The Lowdown on Markets to 7th October 2016
World Markets at a Glance
In this week’s issue
- Sterling has another bad day at the office as woes return over comments on Brexit.
- The FTSE 100 Index rallies on benefits that UK earners will get from a weaker pound.
- UK investors seeking income get a boost from high yielding FTSE overseas earners.
- US unemployment numbers appear solid but not spectacular a rather goldilocks report.
- Equity markets find it difficult to make any headway with the exception of the UK.
- Global investors appear to be chasing down returns irrespective of price or valuation.
“Sterling retreats on hard Brexit concerns whilst the FTSE 100 Index rises”
Whilst the financial markets in the UK reacted positively to last week’s pullback in sterling, the real concern is that we might be heading for a “hard Brexit” once the Prime Minister, Theresa May, pulls the trigger and evokes Article 50 which is being heralded as sometime in the first quarter of 2017.
Clearly from a UK governments perspective it will be imperative that they harmonise the political expectations that will be required, against a backdrop of economic reality, so as to exit the European Union in the most advantageous way for the British people and ensuring that the counties economy continues to grow and prosper over the coming decades.
A rebound in the UK’s economic prospects, posts Brexit, was not unanticipated, but with the recent PMI figures reflecting that businesses and consumer confidence has picked up it has been a very pleasant surprise. Arguably, it now remains to be seen whether this is sustainable, given that things have been helped along by our weaker exchange rate, and of course, the immediate actions taken by the Governor of the Bank of England, Mark Carney by cutting interest rates, and increasing their monthly bond buying programme, offsetting any initial weakness that otherwise might have occurred in the UK economy.
“The Prime Minister has a very difficult path ahead in negotiating the UK’s exit strategy from the European Union”
However what is very clear is that the Prime Minister has a very difficult path ahead in negotiating the UK’s exit strategy from the European Union which is scheduled to last at least two years from the point when she triggers the EU treaty exit clause. And of course, we have already seen the initial effects in the market place from her increasing talk of a “hard Brexit” or a clean break from the EU, rather than a more limited pulling out that would continue us to have access to Europe’s common market.
This hard line approach from the Prime Minister is likely to lead her to having many battles with the Europeans to secure an acceptable Brexit which might mean, that she will need to refer to one of Mrs Thatcher’s famous quotes “this lady is not for turning”, especially, if the recent tough talk from French president, Francois Hollande, about the UK’s exit is anything to go by.
Understandably, the initial reactions within the markets was one of uncertainty, particularly in the sensitive foreign exchange market, where we saw an immediate over reaction in the opening trades in Asia as a “flash crash” hit the pound and saw it tumble from US$1.26 to US$1.18 in the matter of minutes before recovering and closing out the week at 1.246.
Immediately, there was talk of a possible “fat finger trade” but the likelihood is that longer-term global investors have started to consider the ramifications of a “hard Brexit”, and therefore, have begun to repatriate some of their sterling exposure ahead of any further volatility. Obviously, last week’s attack on pound was a concern but let’s just remember that sterling has actually been under pressure, and falling against the dollar, since the European referendum vote on the 23rd June 2016.
“It’s the Eurozone, and the euro, that might eventually find itself experiencing difficulties without the UK membership”
Equally, to try and put this latest collapse into some historical context, since 1971 there has only been seven times when the pound has fallen by more than 15 per cent against the US dollar over a period of six months, currently it is down around 12 per cent over the same time horizon. Clearly, the UK vote to leave the European Union does come with a sense of uncertainty about the future outlook for the UK, which in turn, means that the currency market is likely to react nervously on a day to day basis as developments unfold, but of course, it’s the Eurozone, and the euro, that might eventually find itself experiencing difficulties without the UK membership.
None-the-less, whatever the reasoning was last week it would seem apparent that a weaker pound is here to stay, with some market watchers predicting that parity against the dollar cannot be ruled out. Equally, the weaker pound did have a positive effect on the FTSE 100 Index, which has actually risen by around 18 per cent since it bottomed out post Brexit. Likewise, further sterling weakness could propel the UK’s leading index even higher. Regrettably, this could turn out to be rather risky given that the market is looking a little expensive, and therefore, leaves very little wriggle room for corporate earnings disappointments going forward. In fact, UBS analysts have just revised down their fair value for the FTSE 100 Index to 6,500, from its current 7,044, suggesting a correction of around 8 per cent from here.
However it is also reasonable to say that many of the companies that are constituents of the FTSE, such as Royal Dutch Shell, HSBC, BP, AstraZeneca, RioTinto and BHP Billiton, are huge beneficiaries from any further weakening in the pound, given that a high proportion of their earnings come from overseas. Equally many of these companies have very attractive dividend yields, and pay-out ratios to shareholders, which in simple terms mean that since last June each dollar is now worth another 11.7p which is excellent news for UK investors seeking income.
“US presidential candidate Donald Trump appears to be in serious trouble over his obscene remarks”
Now moving on to the United Sates, and those important Friday unemployment numbers, it would appear that the figures were solid, but not spectacular, a rather goldilocks report, which is likely to suppress some of the speculation that the Fed would move on an interest rate hike in November, nonetheless the latest numbers will leave the door wide open for the US authorities to consider a move in December, particularly now that US presidential candidate Donald Trump appears to be in serious trouble over his obscene remarks about women and his second television debate with Hilary Clinton. Admittedly, he could recover from this but much damage has been done and with influential people like Jack Welch, former GE chief, and other luminaries appearing to be distancing themselves from their Republican presidential nominee does not bode well for Trump.
And so if we now look at the global equity markets it looks as if we might be in a multi-year consolidation pattern, and at some point that will need to end, but of course, irrational exuberance is still high amongst global investors who are still chasing down returns, irrespective of the price or valuation. This is understandable given the returns available on cash deposits and the yields that are on offer from bonds. Admittedly, global investors are still showing some interest in the latter but this could be down to their expectations for further central bank intervention, or perhaps some tactical positioning ahead of the US presidential election.
In terms of the markets, US equities found it difficult to make much headway after the lacklustre domestic US non-farm payroll numbers and mounting concerns about the UK economy, whilst in the UK the latest bout of sterling weakness saw the FTSE 100 Index move higher on the back of those internationally focused companies. In Europe, stocks found it hard to make any progress against a backdrop of sterling turbulence, Brexit woes, and cautionary stance towards the European equity markets. Finally, in Japan the Nikkei 225 Index suffered from a similar story ahead of the US jobs report.
As we have stated over previous weeks, whilst equities remain the only game in town, there now seems to be a rising number of stale bulls, or cautious investors, that are looking for directional signs that might lead them to taking a new direction in asset allocations as we enter the last few weeks of this year and into what is likely to be a very interesting 2017.
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 .