasuries ended the week higher.

She will have plenty to watch in the coming weeks, as US companies announce their second quarter earnings. US bank earnings season began on Friday morning and early indicators were generally positive – JPMorgan, Citigroup and Wells Fargo all announced improved earnings. Investors seemed lacklustre in response, and bank stocks on the S&P 500 actually dipped in early trading on Friday. However, figures released by EPFR Global last week showed that there had already been significant investor inflows to both financial and technology stocks ahead of second quarter earnings announcements. Success may have already been priced in. Moreover, flatlining inflation (mentioned above) has slightly reduced expectations of multiple significant interest rate rises in the near term – rises generally make banks’ core lending business more profitable.

Balance sheet blues

The Bank of England offered similar hints last week, as the deputy governor told press that the central bank was “not ready” for a rate rise. However, another member of the rate-setting committee said that the bank should now consider unwinding its £435 billion of quantitative easing.

One of the post-crisis roles of the Bank of England has been to encourage banks to restore sanctity to their balance sheets. Earlier this year, it applied stress tests to major banks to see how their balance sheets would manage in a crisis. The results were in fact quite encouraging. Last week the Office for Budget Responsibility (OBR) applied a similar test to the government’s finances – and the outcome was much less reassuring.

The OBR said that the government would in fact have failed the same stress tests applied to the banks. Faced with weaker growth, higher interest rates and rising inflation, UK government finances would be on an “unsustainable path”. Borrowing would be £158 billion higher by 2022, and debt would be higher by 34% of national income. The OBR criticised the Conservatives, saying that, after seven years in power, they had left the finances “much more sensitive” to shocks. (The Labour manifesto was also criticised for limiting burden-sharing.)

Yet the government could take heart last week that unemployment fell to a 42-year low, with more than 32 million in work for the first time – and 74.9% employed. The negative news in the report, which was published by the Office of National Statistics, was that the squeeze on wage packets increased in May, courtesy of inflation outrunning wage growth.

Philip Hammond used the debt figures to re-broadcast his message that the UK finances still need serious action, despite the apparent austerity fatigue expressed at the ballot box. Yet the government has largely avoided making economic policy announcements since the election. An exception last week concerned the money purchase annual allowance; the amount that those already taking benefits flexibly can contribute tax-free to a pension. Some had hoped that the pre-existing plan to retroactively apply a reduction in the allowance from £10,000 to £4,000 for the current tax year wouldn’t survive the hung parliament. Unfortunately for them, the government last week confirmed that it would indeed be retroactively applied. It only remains for it to be passed as part of the summer Finance Bill, a vote likely in October.

There were early signs last week that UK corporate earnings might yet please markets in the coming month or so. Robert Walters, the recruitment consultant, said that companies in financial services and IT, as well as small businesses in London, had returned to normal hiring rates, having increased rates since their post-referendum lull. Barratt forecast modest growth in housebuilding, with an improved profits forecast, and Burberry announced strong sales figures. There was less good news from Carillion, as the construction group offered a profit warning and said its debts had become far too large. Meanwhile, Pearson sold its 22% stake in Penguin Random House to Bertelsmann, giving the latter 75% control, and helping Pearson to improve its balance sheet and reorient away from traditional media.

 

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.


Crowning moment

Posted on Monday 26th June 2017

Parliament opened for a two-year term, stocks struggled on a falling oil price, and Chinese companies eager for foreign investors enjoyed a landmark moment.

“Uneasy lies the head that wears a crown,” says King Henry in Shakespeare’s Henry IV Part 2. Last week Elizabeth II appeared to take the warning literally, breaking with the habit of 43 years by not wearing her crown for the State Opening of Parliament – she also donned a day dress instead of the usual robes of state.

Minority government it may be, but the prime minister took the unusual step of setting the term length of the new parliament to two years instead of one, saying she wished to provide for unbroken parliamentary scrutiny of EU exit legislation, ahead of the UK’s departure deadline of 29 March 2019. She has eight EU exit bills to get passed before then. As of this week, she at least has the DUP on her side, thanks to a confidence and supply deal struck on Monday morning.

While the House of Lords is ultimately unlikely to block the eight bills, the Commons provides a range of opponents ready to debate and amend them. Labour has said its priorities are jobs and the economy; the Liberal Democrats tabled an amendment that calls for the UK to stay in the single market; and some Tory Remainer MPs are reported to be exerting private pressure. Moreover, SNP ministers in Holyrood said they could block ratification of Theresa May’s Repeal Bill if many of the powers reclaimed from Brussels are not handed to Holyrood – the UK prime minister said the bill would need Holyrood’s approval.

The election outcome left the Queen’s Speech somewhat denuded – plans to revive grammar schools, hold a vote on foxhunting, end free school meals for infants and curb pensioner benefits were all discarded. But the accompanying notes did confirm that the government will implement three Finance Bills, bringing the first to the Commons this summer. The broader programme will include legislation for changes to National Insurance contributions announced in the Budget and Autumn Statement of 2016 but, of course, not the Class 4 contributions reform announced in the Spring Budget this year. Given the parliamentary balance, much remains uncertain, for savers as for investors, but the forthcoming Finance Bills may offer clarification – and reasons to act.

Another chapter opened for Theresa May in Brussels last week, where exit negotiations officially began, although it was David Davis and Michel Barnier who kicked off proceedings. Their respective gifts – a book on mountaineering and a walking stick – suggested a hard road ahead. First blood went to Barnier, as the UK dropped its previous insistence that the trade deal be agreed alongside the exit bill and citizens’ rights. Instead, the UK will follow the EU’s negotiating ‘sequencing’. Theresa May, arriving later in the week, made what she called a “fair and serious” offer on citizens’ rights, one which keeps some of the rights for EU citizens in the UK, and withdraws others. Donald Tusk said the offer was “below our expectations”.

Disagreement of a different kind appeared to be gaining momentum at the Bank of England. Two weeks ago, the Bank’s Monetary Policy Committee (MPC) voted to leave interest rates unchanged by a majority of five to three. Last week, the governor delivered his delayed Mansion House speech, in which he warned that weak consumer demand and sluggish wage growth made further rises risky, especially because “the reality of Brexit negotiations” was yet to impact the economy. Later in the week Andy Haldane, the Bank’s chief economist and a fellow member of the MPC, said that UK interest rates would have to rise later this year to nip inflation in the bud and ensure a more severe rise wouldn’t be needed at a later date. His view is much changed from July last year, when he said a rate drop might be needed.

“The Bank of England reckons that a15% currency depreciation translates into a one-off 3% increase in prices; although this can take some time to feed through as companies’ currency hedges roll off,” said Nick Purves of RWC Partners. “However, oil prices are now below where they were 12 months ago and this should help to dampen inflation in the coming months. It is not difficult to see therefore why the Bank of England has been reluctant to raise interest rates, despite the fact that the economy has performed better than had been expected at the time of the Brexit referendum.”

The other headline speaker at Mansion House last week was the chancellor. Having assured his fellow diners that Theresa May had not “locked [him] in a cupboard” during the election campaign, Philip Hammond went on to say that he intended to balance the budget by 2025 through continued restraint. He was buoyed later in the week by news that government borrowing fell to its lowest level in a decade in May, helped by improved VAT, Income Tax and Stamp Duty revenues. He also said he was pushing for a business-friendly Brexit that would not cause undue damage to UK financial services.

Index we trust

In the more immediate term, however, investors were focused on the oil price. Last week Brent crude dipped below $45 a barrel for the first time this year, taking the energy-sensitive FTSE 100 down with it. The index slipped 0.53% over the five-day period, although healthcare stocks were also to blame. The S&P 500 also suffered midweek, although oil’s Friday rally meant it ended the period up 0.24%.

Meanwhile, the Eurofirst 300 dropped 0.21%. In fact, business confidence in the eurozone remains at an extended high – the last three months represent the strongest quarterly performance since 2011. Consumer confidence in the currency area hit a 16-year high last week, while French first-quarter growth was revised up to 0.5%. The CAC Mid 60, which charts the fortunes of 60 mid-sized French companies, has been trading around record highs ever since Macron’s rise.

Attention was focused on very different developments in Italy, where the government chose to bail out two Venetian banks at a cost of €5.2 billion. The banks’ surviving ‘good’ assets were formally acquired by Intesa Sanpaolo over the weekend.

“The crisis of the weaker Italian banks has been a difficult conundrum to resolve,” said Stuart Mitchell of S. W. Mitchell Capital. “The politicians were desperate to avoid a full ECB resolution because this would have led to the politically impossible result of ‘wiping out’ all the banks’ depositors. At the same time, the stronger banks were unwilling to take on the risk of the non-performing loan portfolios. But it seems that we have got a very good solution. The ECB resolution board has not considered the two banks to be systemic, so that they can be liquidated under the ‘burden sharing model’ thus avoiding damaging depositors. Intesa has agreed to take on the assets but only if the state injects capital into Intesa to bring the Tier 1 ratio to 12.5%.”

Yet it was in China that index developments caused greatest excitement last week, as mainland-listed Chinese stocks were finally admitted to MSCI World, the most widely used index for global stocks. Admittedly, just 222 companies were admitted, and even then they were only accorded a weighting of 5% of their market value; but a door has been unlocked. A reminder to be cautious came from China’s bank regulator last week, which ordered Chinese lenders to analyse the “systemic risk” posed by some of the country’s larger companies that have been making purchases abroad. The result was that some foreign companies recently acquired by Chinese buyers saw their stock prices slip, notably in the UK.

RWC Partners and S. W. Mitchell Capital are fund managers for St. James’s Place.

Voting is now open for you to nominate your Investors Chronicle and Financial Times ‘Wealth Manager of the Year’ for 2017, with a chance to win £1,000 provided by the award sponsorsTo vote, visit: www.icawards.co.uk.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

 


Docking pay

Posted on Tuesday 20th June 2017

Rate-setters in the US and UK diverged, while Emmanuel Macron won a large legislative majority and David Davis travelled to Brussels to begin EU exit talks.

Politicians may have been doing a fine job of looking amateur in recent months, but investors tend to reserve their strongest criticism for central bankers. In recent years, much of the criticism has been trained on the scale and timespan of quantitative easing programmes introduced after the global financial crisis. Investors worry that these programmes have distorted markets, potentially adding an artificial dimension to the second-longest bull run in US history (now 99 months’ old). Perhaps so, but they remain invested for the moment.

Last week, however, the Federal Reserve took a more hawkish line. On Wednesday, Janet Yellen announced the second US interest rate rise in 2017 – the fourth since the crisis – and forecast one further rise later this year, as well as the beginning of a plan to start unwinding its balance sheet before 2018. Although the June rate rise was widely priced in on markets, investors had not expected such a strong tack to the hawkish side in the Fed’s forward guidance.

Moreover, although the Fed continued to emphasise that its decisions are data-dependent, US data currently offers a mixed picture. Headline growth remains solid and employment remains high, but inflation and retail sales fell in May. The fall in inflation was particularly noteworthy, since it pushed it yet further below the Fed’s target level, potentially undermining the case for a rate rise.

Janet Yellen validated her committee’s decision on the expectation that the fall in inflation was temporary, and not the start of a trend. Markets felt somewhat differently, however, pricing in below-target inflation on a more sustained basis. Yet others were convinced by the logic for a rise, on the basis that longer-term indicators tell a more inflationary tale.

“We agree with Ms. Yellen,” said a note written by the Payden & Rygel economics team. “Look at the components of consumer price inflation, for example. We see that mobile phone plans shaved a surprisingly large 0.2 percentage points from headline inflation in May.”

Markets dipped in response to the rate decision, and US retail stocks took a hit on Friday on news that Amazon would acquire Whole Foods, a high-end American organic supermarket chain, for $13.7 billion, as the move pointed to the sector’s potential vulnerability to technology companies. The S&P 500 ended the week down 0.1%.

Prices vs wages

Meanwhile, the Bank of England’s Monetary Policy Committee struck a very different pose. Despite UK inflation rising to a four-year high of 2.9% in May – almost a whole point above the Bank’s target – Mark Carney et al chose to leave rates on hold last week. Even food prices in the UK are now rising, after a three-year slide. When UK inflation reaches 3%, the central bank governor is obliged to pen a letter to the Treasury to explain why the target has been so strongly breached. It is notable that retail price inflation – which includes housing costs excluded in the consumer price calculations – is already at 3.7%. The FTSE 100 dipped 0.8% last week.

Yet markets hadn’t expected a rate rise and the surprise came instead via a split vote – three of the eight committee members voted to push interest rates up, the closest the Bank has come to raising rates since 2007. Although inflation is indeed high, there are other reasons that the Bank found to hold fire. One is continued political instability, both governmental and in terms of EU exit negotiations. Another is the economic growth rate, which in the first quarter was the lowest of all 28 EU countries. A third is a dip in non-food sales, suggesting that retail sentiment is flagging – DFS’s poor results, announced last week, offered one example of the impact. A final challenge is wage growth, which has now fallen significantly behind price growth.

The average basic weekly wage is in fact down slightly from where it was in March 2008 – this represents the longest stagnation in UK wages in living memory. Recent research published by the Resolution Foundation shows that the 2010s are on course to be the worst decade for UK wages since the first decade of the 19th century. To some, this is the flip side of the UK’s high employment figures. To the Bank of England, it may have provided one more reason to hold off on any tightening measures.

Such trends do not make for happy reading, especially for those just starting their careers, as they point to a marked shift in the balance of wealth towards the older generation – the asset owners. Yet research published last week by Key Retirement showed that nearly two out of five people are not aware that gifts to family members could be liable for Inheritance Tax. Many also didn’t know that they could give away £3,000 per year tax-free or make tax-free gifts to couples getting married. Yet the poll found that nearly six out of ten people want to be able to help children and grandchildren get onto the property ladder.

Furthermore, research conducted by St. James’s Place and Capital Economics has found that every £1 of wealth transferred between the generations could add £1.65 to the UK economy. The study found that there is an estimated £6.6 trillion of wealth held by those aged 55 and over in the UK. The figures show £2.8 trillion of the total is expected to be available for transfer over the next 30 years, adding £677 billion to the economy – equivalent to 1.2% of GDP each year.

For those considering how best to save, invest, protect and pass on their wealth, this Wednesday may provide several reasons to take action, as the Queen delivers her (postponed) speech to open parliament. Since the Conservatives failed to win a majority, the contents of the speech should reflect whatever deal is struck between the Conservatives and Northern Ireland’s Democratic Unionist Party (DUP). That may have implications for all kinds of issues, from the State Pension triple lock (which the DUP favours keeping) to the dividend allowance.

It should also indicate the government’s intended direction of travel on EU exit negotiations. Last week, two of the four ministers in the government’s EU exit department quit their posts, while a poll showed that 43% of non-UK City workers plan to leave the UK before 2019, the year set for the UK’s exit. The UK chancellor, apparently emboldened by the prime minister’s electoral disappointments, warned last week that business concerns must be at the centre of the UK’s approach to exit negotiations, and that a departure from the EU without a deal would be “a very, very bad outcome for Britain”. Meanwhile, the previous prime minister and chancellor both offered their own public criticisms of ‘hard Brexit’ policies.

David Davis, UK lead negotiator in exit talks, has already arrived in Brussels, where discussions begin today – Theresa May will follow on Thursday. The initial focus of disagreement is expected to be ‘sequencing’ – whether the UK has to stick to the pre-established order of negotiations, thereby resolving the size of the exit bill and citizens’ rights issues ahead of other matters.

All such challenges were overshadowed, however, by the Grenfell Tower disaster of last Wednesday in Kensington, which is now reckoned to have claimed at least 79 lives, and continues to cast a pall over the nation. A terror attack in North London on Sunday night added to the sense of instability.

Macron moment

Meanwhile, the new French president met with Theresa May last week to hold discussions ahead of an overwhelming win in France’s legislative elections over the weekend – his party took 350 of the 577 seats available, although turnout was low. The scale of the win gives him strong backing to proceed with his plans to reform France’s long-unreformed labour market.

Eurozone economic and corporate indicators remain buoyant – last week strong industrial output figures added to the sense of momentum. The Eurofirst 300 dipped 0.5% last week, partly on news of the Fed’s rate rise plans. But the index has risen almost 8% this year, reflecting growing confidence in the currency bloc’s outlook – it has been a good year for investors with holdings in Europe. Last week, a deal was struck to ensure that Greece could meet its summer debt repayment obligations without defaulting – success in terms of a crisis averted, although not yet the beginning of a long-term resolution.

 

Payden & Rygel is a fund manager for St. James’s Place.

Voting is now open for you to nominate your Investors Chronicle and Financial Times ‘Wealth Manager of the Year’ for 2017, with a chance to win £1,000 provided by the award sponsorsTo vote, visit: www.icawards.co.uk.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

 

 


Interesting times

Posted on Monday 12th June 2017

The election did not provide the result that pundits expected or that markets prefer – it may take time before politics in the UK settles.

‘May you live in interesting times’, goes the old curse. Its force is surely not lost on the prime minister just now.

London’s leafy Kensington is the UK’s richest constituency and not normally a bellwether of the national mood, but last week it summed up Theresa May’s woes. A Kensington constituency has existed since 1974, and has always been firmly in the Tory heartlands. On Thursday Labour won it by just 20 votes, one of the more extreme examples of a broader shift in political sentiment that has taken place in recent weeks. Indeed, perhaps the most striking statistic of the election was that Labour won 40% of the national vote, up from just 30% in 2015.

Kensington also announced a day late. Faced with an extended recount, its tellers were eventually sent home to sleep off their exhaustion before resuming their reckonings. Kensington’s fatigue was felt nationwide – two general elections, a Scottish independence referendum, and an EU membership referendum in the space of less than three years is a lot of politics. Yet much remained up in the air, even after the prime minister had announced that the Queen had asked her to form a minority government. The prime minister has already publicly expressed her confidence in the prospects for a deal between the Conservatives and Northern Ireland’s Democratic Unionist Party (DUP) – the DUP’s ten seats would turn a Conservative parliamentary minority into a narrow majority.

Theresa May had of course gone to the polls to secure an unassailable majority ahead of EU exit negotiations, which are due to start on Monday next week. Instead, despite winning 56 seats more than Labour, she now cuts a diminished figure, having seen a 20-point polling lead fall into single figures in a matter of weeks. There were several factors apparently at play, some of her own making. Symmetry was one: the Leave vote had been an anti-establishment move dominated by older voters. That establishment has since declared itself not just for Brexit, but for a hard Brexit; last week’s vote had a strong ‘Remain’ element and saw the highest turnout of young voters since 1997. Theresa May hadn’t banked on a revenge vote.

“May’s honeymoon was over the moment she opportunistically called for a general election,” said Stuart Mitchell of S. W. Mitchell Capital. “[Consider] her tortured logic that a greater Tory majority would improve Britain’s negotiating position with Brussels. The various weaknesses of her character became at once very apparent – the hint of authoritarianism, her inability to operate collegiately and above all her fragility when under pressure. Britons were also somewhat unsettled by the ‘no deal is better than a bad deal’ approach to the Brexit negotiations. How did this bring the country together after such a punishing referendum campaign?”

As it happened, the prime minister did succeed in a few lesser aims. UKIP limped out of the poll looking like a spent force, having haemorrhaged votes to both Labour and the Conservatives, while the Scottish National Party lost a third of its seats, capping hopes for a second independence referendum any time soon. Yet the outcome was largely a personal and political disaster, and Theresa May must now rely on DUP votes to get her way. Not everyone believes she can survive long, even if the poor economic growth rate of the first quarter proves to be a blip and not a trend. Data published by Visa last week showed that UK consumer spending has fallen on an annual basis for the first time in almost four years.

“In all the heat and light that accompanies an unexpected political outcome, a lot of extreme conclusions have been discussed by market and media commentators [but] economically not a lot has changed – in some respects, the outlook for the UK economy has improved,” said Neil Woodford of Woodford Investment Management. “My expectation now is that the new Tory-led administration will adopt a more stimulative position – borrowing more and spending more. Overall, this will be positive from the perspective of UK economic growth.”

News of a hung parliament immediately pushed the pound down by a couple of cents against the dollar, but thereafter it appeared to find its level. Meanwhile, a poll conducted by the Institute of Directors showed a “dramatic drop” in business confidence following the news of a hung parliament – business leaders had feared the election risked adversely impacting the economy at just the time the government should be focusing on EU exit negotiations.

“Sterling will be the key driver for markets, with the FTSE 100 supported due to the high exposure to overseas earnings,” said George Luckraft of AXA Investment Managers. “The ensuing uncertainty is a negative for the UK economy, with some decisions being put on hold. Theresa May’s position is seriously damaged, with sections of the Conservative Party likely to look for change. The case for further austerity appears to have been rejected, with a probability that the budget deficit will be higher whatever the government.”

The currency dip helped push up the FTSE 100 on Friday, although it ended the week down 0.27%. The yield on the 10-year gilt ended the week marginally tighter, but yields were already very subdued.

“We believe the excitement of the media about the surprise outcome will be short-lived and economic realities will come to dominate investor actions in the coming months,” said Sandro Näf of Capital Four Management. “As a result, we expect, just like during summer 2016, a muted market reaction to the recent political developments in the UK. We continue to believe that the UK economy is healthy and able to absorb the transition to a more independent economic area.”

Markets elsewhere were relatively unmoved. The Eurofirst 300 ended the week down by 0.5%. There were reasons for the phlegmatic response, among them the fact that the election had multiple possible outcomes and investors hadn’t simply banked on one of them – unlike in the EU exit referendum and US presidential election. Moreover, Theresa May’s position on the UK’s EU exit had hitherto been forthright – her failure to capture a parliamentary majority may now change that.

“If anything, perhaps the odds of a softer Brexit go up now – but the process will be even more convoluted,” said Blake Hutchins of Investec Asset Management.

Matters of state

If investors seemed relatively unfazed, it is also possible that they were simply baffled. Despite the alliance with the DUP, the election has increased political uncertainty in the UK, weakened the government, and lowered the chances of the prime minister enjoying a free hand in EU exit negotiations. She is now potentially faced with war on two fronts – at home and in Brussels. More positively, it may be that the UK engages in a much deeper domestic debate on the nature of its exit, since she will require more cross-party support than she had once countenanced.

Some Tory Remainer MPs have already said they will push for a softer EU exit. Even David Davis said that leaving the single market may no longer be feasible, while Nigel Farage warned that the exit timetable may be pushed back. Michel Barnier, leader of the EU negotiating team for the UK’s exit, also said a postponement might be needed.

Yet in her first public statement after the result was confirmed, Theresa May said that she planned to get on with the job with an unchanged timetable. In theory, that means she must be ready to begin next week, although little tangible progress is expected to be made before German federal elections in September. The 19,000-odd statutory instruments the UK has signed up to over the past few decades may have to wait a little while longer before finally being unwound.

Washington pause

Not all eyes were on the UK last week, however. In Continental Europe, an early Italian election looked increasingly plausible, the ECB took some first baby steps towards winding down its quantitative easing programme by saying it would not lower rates any further, and Emmanuel Macron’s party looked set for a landslide in France’s parliamentary elections. Meanwhile, minutes released by the US Federal Reserve last week pointed to a rate rise later this week, and markets have certainly priced one in.

Yet while central banks drew some attention, the city of Washington D.C. appeared to stop in its tracks for the day to watch the Senate testimony of James Comey, as he spoke about claims that President Trump had pushed him to drop an investigation into the latter’s links with Moscow. The S&P 500 ended the week up 0.12%. The odds for Donald Trump being impeached dropped after the hearing, but the mere fact it is being talked about is a reminder that politics is at a volatile moment – even if markets remain calm for the time being.

AXA Investment Managers, Capital Four Management, Investec Asset Management, S. W. Mitchell Capital and Woodford Investment Management are fund managers for St. James’s Place.

 

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