Market Bulletin – Distant Horizons

Distant Horizon

In a week marred by violence on both sides of the Atlantic, positive indicators in leading economies could not prevent markets delivering a mixed performance.

“The future influences the present just as much as the past,” said Friedrich Nietzsche – an insight that could surely be applied to markets.

Events in the US last week certainly led investors to feel more cautious about the future – and to adjust positions accordingly. Donald Trump blamed both sides after a white nationalist demonstration in Charlottesville turned violent and, ultimately, deadly. In doing so, he alienated both leading Republicans and several senior business figures. A number of the latter quickly announced their departure from two White House business panels – the Manufacturing Council and the Strategy & Policy Forum. The departures led the president to disband the committees altogether.

The decision presumably means that big business will not enjoy the president’s ear as much as it had. Yet even with the councils in place, he still had a long way to go before ratifying corporate tax cuts or deregulating the financial sector as pledged – hopes for those reforms had contributed to the so-called ‘Trump rally’ that followed the president’s successful election campaign last autumn.

It came as no surprise, therefore, when US stocks dipped in the second half of the week. The departure of Steve Bannon, Donald Trump’s chief strategist, from the White House, prompted cheers on the trading floor of the New York Stock Exchange, and helped shave one-week losses on the S&P 500 to just 0.27%.

Yet even discounting Bannon’s departure, it might seem surprising that stocks didn’t dip further. Consider the fact that the S&P 500 undergoes a daily 5% dip several times over the course of a typical trading year – and yet this year you can count even its 1%-plus single-day declines on the fingers of one hand. Neither an escalation in nuclear rhetoric between Washington and Pyongyang, nor the president’s equivocation over neo-Nazi demonstrations in the US, has meaningfully moved the dial. Volatility on the US’s main index did spike late in the week, but still remained comfortably below its long-term average.

Yet amid the apparent political madness there may be method in investors’ muted response – and in their focus on more distant horizons. After all, forecasting how the Charlottesville tragedy and its aftermath will affect corporate earnings is tantamount to soothsaying, while the demise of two business councils doesn’t mean the president has to change his tax plans. It is easy to overreact to events in the short term – and often much harder to quickly reverse any losses that result.

Moreover, the conduit for investor caution this year has probably been the dollar above all – the greenback has slid almost 9% against a basket of six leading currencies in 2017. That may have acted as a boon to many US companies, particularly those reliant on exports. Moreover, US consumer sentiment last week struck its highest level since January.

Easing easing
The Federal Reserve certainly appears to view the broader US economy in a favourable light, if the latest committee minutes (released last week) are anything to go by. Central bank officials now believe that it can begin to reduce its highly-extended balance sheet “relatively soon”, although members remain concerned at persistently low inflation. The other leading indicator the Fed is mandated to respond to – unemployment – has pointed to a rate rise for some time.

Winding down quantitative easing (QE) is an enormous job. Six major central banks worldwide pursued QE in earnest after the crisis, and today it is the ECB that holds the most assets, followed by the Bank of Japan (BoJ). Between the six of them, the banks hold more than $15 trillion in assets, with almost two thirds of it in government bonds.

In fact, both the ECB and BoJ were last week supplied with further reasons to taper their holdings, should they so desire. Japan clocked its sixth consecutive quarter of growth, the country’s longest unbroken stretch in more than a decade. Its economy grew 1% in the second quarter, a remarkable rate of outperformance of expectations. The latest indicators suggest the third quarter is on a good track too, with private consumption levels a particular highlight. The buoyant figures may yet give the prime minister some of the momentum he needs to push on with his reform agenda. The Nikkei 225 fell 1.3% last week, suffering in part from a strong yen and weak dollar.

Across the eurozone, impressive growth numbers for the second quarter offered cause for confidence. German GDP actually slowed marginally in the second quarter, but still came in at 0.6%, meaning it achieved its best annualised rate since 2014. France grew by 0.5%, while Spain surged by 0.9%, and the Netherlands rocketed 1.5% – a stellar rate for a developed market. Moreover, the countries most afflicted by the global financial crisis are showing healthy recovery signs too. Ireland is a particular highlight, and is currently growing 6.6% year-on-year, while its sovereign debt yield is close to that of France. The second quarter of 2017 was the 17th consecutive quarter of eurozone growth. The ECB can always give the excuse of low inflation for sitting on its hands, although it also expressed concern over the strength of the euro – and how QE withdrawal might add momentum to the trend.

Yet gains on European markets last week were pared back following a vicious terrorist attack in Barcelona on Thursday which killed 14 people and injured at least 100. The Spanish prime minister identified the incident as a jihadist attack. The Eurofirst 300 ended the week up 0.48%, as leisure and travel stocks suffered on Friday.

Waiting game
If indicators in the UK were less robust, they were encouraging all the same. Inflation defied expectations by remaining unchanged at 2.6% in July, held down in part by falling fuel prices. In its latest report, the Bank of England said that it expected inflation to climb to 3% in October – another blow for cash savers. The FTSE 100 rose just 0.19%.

The UK’s relationship with Europe continued to loom large over the course of the week. Paul Jenkins QC, former head of the government’s legal services, mocked the prime minister’s assertion that the UK could break free of European laws while still enjoying the benefits of the single market, saying it was “foolish” and that keeping close links to the customs union and single market will mean keeping to EU law “in all but name”. Meanwhile, a report published by Economists for Free Trade, a group of pro-Brexit economists, argued that removing all tariff barriers would help to generate £135 billion extra per year for the UK economy. On markets, the pound struck a ten-month low as an imminent rate rise looked increasingly unlikely, but UK wage growth showed up better than expected last week, rising 2.1% in July, while unemployment fell to a new low of just 4.4% (although productivity also fell slightly).

Meanwhile, UK pension policy received renewed scrutiny last week as the chief executive of Royal London warned that, while drawdown and individual pension sales had risen markedly this year, too many retirees were forgoing professional advice. Given the sums involved, and their importance to managing retirement, this is a high-risk strategy.

“We are… concerned that some providers may be ‘sleepwalking’ their existing non-advised pension customers into their own in-house drawdown offerings, repeating some of the poor practice seen in the historic annuity market,” said Phil Loney, chief executive at Royal London.

Finally, the UK government published rudimentary plans to retain current customs arrangements for a transitional period after the UK’s formal exit from the EU. David Davis hopes that the EU will allow the UK to continue to operate under the EU customs umbrella while also negotiating new trade deals – those deals would then be implemented once the UK left the customs union. It remains to be seen whether the EU is now open to what senior officials had previously dubbed a “having your cake and eating it” impossibility.

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