Market Bulletin – Courtship Display

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 21st consecutive 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.

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