The Lowdown on Markets to 1st July 2016
World Markets at a Glance
In this week’s issue
- Global equity markets continue to rally on the post Brexit vote.
- The FTSE 100 Index records its best weekly performance since 2011 rising by over 7.0%
- Bank of England Governor, Mark Carney, talks of further monetary policy stimulus.
- US Federal Bank official Mr Fisher comments on Brexit but domestic US takes president.
- Sovereign bond yields continue to fall even though global equity markets rally higher.
- With Central banks firmly back in the driving seat it’s difficult to be bearish just mindful.
“Global equity markets continue with their post Brexit recovery”
In advance of the UK public voting on the European referendum global equity markets had feared the worst, and for a short period of time after Britain had voted to leave the European Union they did indeed react negatively with most markets around the world falling on their openings reflecting the uncertainties that Brexit would bring to the already weakened global economy.
The initial news that Britain would leave the Union also created upheaval in terms of the political outlook with the prime minister, David Cameron announcing that he would step down in favour of others that could invoke article 50 and confidently take Britain through what will be a challenging period of departure from Europe. Shortly after this we saw a third of the opposition cabinet resign on a no confidence vote for Labour leader Jeremy Corbyn which has left their party in total disarray.
“The initial news that Britain would leave the Union also created upheaval in terms of the political outlook”
In respect to the stock markets we saw some sectors in the UK such as housebuilders, banks, and consumer related companies shares hit very hard on concerns over future consumer spending and worries of the strength of their financial balance sheets. Understandably, it was the FTSE Mid-Cap and Small-Cap indices that suffered the most, whilst the larger cap stocks in the FTSE 100 Index fared better on the principle that with sterling collapsing they would improve over the longer-term.
And so in the aftermath of Brexit we saw the FTSE 100 Index plunge 8.7%, the pound collapse, UK Gilt yields hit record lows, and billions of dollars pouring out of global equity markets, as investors scurried out of riskier assets in favour of sovereign bonds, gold, and yen, leaving the investment climate looking rather bleak.
“Like the uncertain British weather, the climate changed over the next five day trading period which left the FTSE 100 Index recording its finest weekly performance since December 2011”
Then like the uncertain British weather, the climate changed over the next five day trading period which left the FTSE 100 Index recording its finest weekly performance since December 2011, rising by a staggering 7.15%, and ranking up its tenth best weekly performance in the Footsie’s 33 year history. Unfortunately, the FTSE 250 Index found life slightly more problematic, lagging behind its larger brethren by some way, given that this index is considered to be a much closer barometer to the UK economy than the FTSE 100 Index.
And so what has happened that has changed investor sentiment so quickly? Well as in the past few years every time a catastrophe supposedly strikes, the central banks, like “white knights in shining armour” come to the rescue and in the UK’s case the Governor of the Bank of England, Mark Carney, followed on from his previous announcement by saying that the UK economic outlook has worsened and some monetary policy will “likely be required” in the summer months eluding to further interest rate cuts, rather than the perceived interest rate hikes assumed before the referendum vote.
“Directly after the Governors comments we saw the equity markets rally”
Directly after the Governors comments we saw the equity markets rally, 10-year Gilt yields collapse to a new all-time low of 0.78%, and sterling hover just above its recent lows. Likewise, we also saw government bond yields around the world skid lower as investors began to envisage other major central banks might consider a similar option, and in the case of the US Federal Reserve Bank, who most presumed would be raising interest rates fairly soon, a dilemma appeared on the horizon.
Indeed, Mr Fisher, a Federal Reserve Bank official, has already said that the US central bank would like to know how quickly the British economy will reach its new configuration with new trade, and of course, the implications surrounding the British decision to leave the Union. Also other European countries might now decide to hold their own internal European referendums which could have added complications for central bank policy.
“The US central bank must focus upon US economic data, as well as Brexit”
Arguably, he then went on to say that the US central bank must focus upon US economic data, as well as Brexit, adding that US domestic developments are more important than just Brexit alone, this would suggest that perhaps the Fed might consider raising interest rates this year, with the favoured month being December. This would then accommodate the outcome of the US presidential election, planning for Brexit, and some additional global economic data.
Certainly, it has been an amazing couple of weeks, given that we have barely moved out of the most important decision that the UK public have made in over 40 years, by leaving the European Union, than the markets have once again rallied on just a few words spoken by central bankers. In reality, the response from the “out vote” has already had huge ramifications for the UK, firstly, an uncertain political backdrop, secondly, a deteriorating UK economy, thirdly, a sterling devaluation, fourthly, UK recession fears, fifthly, Eurozone contagion and sixthly, article 50 has yet to be invoked by the newly nominated UK prime minister.
