The Lowdown on Markets to 14th October 2016
World Markets at a Glance
In this week’s issue
- Chinese economic data and US corporate earnings keep equity markets cheerful.
- The FTSE 100 Index continues to rally on the back of continued sterling weakness.
- Britain is the country of preference for overseas tourists and exporting companies.
- Both the Fed and the Bank of England are happy for inflation to overshoot their targets.
- As for UK consumers they face sterner headwinds as import costs are likely to rise.
- Global equity markets are lacking some direction but remain the asset class of choice.
“Stock markets react optimistically to economic and corporate data”
Whilst markets tend to react negatively to uncertainty, they tend to respond positively to optimistic economic and earnings surprises, and of course currencies, especially to a substantial devaluation such as we have seen in sterling. History shows us that when a countries currency devalues then its stock market tends to gain some upward momentum and rally. Since Britain voted to exit the European Union we have seen sterling fall by just over 17 per cent against the US dollar, and by similar amounts against the euro and Swiss franc, equally, since the end of June the FTSE 100 Index has risen by a comparable amount.
Whilst this would all seem good news for UK investors with UK large cap exposure, or even better still, International equities, a devaluation in a countries currency can have “the good the bad and the ugly” consequences over a period of time, given the effects on their imports and exports.
Firstly, it is true that the constituents of the FTSE 100 Index collectively makes around three quarters of its money beyond the shores of Britain, these company revenues earned in foreign currencies are then converted back into sterling for reporting purposes, which in times of a weak currency improves the corporate profitability for these companies. Equally, for many of these companies they can gain a competitive advantage through lower export prices, which again, can see additional cash hit their bottom line in the post years of devaluation.
Regrettably, not all UK companies benefit from currency devaluation, for instance, a business that is deemed to be domestically driven might suffer from higher import costs, or an increase in inflation, which in turn, can lead to lower consumer spending or a pick-up in unemployment rates. Certainly, companies that are classified as mid or small caps can come under this category, and of course, since the demise of the European Union vote many of these companies have been under performing their larger brethren.
However, it might be worth remembering that many of the mid-cap companies derive the bulk of their earnings from overseas, around 50 per cent to be precise. Whilst the FTSE 250 Index has recently gained some of its composure, rising by 20 percent since the end of June, it still looks fairly attractive from a valuation perspective, and perhaps more importantly, many of the companies have benefited from the arrival of overseas tourists that are taking advantage of our cheap currency through taking a vacation in Britain.
Britain has become the cheapest place to buy designer apparel for overseas tourists, given the fall in the pound. Expensive products from handbags to shoes are now cheaper in Britain than in other countries. This is paradise for overseas luxury goods seekers and recent figures confirm the shopping spree with August’s figures showing that spending by foreigners surged by more than 36 per cent over the month. Also it is likely that we might see further mergers & acquisitions appear in the coming months, given that it’s a cheap hunting ground for many of those overseas companies.
Unfortunately, the weaker pound is not such good news for the UK consumer as all import goods such as petrol, cloths, selective foods, and foreign holidays, have already become 20 per cent more expensive, leading to a rise in costs at the petrol pump, check-out stores, and travel agents. This in turn, can eventually lead to higher inflation, a rise in wage inflation, unemployment, and perhaps a spate of union disorder.
Actually, what we saw last week from Unilever and Tesco was a build-up of dysfunction within the retail sector, when the British-Dutch multi-national consumer goods company wanted to pass on the import costs for a certain number of their branded goods, such as Marmite, onto the supermarket chains. This created some tension between the supplier and customer which then led to a number of leading household brands disappearing from supermarket shelves, as the likes of Tesco refused to pass on the extra cost to their customers, meaning that the supermarkets margins would have been squeezed.
However, a resolution was found with Unilever announcing that an agreement had been reached between themselves and Tesco. Understandably, this might have future ramifications if sterling were to fall further over the coming months and create further animosity between suppliers and end customers.
Looking more globally, much of last week’s focus was on the outlook for US monetary policy given that the minutes from September’s Federal Reserve Bank meeting, clearly indicated that several of the committee members were in favour of a rate hike even though their actual decision was to leave interest rates at their current level. Never-the-less the Fed will be expected to act in early December announcing a 25 basis point hike.
Likewise, yields on government securities in the UK and US have been quietly rising over the past few weeks, which might indicate some concerns over a build-up of future inflationary pressures, or the likelihood of higher interest rates, especially from the US perspective. However, it is conceivable that interest rates are likely to remain restrained, or subdued, for a very long time period, even tolerating higher levels of inflation.
This was noticeable in a recent comment made by the Fed chair, Janet Yellen, when she said that “it may be wise to run a high pressure economy with a tighter libor market to reverse out some of the negative effects on the Great Recession”. Then she went on to say that “a disappointing economy may force economists to think about the economy in new ways”.
Clearly, Ms Yellen is indicating that she might be willing to allow inflation to run a little higher than the 2 per cent Fed target, erring on the side of being a little slower to raise rates, rather than too fast, which buys her some time to see how the US economy unwinds over time especially knowing that outside forces such as Brexit, or a severe economic downturn in the Chinese economy, could have undesirable effects on the US economy.
Similarly, the governor of the Bank of England, Mark Carney, has told an audience in Nottingham that he would be willing to tolerate an inflation overshoot above the banks 2 per cent target and believes that that will be reached within the next two years. And speaking on the collapse of the pound he said that the central bank was “not indifferent” to the level of sterling but did not target the exchange rate. And likewise, signaled that a further cut in interest rates should not be ruled out.
Moving on to the Chinese economy it was revealed last week that exports had fallen more than expected for September whilst imports also declined. Indeed the country’s exports contracted by 10 per cent year-on-year, suggesting that it was a sign of weaker demand for Chinese goods. Clearly, the country’s economic transformation from being export to domestically lead is still showing some signs of transformation pain which is likely to continue for some time to come. However, on a more positive note China would seem to have climbed out of producer price deflation for the first time since January 2012 which was taken positively by the market.
And finally in respect to last week’s market movers, Wall Street took heart from the better than expected corporate earnings results from the leading US financials, with the likes of Goldman Sachs, Citigroup and JP Morgan helping market sentiment. However, that’s not to say that there were not some disappointments, such as HP, the PC maker, that announced downbeat cash flow guidance for 2017 and a fresh round of job cuts.
In the UK, the FTSE 100 Index set an all-time intraday high earlier in the week, whilst sterling came under further pressure. In Europe the financials gained some ground on the back of those US bank results, whilst in Japan the market was uninspired by what we’re happening both domestically and internationally.
Clearly, we still remain in a period where the markets seem to be lacking any real direction, but as we have seen in recent week’s government bond prices are falling, whilst yields are rising, perhaps concerned over the possibility of higher interest and inflation rates. In respect to global equities, the mood by investors still seems to favour those of Asia and the emerging markets over those of the developed world. Admittedly, the devaluation in sterling has been a positive boost for UK large caps, which in turn, has benefitted the FTSE 100 Index. Another theme that still remains to be intact is that of global equity income given the low and unattractive cash and bond yields still available.
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 .