Produced by St. James's Place Wealth Management


Cutting edges

Posted on Monday 10th December 2018

Trade tensions reached a new level on technology fears, pushing down stocks around the world.

Over the long term, China can lay claim to pioneering some of the world’s most significant inventions. Gunpowder, paper, the compass and printing may be the famous four that Chinese schoolchildren memorise in school, but there are many more; among them football (just not the ‘association’ kind), umbrellas, wheelbarrows, kites, and fermented drinks.

These days, China’s relationship with innovation (the technological kind) is more controversial – and its impact on markets significant. Last week, leading stock indices opened the week positive, following a 90-day trade truce between the US and China. Yet the initial rise was more than reversed midweek, as Donald Trump tweeted “I am a Tariff Man” and appointed a renowned China hawk to head the US team in trade negotiations with China. Perhaps more unnerving was news that the Canadian authorities had arrested the chief financial officer of Huawei during an Ottawa layover. She now faces an extradition hearing over whether she should be handed over to US authorities.

The world’s largest telecoms equipment manufacturer and second-largest smartphone manufacturer faces scrutiny over reportedly breaking the rules of US sanctions on Iran. The move is a bold one, and redolent of Cold War manoeuvring. US and Chinese stocks took a dive in response, with the former falling into negative territory for the year. The MSCI World Index had a bad week, while the FTSE 100 struck a two-year low, driven down by the automated selling of tracker funds.

Technology stocks were in the eye of the storm last week. The sector is now vulnerable not merely to worries over consumer protection and intellectual property, but also to trade tensions and competition between the great powers. The US, New Zealand and Australia have all banned Huawei from their future 5G networks and the head of MI6 said this week that the UK must now make some choices of its own. BT announced on Wednesday that it will remove Huawei technology from its core 3G and 4G networks within two years – BT’s share price had a jumpy week.

Such moves reflect both privacy and security concerns. In recent years, Beijing has taken a far more assertive line in international relations while, back at home, it stipulated that “all organizations and citizens shall… support, cooperate and collaborate in the national intelligence work”. A media report last week detailed how the Chinese state invested $200 million in a Boeing satellite facility in California, raising fears of technology transfer to Beijing. Moreover, China’s technology champions show increasing signs of state control in some of their financial decisions, such as acquisition policy.

The most prominent of those is Alibaba, the Chinese internet giant, which boasts better operating margins than Amazon, and saw the same choppy trading last week as other tech stocks. “Jack Ma has been hugely successful in building Alibaba but has now stepped back from running it, as the company’s priorities have changed,” said Glen Finegan of Janus Henderson Investors, manager of the St. James’s Place Global Emerging Markets fund. “In China, monopolies are used [by Beijing] to fund government projects. We prefer family businesses where the processes and aims are aligned with those of shareholders. There’s a reason that Gazprom and Lukoil in Russia trade at such low multiples.”

Western technology majors are facing their own, related pressures. Google will be grilled by the US Congress this week. One likely question is why the company is working on a censored search engine for China. Last week, a UK parliamentary committee released documents showing that Facebook had considered offering fuller consumer data access to companies that advertise on its platform. The S&P 500 Information Technology Index had a bad week.

Rate-Fed

There was a short-lived market bounce on reports that the Federal Reserve is softening its rate-rise outlook for 2019. Some of that softening relates to concerns over the outlook for the US economy. Last week, the US yield curve edged still closer to inversion; in an inverted yield curve, short-term bond yields are higher than long-term bond yields. Historically, an inversion has augured recession, albeit with a 21-month average time lag.

It was not all bad. The ISM non-manufacturing index for the US came in very strong; IHS Markit’s services sector index was also positive; and the US jobs market is now the best it has ever been for American workers who lack a high school degree. Moreover, profit margins for S&P 500 companies remain sharply up in 2018. The US trade deficit rose too, but this actually represents the positive state of the US economy – the dollar is rising and US consumers are in spending mode. Nevertheless, investor nerves are apparent even in the US, and not just over politics.

“We expect global GDP to slow quite sharply over the next year or so,” said a Capital Economics report released last week. “There has been a slowdown in the eurozone already and the US is likely to lose steam as monetary tightening starts to bite and the fiscal boost fades. The slowdown in the US should prompt the Fed to end its tightening cycle in mid-2019 and begin cutting rates in 2020.”