Clearly, central banks around the world have now become the all empowering market enforcers, and over the past decade, both markets and global investors, have reacted eagerly to every word spoken irrespective of the ramifications or longer term outcome.
‘In the words of Sir Winston Churchill “never let a good crisis go to waste” ‘
Admittedly, this does present global investors with investment opportunities and in the words of Sir Winston Churchill “never let a good crisis go to waste” does spring to mind. Arguably, the next two important dates on the horizon are the 14th July 2016 when Bank of England Governor Mark Carney makes a further announcement that could signal the Banks intentions regarding interest rates, and then the 09th September 2016 when the new leader of the ruling Conservative party is named. This in turn, should then lead us to the unravelling of the Brexit decision, and as a result of this, see asset allocators and individual investors adjust their portfolios accordingly.
Clearly last week has already seen some investors react to the Bank of England comments by adding to their positions in UK large caps, hence the aggressive rise in the FTSE 100 Index. Understandably, the assumption is that many of these international businesses that make up the FTSE 100 Index will benefit from the devaluation of sterling when they report future corporate earnings, and of course, from the income generation that might come from there historically high yields.
Clearly, these two facts are true, but it is also true, that we have seen dividend cuts of over £3.6 billion so far from FTSE 100 related stocks this year, and that none of the current top 10 highest yielding stocks in this index can comfortably afford paying out next year’s dividends, unless they pay them out of capital, or debt, or cut their future dividend payouts. Also remember that this index is highly concentrated towards a small number of sectors, meaning that we currently have 11.7% in personal & household goods, 10.4% in oil & gas, 9.5% in industrial goods and services, and 9.4% in banks. Admittedly, over 70.0% of the revenues generated does come from overseas earnings which will be positive if sterling remains weak?
“It is also worth noting that a very high percentage of these businesses also benefit from the weaker pound”
Equally, if you now look at the FTSE 250 Index, or indeed smaller companies, it is true that many of these businesses are more domestically driven, and therefore, are more vulnerable to any further downturn in the domestic economy, however, it is also worth noting that a very high percentage of these businesses also benefit from the weaker pound, given that they are in the service sector.
For example, whilst it might be more expensive for the Brits to take holidays this year outside of the UK, it is very attractive for tourists overseas to visit our shores, indeed, for many global travelers it’s time to be in London, not out. In fact, it is forecast that approximately 36.7 million people will visit Britain this year, and spend around £23.0 billion.
“It is forecast that approximately 36.7 million people will visit Britain this year, and spend around £23.0 billion”
Given these statistics this should certainly benefit many UK businesses in sectors such as restaurants, travel agents, hotels, and pubs, and in terms of these companies, many of them are constituents of the FTSE 250 Index. Equally, there are also many businesses within this index that will face some strong headwinds over the coming months, given that they are domestically driven, housebuilders are certainly one area of contention that might suffer from any slowdown in new house builds.
However, from a forward price-to-earnings [P/E] perspective, the FTSE 250 Index is at its cheapest level since February 2013, which is attractive and gives investors the opportunity to invest in both a domestic and global growth theme through a much wider disbursement of stocks and sectors than there is in the FTSE 100 Index, therefore, it should not be totally overlooked due to Brexit woes.
“Looking outside of the UK, and on a global theme, clearly Brexit has had an effect”
Now looking outside of the UK, and on a global theme, clearly Brexit has had an effect, however, on fundamentals we have seen US exports pick up, and with the rise in the crude oil price, this could be bullish for acceleration in corporate earnings going forward. Equally, over recent weeks we have seen global investors sell down their equity positions in favour of bonds and cash deposits, however, with interest rates and bond yields at historical lows, and likely to fall further, investors might need to rethink their global equity strategy, especially with the global economy slowing down again and returns on cash unable to feed many investors’ appetite for income.
Understandably, it sometimes feels that as an investor you are between a “rock and a hard place”, with the fundamentals rather gloomy, and the macro all about daily events, which creates lots of noise and uncertainty. Certainly, as we saw a couple of weeks ago, before and after, the referendum vote, it was very easy to become fearful of the markets, and make rash decisions, however, we have learnt from many previous disturbing events that it is best to do nothing until the outcome is known, and then analyse the situation, which in hindsight appeared the best action to have taken on Brexit, and of course, with the central banks being so verbally power it is best not to be too bearish, just mindful.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum, he worked within a larger asset managers, primarily as an Investment Director with Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority .