The story for September remains mundanely similar as for much of the year. Global political noise is barely being acknowledged by capital markets; central banks attempt to signal the way higher for rates without spooking the market; the global economy continues to bump along. Despite an increasingly aggressive stance from North Korea, a destructive hurricane season, hawkish comments from central bankers and elections in Germany, local currency stock markets maintained the momentum seen all year.
The only real discernable impact on portfolios was the strength observed in sterling. The graphs below show how against the Euro and the Dollar the pound rallied strongly, and this was replicated across other currencies too. In a reverse to the period after the Brexit vote, the FTSE 100 fell as the rally in the pound discounted foreign earnings received by the majority of companies within the index.
The US markets have had a lot to digest over the past month. As the month began Trump revisited his most successful policy to date, that of ruffling feathers, offering an ultimatum to Congress if they didn’t finance his Mexican wall project. This was quickly superseded by the destructive power of hurricane Irma, and more significantly by escalations of antagonism out of Pyongyang. It is, however, the actions of the FED that will perhaps have the most lasting impact on markets. Further guidance on rate rise expectations and asset sales have pushed up the yield curve, leaving the 2-year yield at the highest point in almost 10 years. This not only spilt over onto the back end of the Treasury curve but also onto German and Japanese yields. Coordination will occur across fixed income markets whether we like it or not! Despite all this, US equity markets saw through the worry and focused on a solid quarter on quarter GDP figure of 3.1%, highlighting the stability of fundamentals.
As the month drew to a close, a well-trodden theme returns, that of the President and his policy agenda. While the failure to repeal Obamacare had led the market to fully discount the ability of Trump to succeed in reducing the Corporate Tax rate, September saw a reevaluation of this. The Russell 2000 index of small companies, those most likely to benefit from tax rate cuts, gained nearly 6% v the 2% gain in the S&P 500 as the “framework” to reduce the Corporate Tax rate from 35% to 20% was unveiled. While the framework is a generous term for a policy devoid of any detail, we observed the dance of expectations begin once more.
The UK is bleeding and ‘death by a thousand cuts’ is a neat way to summarise Brexit. Inflation hit 2.9% for the year to August, continuing to squeeze a consumer with little to no wage growth. Commentary can appear bleak, with a report suggesting 35% of Euro area firms expect to cut investment in the UK due to the presence of Brexit. While it is comparably easy to vilinise the Brexit effect on the country as it is to mock President Trump, it is not all a picture of doom and gloom and we must remain impartial. Despite meagre wage growth, job creation remains strong with an unemployment rate low enough to beat the past 42 years of data. Further, tourism is gaining traction with 4 million visitors over the past 12 months a new record. The unfolding backdrop is interesting, but the key moment of the month came from the BOE – “some withdrawal of monetary stimulus is likely to be appropriate over the coming months”. This unexpected hawkish behaviour ‘stimulated’ bond markets into action, bringing in the next predicted interest rate from a few years away to possibly November. The question we need to answer is: is this the boy who cried wolf, is this a one-off move to allow space for a future cut, do the BOE see aggregate demand pressures, or has the supply side been repressed enough to offer far less spare capacity than was originally the case? Either way, it drove the fixed income markets wild with the resultant spill over to currency impacting portfolios disproportionately.
One more political hurdle cleared, with one to go next year. The re-election of Merkel provides the last banana skin of the year, allowing attention to firmly focus on upbeat fundamentals. Consumer confidence is at a 16 year high, there has been strong household spending growth and German business confidence came in at the highest level since the reunification in 1990. Despite a strong currency for much of the year, there has been limited impact on growth, with a survey of export orders only falling modestly. What will be pleasing for the ECB is that the recovery has now spread from Germany and Spain with France, Italy, Portugal and Greece picking up the batton
While inflationary pressures remain muted – annual CPI at 0.4% in July and core inflation negative for the last 6 months – there continues to be shoots of positivity. Business confidence is at a 25 year high and this is now the longest unbroken period of growth in over 10 years. Abe’s three arrows may finally be hitting the mark and he is taking advantage of his current popularity to call an election. Are there signs this tanker is starting to turn?
Emerging markets continue to benefit from improving growth prospects alongside a weakening dollar. This, in turn, is reducing inflation and improving the power of the consumer. Specifically, we saw unexpectantly large falls in Russian inflation from 3.9% to 3.3% that led to a 50bp cut in interest rates while Brazil began pulling out of recession with a 0.2% GDP growth despite political paralysis. China presents a mixed picture. Data points such as Industrial Production, cement and electricity production and Fixed Asset Investment simply a reduction in the pace of output, however, the Caixin PMI composite has risen back to levels seen at the start of the year. Is this surprising given the upcoming Party Congress? 5 out of the 7 members of the all-powerful Politburo Standing Committee are set to be replaced, while about half of the 18 strong Politburo is also outgoing. Expect stability of fundamentals in the lead up to this political reshuffle, and then re-evaluate the data.
The above article was first published by Parmenion on 5th October 2017