If markets are sensitive to rate policy, they may be more vulnerable to quantitative tightening (QT), as central banks sell back bonds they previously bought up. QT only began on an aggregate global scale this year but is set to continue through next year.

Political discord

The European Central Bank can find its own reasons to stall on QT for a while longer, among them disappointing growth and febrile politics across several EU economies.

Germany posted negative growth in the third quarter. Both manufacturing and banking are facing significant headwinds. Last week, the head of Volkswagen warned that 2019 would be the “most difficult year ever”, with court cases (over emissions cheating) slated in 50 countries worldwide. VW also faces a threat from technology, as cars become smart products and are increasingly ranked by the quality of their software, not hardware. Meanwhile, the finance minister said Deutsche Bank and Commerzbank could potentially merge.

France has suffered street protests that almost forced the government to declare a state of emergency and did persuade it – last week – to cancel a fuel tax rise and place its October wealth tax cut under review. In neighbouring Belgium, the government lost its parliamentary majority over a UN migration pact. The EURO STOXX 50 fell significantly over the five-day period.

More positively, eurozone finance ministers agreed measures to improve the eurozone’s crisis-fighting capacity: notably a stronger banking union and moves towards ensuring bondholders aren’t so easily bailed out in future downturns. Moreover, Rome hinted at softening its budgetary plans; the yield on Italian 10-year debt hovered around 3% – not low, but hardly in crisis territory.

Across the Channel, meanwhile, the political maelstrom continued, as Theresa May lost three parliamentary votes in a day - hers is now the first UK government to be deemed in contempt of parliament (for failing to publish the full Brexit legal advice). A vote forcing the Brexit issue to go back to MPs if she loses her key vote this Tuesday may yet prove decisive (although at time of writing, there are reports it will be postponed or cancelled). The latest polls suggest 86% of Labour members want to remain in the EU, while most Tory members still want Brexit – just not the one Theresa May has been touting.

“The withdrawal agreement is less a carefully crafted diplomatic compromise and more the result of incompetence of a high order,” said Mervyn King, former Bank of England governor and a prominent Brexiteer. “It is time to think again, and the first step is to reject a deal that is the worst of all worlds.”

Retirement care

Despite the momentous matters under discussion, the normal business of government continued. Last week, it was reported that a forthcoming Department of Health green paper will trail the idea of introducing automatic enrolment for later-life care costs. The proposal reflects the reality that people are living much longer after retirement; that the population is ageing, making it harder for the state to provide financial backing; and that the cost of care itself is rising.

Last week should also have concentrated the minds of anyone born after 5 December 1953, as their State Pension age rose as part of reforms which aim to reduce the burden on the state to fund retirement. Amid such buck-passing by central government, personal retirement planning is becoming ever more important.

 

Janus Henderson Investors 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 2018. “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.

© S&P Dow Jones LLC 2018; all rights reserved

Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

 


Positional play

Posted on Monday 3rd December 2018

Relationships between major powers continued to fray midweek, but a US-China trade ceasefire was agreed over the weekend.

Half a league, half a league,
 Half a league onward,
All in the valley of Death
 Rode the six hundred.
‚Äč“Forward, the Light Brigade!”

So opened Tennyson’s poem describing the mistaken British charge against a Russian artillery battery in Crimea in 1854. Last week, it was Ukraine’s turn to feel the force of Moscow’s intentions in the region, as three Ukrainian naval ships were requisitioned by Russia’s fleet off the Crimean coast.

The timing could barely have been worse for international relations – perhaps intentionally so – coming the same week that the G20 gathered in Buenos Aires amid growing political divisions worldwide. Adding to the sense of a summit doomed to failure, Angela Merkel’s plane was forced to turn back due to a technical failure, ensuring she missed the opening.

The growing clefts are apparent across several of the world’s most important economic unions and relationships. In Europe, there was a face-off last week between a group of fiscally-conservative northern nations (dubbed the ‘Hanseatic’ group) and a France in search of further eurozone integration; the German finance minister floated the idea of France giving its UN Security Council seat to the EU; the US president warned Theresa May’s EU withdrawal deal was “good for the EU” and would make it harder for the UK to sign a trade deal with the US; he also cancelled his scheduled G20 head-to-head with Putin; the EU said it would extend its sanctions on Russia beyond their current December expiration; and Washington pledged a second round of “very severe” US sanctions on Moscow.

Not that the previous round has yet inflicted much visible damage. Instead, a largely strong oil price has proved a boon to the Russian economy, although in recent days it slid below $50 for the first time since October 2017. (Putin met with the Saudi crown prince last week to agree production cuts.)

Fresh threats of US sanctions are expected to target Russian debt; but last week the finance ministry in Moscow reported a $1 billion issuance of seven-year bonds, denominated not in dollars but in euros. “We are not leaving the dollar,” Vladimir Putin said on Wednesday. “The dollar is leaving us.” The finance ministry reported that 75% of the issue was bought up by foreign investors. In this area, the Kremlin may in fact be making a bet that long-term investors do not allow politics to dominate their investment decisions, partly because nimble companies can work around all kinds of headwinds, and partly because it is difficult to price geopolitics – or even trade troubles, when they are so entangled in geopolitics.

“Geopolitical risks are significant at the moment and we investors have absolutely no idea how to price any of that in,” said Megan Greene of Manulife.

Honey run

One key risk companies have been having to work around has been the deepening US-China trade war. With $250 billion in tariffs already active, the impact is increasingly being felt by companies. Yet the trend makes last week’s US trade balance figures appear all the stranger – the US reported its largest trade deficit in five months. There is evidence this could be a case of unintended consequences.

“A few countries will do really well from this tariff war, mainly around China – Malaysia, Thailand and Vietnam – and it’s because of trans-shipping,” said Manulife’s Greene. “In some cases, China sent solar panels to Malaysia, where they put a label on them and then sent them to the US and no tariffs were ever exchanged. Likewise, China is the biggest honey producer in the world. So China has just started sending plain glass bottles of honey to Malaysia where they literally put labels on them and send them to the US.”

In fact, the G20 saw the US and China agree a cooling-off period, suspending some new tariffs and reducing others, with a 90-day truce. The suspension will come as a relief to Beijing, as figures last week showed that Chinese factories are now producing more than they are selling – if demand fails to pick up again, Chinese businesses will ultimately have to shut down some production. (The Shanghai Composite ended the week marginally higher.) Despite GM’s announcement of US factory closures last week, the US looks to be a in a stronger position; last week, third quarter GDP was confirmed at 3.5% and equities even received a boost from some apparently dovish comments by the Federal Reserve’s governor – the S&P 500 enjoyed a strong week.

His words were arguably most important in emerging markets, where a strong dollar has weighed on companies with dollar-denominated debt. Moreover, after the sell-off in emerging market equities earlier this year – in part on Fed policy and trade worries – there are signs investors may have overreacted to troubles.

“There is an opportunity in emerging markets because you see value supported by robust fundamentals, especially since the sell-off,” said Wei Li, head of investment strategy at Blackrock. “The main emerging markets index is down 13% on the year versus a 35% return in 2017, opening up a significant value gap. And that is despite robust global growth dynamics, which tend to benefit emerging markets more than developed markets. Added to it all, we’ve seen strong earnings growth.”

Wei is not alone in her view.

“The last time that we saw such negative investor sentiment on emerging markets was in 2000,” said Tommy Garvey of GMO, co-manager of the St. James’s Place Balanced Managed fund. “Back then you couldn’t find anybody saying anything good about emerging markets. Over the next ten years, emerging markets returned about 11% per annum, while the S&P 500 did nothing. We don’t think that in its current form the trade wars have any meaningful impact on the outlook for emerging markets.”

Pawn in their hands?

Clear views on the UK’s trade outlook, on the other hand, are harder to find. Last week, as the world chess champion won a tiebreaker to hold onto his title in London, Theresa May faced a task fit for a political grandmaster: marshalling as many MPs as possible to vote for her much-criticised deal by 11 December. She was obliged to acknowledge Bank of England and UK government forecasts of a loss of GDP in all forms of Brexit; the latter claimed alternative trade deals would not make a meaningful difference to the balance.

A study by Capital Economics said the government report was “probably a little too pessimistic about the fallout from a no-deal Brexit and a little too optimistic about the impact of a deal based on the Chequers plan.”

At any rate, November was a rough month for sterling, while a leading poll aggregator showed a shift from the Tories to Labour. John McDonnell, shadow chancellor, last week told media that a second referendum was “inevitable”, while the Secretary-General of the European Commission crowed that the withdrawal deal meant “the power is with us”. The FTSE 100 enjoyed a marginally positive week, aided by an early fall for sterling.

Theresa May could at least console herself that, should she need to quit politics, her State Pension might be available sooner than the 62-year old had expected. On Friday, a campaign group won the right to a judicial review of the government’s handling of the rise in the state pension age from 60 to 65. Sadly, even a reversion to 60 won’t offer women retirees much of a boost. Figures from 2017 show the average woman’s State Pension was £126 a week, versus £154 for a man, highlighting the urgent need for adequate retirement planning.

 

 

Blackrock, GMO and Manulife are fund managers 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 2018. “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.

© S&P Dow Jones LLC 2018; all rights reserved


Technology revolutions

Posted on Monday 26th November 2018

Trouble for technology stocks dominated US markets, while growth and trade fears weighed on sentiment globally.

Steamships and railroads opened up the nineteenth century world; electricity, gas and oil powered the new industrial processes of the twentieth. Such shifts were mirrored on stock markets.

In 1917, the largest stock on US markets was US Steel, followed by American Telephone & Telegraph, Standard Oil of New Jersey and Bethlehem Steel. Fifty years later, the top ten stocks still included three oil companies, General Electric and General Motors.

But the largest was a computer company, IBM. And today – half a century later – it is information technology stocks that dominate the view on the S&P 500, accounting for the five largest stocks and driving most of the market activity. Some have called this digital electronics takeover the ‘Third Industrial Revolution’.

Last week, after a phenomenal couple of years on markets, the revolution lost a few converts. On Monday and Tuesday, the FAANG stocks took a hit – at one point, they were 20% down from their 2018 highs. Watching paper losses of billions of dollars can be unnerving, and there are undoubtedly concerns about the pressures faced by the industry, such as the apparent expiration of Moore’s Law (whereby computer chip capacity has been doubling every two years since the ‘70s); increasing regulation (and, potentially, tighter antitrust rules); trade tariffs; and new taxes. A slew of negative news stories hasn’t helped either, stoking public anger and sparking employee walkouts.

In this light, it is worth remembering a few fundamentals. According to Statista estimates, 46.8% of the world’s population used the internet last year; and 50.8% will do so next year. Moreover, online accounted for 10.2% of global retail sales last year, and should account for 13.7% next year. Advertising, of course, is following the money, and all this is taking place while the global population continues to rise; within that population, 46.6% of households had a home computer last year, forecast to rise to 47.6% this year. In short, this revolution is not for turning.

But even the best trades can get overcrowded. So, did last week’s fall represent the triumph of fear, or of reality? The answer may depend – whenever does it not? – on which individual stocks you hold. All the same, there may be signs of short-termism in the recent investor turn.

“The majority of our large technology related holdings, including Alphabet, Visa, Microsoft and Oracle, have not been impacted materially by the share market correction over the past few months, but a few have seen material recent price corrections, most notably Apple and Facebook,” said Hamish Douglass of Magellan Asset Management, manager of the St. James’s Place International Equity fund and co-manager of the Global Growth fund. “Much of the share price reaction relates to short-term market sentiment rather than any change to the underlying economics or business outlook. We continue to have a high degree of conviction in the investment cases for each of these companies and believe each will deliver attractive returns over our investment horizon.”

One concern is White House policy. Last week, the Commerce Department launched a public consultation on “whether … certain emerging technologies are essential to the US” – and therefore need new export controls. For decades, these technologies originated from the public sector; even the iPhone’s most life-changing functions – GPS, touchscreens, voice recognition – ultimately derive not from Silicon Valley but state-funded research. For today’s emerging technologies, that is no longer the case – and new export controls for technology companies may yet be the result.

What the technology giants have proved themselves masters of is commercial application, and they are already currying official favour to protect their market hold. Google is set to increase its vetting of adverts before the EU elections in May 2019, while Facebook has pledged tougher security and even funded journalism training. (It uses less self-denying methods too; last week, it hired a senior Department of Justice official as an associate general counsel.) But opportunities in the sector are not limited to the biggest names.

“In the software space, we hold Workday and Atlassian, which are category leaders in their respective markets,” said David Levanson of Sands Capital, co-manager of the St. James’s Place Global Equity and Global Growth funds. “They have very attractive, defensible and visible business models. Their subscription models feature high percentages of recurring revenue, typically under multi-year contracts, and very high retention rates, which helps in the event of a downturn. We also believe many of the secular trends that should benefit our businesses remain intact.”

Summit discord

Technology is not the only headwind on markets. Last week’s Asia Pacific Economic Cooperation summit failed to publish a communiqué for the first time since APEC’s founding 30 years ago. Behind that failure lay US-China tensions and a US decision to help Australia build a naval base in Papua. (Expectations are low for this week’s G20 in Argentina.) Moreover, the price of a barrel of Brent crude oil slipped still further last week, falling below $60 and pushing down energy stocks.

Meanwhile, the OECD warned that global growth is already slowing: global export orders, industrial production, retail sales and container port traffic have all exhibited the same rapid deceleration in recent quarters. Like US debt and Fed rate rises, such trends unnerve investors. The S&P 500 finished down for the week. Even last Friday’s Thanksgiving boost on markets was short-lived; Best Buy, Target, Macy’s and other leading US retailers had reported enjoying a retail boost in the wake of store closures or bankruptcies of their longer-standing competitors, such as Toys ‘R’ Us and Sears.

If trade tensions hurt the US, they may hurt China more. The Shanghai Composite index is now down more than 20% for the year – the S&P 500, on the other hand, is close to where it began. Indeed, the recent slide in US tech stocks looks less frightening when set against the past couple of years. The S&P Information Technology index opened 2016 at 721 points; even after this year’s precipitate fall, it still sits above 1,100, a rise of well over 50% in less than three years – and that’s before dividends.

The B-word

Stocks in the UK, of course, have had a much tougher year than the S&P 500, making last week’s dividends news all the more gratifying. Payouts reached a third quarter record of £32.3 billion, with year-on-year growth of 6.9% comfortably outpacing inflation. The smoother path of dividends provides a valuable counter to the recent spike in market volatility.

The FTSE 100 struggled through the week but ended only marginally down. Theresa May’s success in agreeing a Brexit deal with the EU delivered sterling a boost midweek, and the EU formally signed up to the deal at the weekend – but Westminster will be a harder sell than Brussels.

Investors have also been concerned about Italy’s budgetary plans, although the worries may now be priced in – and the yield on Italian 10-year debt actually fell last week. While Italy’s population may be supportive of the expansionist budget, it is apparently more reluctant to risk buying up the debt, as a disappointing issue last week went to show. (Domestic ownership of Italian government debt has long been high relative to other European countries.) Nevertheless, some recent analysis suggests that Italy enjoys a “high fiscal multiplier”, meaning that even a modest increase in spending should have an accelerated effect on growth. That may yet mollify an anxious EU.

Beyond Brussels

As in Italy, so in the UK – political wrangling in Brussels can all too easily distract from ongoing challenges at home. Figures released last week show that the number of adults aged 85 or more who will need constant care is set to double to almost 446,000 in England over the next 20 years. The over-65s requiring constant care, meanwhile, will increase by more than a third, reaching a million in 2035. This places a major burden on state and family alike, underlining the imperative for early and comprehensive financial planning to cover potential costs.

 

 

Magellan and Sands Capital are fund managers 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 2018. “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.

© S&P Dow Jones LLC 2018; all rights reserved


A good deal worse?

Posted on Monday 19th November 2018

May’s Brexit deal split her Cabinet, imperilled her leadership, and rocked markets.

There are decades when nothing happens and there are weeks, said Lenin, when decades happen. Has the UK just been through one of those weeks?

There are reasons to think so. When Theresa May delivered first a Brexit deal and then Cabinet approval (of sorts) for that deal, sterling quickly strengthened. The prime minister could point to a not inconsiderable achievement – a 585-page draft withdrawal agreement that not only stood to deliver a UK exit but also met a couple of the leading aspirations on both sides: not least, sovereignty over UK borders and continued market access, at least for the short term.

Her pleasure was not widely shared by her parliamentary colleagues. Indeed, even after a marathon five-hour Cabinet meeting, she quickly suffered ministerial resignations, among them her Brexit secretary, deputy Brexit secretary and Northern Ireland secretary. The following day, the deal was pilloried from all sides as she faced three hours of questioning in the Commons. As a result, the pound fell 2.5% on Thursday, taking domestically focused shares down with it. The options markets now imply the balance of risks for sterling is skewed to the downside.

The causes of parliamentary opposition to the deal were multiple but the strongest Remainers and Brexiteers alike were united in their view that the terms represent an enormous transfer of sovereignty to the European Union, since until at least the end of 2020 it entails the UK accepting EU rules while rescinding its right to vote on them – surely the very reverse of ‘taking back control’. (Michel Barnier, as it happens, has since proposed extending the transition to 2022.) During transition the EU would enjoy a range of continued powers in the UK, from blocking mergers to ruling on agricultural culls. Although a panel could arbitrate judicial disputes, ultimate power would rest with the European Court of Justice. Moreover, while a border down the Irish Sea was avoided, Northern Ireland would have to accept closer regulatory alignment with the EU than England, Scotland or Wales.

The DUP expressed immediate opposition; so, too, did leading Europhiles, Scottish Tories (due to clauses on fishing rights), the Scottish National Party, the Labour leadership, the Liberal Democrats, and the pro-Brexit European Research Group (ERG). (Nigel Farage called the deal “the worst in history” before it had been published – or he’d seen it.) The ERG was upset by two major concessions: the Irish backstop, as the UK couldn’t unilaterally withdraw from the Customs Union; and “level playing field” requirements, whereby the UK would observe EU rules for several areas (during transition), not least in regard of the single market. A no-confidence vote in the prime minister could yet be held, although parliament’s vote on the deal may be more dangerous for the prime minister.

All of this added weight to the impression of a nation watching the latest act in a long-standing Tory argument, one that has claimed the past three Conservative prime ministers and looks ominously close to claiming a fourth. At the least, last week appears to have significantly broadened the range of possible Brexit outcomes. It is still just about conceivable that, with some exceptionally deft politicking, the prime minister’s deal might pass through the UK parliament but, at time of writing, few are betting on it – and that includes the bookies.

The alternatives involve some kind of political crisis or turnaround. Theresa May would have to go if she lost a no-confidence vote and could surely not survive the constitutional crisis – with executive and legislature at odds – that would be created by parliament rejecting her deal. But choosing a new leader does little to reconcile a polarised party that lacks a majority or to precipitate a new Brexit deal that can satisfy the pledges made. (As for the Labour leader, he has studiously avoided suggesting any kind of solution at all – although will reportedly spell out a plan this week.)

If parliament then refuses to vote through a no-deal exit from the EU, a general election or second referendum becomes more likely. Neither is likely to be pleasant, given the tone of Brexit rhetoric. Yet either side might fear that such an impasse would only boost their opponents – the prime minister is hoping that such calculus will help persuade them to vote through her deal. Besides, many MPs may prefer what they see as a bad deal to a no-deal exit.

“The UK’s negotiating power has been overestimated by many – the EU has dictated the terms of Brexit from the beginning,” said Azad Zangana, Senior European Economist and Strategist at Schroders. “The deal is largely as we expected, but this is only the beginning … we believe the risk of a no-deal Brexit will focus minds and lead to cross-party support for May’s deal.”

Brexit developments have implications that stretch far beyond the purview of markets, but investors cannot ignore them. As has been the case ever since the referendum was called, these developments have been mediated to assets through sterling. A weaker sterling is often good for the FTSE 100, since three quarters of the revenues of companies listed on the FTSE 100 are derived from outside the UK – for such companies, their revenues therefore go up in sterling terms when the pound declines. However, a quarter of the revenues are still derived from the UK and, just because a company derives most of its profits abroad, it does not follow that it will be immune to UK developments, and particularly to short-term sentiment – indeed, the FTSE 100 declined last week, due in part to slippage among financial, property and retail stocks.

These variables only serve to highlight the value of diversification, not merely across different stocks and different market capitalisations, but also across geographies. After all, a decline in sterling against the dollar automatically makes any dollar-denominated holdings more valuable in sterling terms. Viewed in these terms, the greatest danger for investors is not short-term politics, but a failure to diversify.

Trade off?

Amid last week’s chaos, events beyond the UK’s shores could all too easily lose their resonance. Yet there were unnerving economic signs last week, as third-quarter growth (annualised) for both Japan and Germany came in negative. Japan’s dip appeared to reflect immediate unforeseen events – the recent earthquake and round of severe floods. In Germany’s case, it reflected both pressure on export volumes and tighter automobile emissions rules – Mercedes-Benz has reported that emissions testing is now taking twice as long as previously. Japanese and European stocks both declined over the week; European stocks suffered due to both Brexit worries and to Italy refusing to amend its budget ahead of the EU’s deadline. This means it is now in contravention of the Stability and Growth Pact, laying it open to punitive measures. (Would that be the same pact that Germany and France contravened in 2004 without sanction…?)

On Wednesday, meanwhile, the S&P 500 clocked a fourth consecutive day of losses. The oil price continued to decline – down to $66 from $80 a month ago – hitting energy stocks. Meanwhile, technology stocks slipped on profitability fears, hinging on concerns over Apple’s iPhone business hitting a peak. Stocks partially recovered later in the week.

 

Schroders 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 2018. “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.

© S&P Dow Jones LLC 2018; all rights reserved


Soldiering on

Posted on Monday 5th November 2018

After a tough October, investor optimism returned last week, boosted by strong corporate earnings.

“Money is a good soldier, and will on,” said Falstaff, one of Shakespeare’s laziest and best-loved characters. How right he was – all the same, the money still needs to be in the right place.

Two years after Falstaff’s maiden appearance on the English stage, the first stock market opened in Amsterdam, in 1602. Over the ensuing two centuries, the original listing – the Dutch East India Company – would pay out dividends worth 1,600% of its value.

Unfortunately, many investors struggle to see beyond next week; for those who persist in thinking short term, October was an exceptionally difficult month. The S&P 500 has dipped into negative territory for the year twice in the past fortnight, while volatility on the index jumped to its highest level since March on Monday evening. Indeed, October saw US stocks record their greatest number of negative days in a month since October 2008, in the depths of the financial crisis.

Where US equities led, the world largely followed: Japan’s TOPIX struggled through October too, spurring the Bank of Japan to further supportive action. ‘Red October’, as it was dubbed, also saw the FTSE All-World suffer its worst trading month for six years, on fears over Chinese growth, trade wars and US interest rate rises. Yet there were signs not merely that fears were overwrought, but that the quirks of human psychology were at play. Consider timing: over the course of 2018, the final hour of each day’s trading has contributed – on aggregate – 5.1% of losses on the S&P 500; whereas the first hour has contributed an aggregate 0.5% in gains. Rational investing this is not.

By the end of last week, the mood had already changed, as investors were reminded – courtesy of earnings seasons – that companies are still making money, be that in the US, Asia or Europe. The S&P 500, FTSE 100 and Japan’s TOPIX all rose over the course of the week. Yet that is often the way.

“Since 1980, we have had 36 market corrections – defined as a decline of 10% or more – averaging a decline of 15.6% and lasting three to four months, but only ten such corrections resulted in bear markets,” said Jim Henderson of Aristotle, manager of the St. James’s Place North American fund. “Since the financial crisis of 2008, the market has been remarkably devoid of volatility and we are only now getting back to normal. But trying to time the market is futile; markets are generally driven by corporate earnings, which at this stage of the cycle appear healthy.”

Indeed, second-quarter US growth came in at 3.5%, completing the US’s fastest-growing half-year since 2014. Last week, perhaps with an eye on this week’s midterms, Donald Trump tweeted positively about a chat with Xi Jinping, the Chinese president, and stressed the potential for trade deals at the forthcoming G20. The S&P 500 duly rose, led by semiconductor and industrial stocks, which are super-sensitive to US–China trade relations.

Even if the tweet was just so much smoke and mirrors, investors could find other positives. S&P 500 companies are set to report 26% annualised profit growth for the third quarter – the best since 2010. Worries over growth peaking and trade tariffs hitting bottom lines did limit gains, not least for technology stocks. However, Friday’s US payrolls report showed 250,000 new jobs and 3.1% wage growth – the highest since 2009. The S&P 500 ended up 1.5%.

Political calls

Yet the gains on the S&P couldn’t compare with the rises on Brazil’s B3 index last week, following the election of Jair Bolsonaro as president. The hardline candidate, who has praised dictators, hinted at media controls and encouraged police to kill criminal suspects, won a clear majority. It is his economic liberalism that appeals to investors and took Brazil’s main index to a new high.

“His party gained more presence in the National Congress, but we are yet to see if it translates into better policy-making,” said Polina Kurdyavko of BlueBay, the emerging markets debt manager within the St. James’s Place Strategic Income fund. “Overall, we like Brazilian corporate credit, especially distressed assets and merger & acquisition candidates.”

Donald Trump was quick to phone the new president with congratulations, seeing in the new leader of South America’s largest economy a crucial ally. But he might be forgiven for asking, as Henry Kissinger once did: “Who do I call if I want to speak to Europe?” Last week an answer grew more distant, as Angela Merkel, after stinging federal elections, said she would not seek re-election as party leader in 2021, adding yet another worry to the EU’s list. Although some companies, such as Volkswagen and ING, reported strong results, the eurozone is now growing at its slowest rate in four years – third-quarter growth was a mere 0.2%.

Relations between Rome and Brussels remained fraught last week. Italy’s bond yields are at dislocated levels, relative to its debt rating and debt-to-GDP ratio. On Tuesday, the European Commission rejected Italy’s draft 2019 budget and gave Rome a three-week deadline to submit a new fiscal plan – or face an ‘Excessive Deficit Procedure’, which could lead to sanctions.

Budget bliss?

Glancing over to Italy, Philip Hammond might deem himself lucky. Last week’s UK Budget was no show-stopper, but the chancellor did announce an end to austerity – much disputed since – and offered some handouts to boot.

“This was an astute political Budget and one which underlined the significant economic improvement that is unfolding here in the UK but which markets, politicians and commentators have, thus far, refused to acknowledge,” said Neil Woodford, manager of the St. James’s Place UK Equity fund. “It confirms many of the economic assumptions that I have embedded in the portfolio strategy.”

A few of the new measures could be felt on markets, but not many.

“It was a relatively bland affair – there was something of a relief bounce for gambling stocks on news that the gambling levy increase would be less than expected, and housebuilders benefited from the ‘Help to Buy’ scheme being extended to 2023,” said Nick Purves of RWC Partners, manager of the St. James’s Place Equity Income fund.

One significant measure was a tax on major technology platforms, such as Google, Amazon and Facebook. Yet while perhaps a useful revenue-raiser and popular with voters, the measure’s business impact may be marginal.

“Our long-term valuations already incorporate these companies ultimately paying tax broadly in line with the typical rates in geographies where these new measures are being introduced – and the announcement itself came as no surprise,” said Hamish Douglass of Magellan Asset Management, manager of the St. James’s Place International Equity fund. “Given the low percentage of these taxes, the impact is low.”

The chancellor did spend a £68 billion windfall he received from improved tax receipts to deliver the largest discretionary fiscal giveaway since 2010. Interestingly, part of the bounty comes from a significant upgrade in the estimated  pension freedoms tax haul for this year. The Office for Budget Responsibility’s fiscal outlook reveals that the Treasury will net an extra £400 million as a result of people paying tax on their pension withdrawals, bringing the total take to £1.3 billion in 2018/19.

Fortunately for higher earners, pensions tax relief was left well alone, and there was some further good news for the UK’s retirement savers. Budget notes confirmed an additional rise in the lifetime allowance from next April, meaning that many individuals will be able to withdraw a little more from their pots before being hit with a 55% tax penalty.

 

Aristotle, BlueBay, Woodford, RWC and Magellan are fund managers 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 2018. “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.