Market Bulletin - Norman Conquest
US stocks performed strongly on trade news, as Brexit negotiations returned to the fore.
“We won the battle, but we haven’t won the war,” said Anthony Quesnel, a French fisherman, after last Tuesday’s ‘scallop skirmish’ off the coast of Normandy. The British vessels were outnumbered by seven to one – not so different, in fact, from the relative sizes of the economies of the EU (ex UK) and the UK. The tabloids were suitably febrile in response.
Meanwhile, Dominic Raab, the Brexit secretary, expressed some war-weariness of his own early in the week, questioning whether a deal could be struck next month as initially planned. In Japan, the head of Keidanren, the country’s leading business lobby – representative of, among others, Toyota, Honda and Nissan – added his voice to those business leaders now coming out to express strong concern over the lack of Brexit progress and clarity.
Markets apparently saw things differently. One encouragement came from the French president, who said France is “prepared” to help forge a deal with the UK after Brexit and that he would tell EU leaders as much. But investors were more sensitive to the words of Michel Barnier, the EU’s Brexit negotiator, when he told a press conference that the EU is “ready to propose a partnership like we have never had before with any third country”. The comment – which now looks to have been overinterpreted – sparked sterling’s largest daily rise against the dollar in two months.
Moreover, after a meeting on Friday between Raab and Michel Barnier, the two sides said 80% of the withdrawal agreement is now worked out, and that a deal might be ready for the October summit, despite ongoing areas of disagreement. However, there was a further fly in the ointment for the prime minister by Sunday, when David Davis, the former Brexit secretary, said he would vote against the ‘Chequers plan’ in Parliament, raising the prospect of a Commons defeat. Boris Johnson made the strength of his opposition to the plan plain in a newspaper column.
After an auspicious start to the week, the FTSE 100 soon lost ground; a fair proportion of its losses could be put down to the initial rise in sterling, which made companies’ non-UK earnings less valuable in sterling terms. Indeed, the index hit a two-week low. The FTSE 250, which is dominated by UK-focused stocks, slipped far more marginally. One company to buck the trend was Whitbread. The hotel and restaurant company ended the trading week up almost 15% following news that it had agreed to sell its Costa Coffee chain to Coca-Cola.
The prime minister, meanwhile, was looking for business opportunities further afield, making a three-day tour of sub-Saharan Africa to boost the UK’s trade and investment prospects following Brexit. Although Africa currently accounts for just 3% of UK goods and services exports (against 54% for Europe), it hosts some of the world’s fastest-growing economies. Moreover, the low export number may also represent significant unrealised potential. The tour marked a statement of intent; as the Kenyan president was keen to point out, May is the first British prime minister to visit Kenya as head of state since Margaret Thatcher was in office.
While UK stocks struggled, the S&P 500 enjoyed a strong week on a combination of positive corporate news and the confirmation of a trade deal between the US and Mexico. In fact, the S&P 500, Nasdaq and Russell 2000 indices all clocked record closes midweek.
The United States Department of Commerce reported that its most all-inclusive measure showed after-tax profits at US companies rising 16.1% in the second quarter (annualised). It said the profits were the result of both the president’s tax-cuts package in November last year and of the economic growth rate, which had beaten expectations. The figures highlighted the growing fissure between stellar corporate profits in the US, and increasingly sluggish results in much of the rest of the world – a fissure that is well-represented on stock markets too.
“It’s hard to see how companies can continue to deliver the type of earnings growth they delivered in the first half of the year,” said Chris Ralph, chief investment officer at St. James’s Place, speaking live on CNBC. “It is going to be harder for equities to retain the momentum they gained in the first half of the year.”
But perhaps the signal event of the week came in the form of a phone call between the US and Mexican presidents – the latter only recently elected to office. As a result, the two countries were able to agree a successor deal to the North American Free Trade Agreement signed under Bill Clinton, a treaty for which Donald Trump has repeatedly expressed contempt.
The new deal is not wildly different but does introduce a few new rules that favour the US: stronger rules on Mexican car exports to the US (e.g. 75% of the contents must be US-made); a new sunset clause (i.e. the power to review and exit) after six years; and new intellectual property protections. (Moreover, the US made no promises to drop tariffs on steel and aluminium imports from Mexico and Canada.) The Mexican president said he would look forward to celebrating the new deal over a glass of tequila with the US and Canadian presidents. Negotiators missed the Saturday deadline for a deal with Canada, but talks were then extended rather than ended.
Thus far, markets have been relatively sanguine about the outcome of recent trade tussles, suggesting investors believe workable arrangements of some kind will continue, even if they are less than optimal. The boost from the US–Mexico deal was real but muted. But that is not to say that investors are simply ignoring developments.
“The ebb and flow of global risk appetite in response to macro considerations and geopolitics continues to drive the fortunes of the global corporate bond market above more traditional factors,” said Scott Service of Loomis Sayles, manager of the St. James’s Place Investment Grade Corporate Bond fund. “The Trump administration’s focus on trade imbalances with China, as well as with Mexico, Canada and the EU, has been causing consternation across both equity and credit markets. Markets have not adequately priced in much of a downside scenario… increased volatility ahead of the US midterm elections in November could be in the offing.”
Trade tension is not the only pressing concern in emerging markets. Last Thursday, Argentina raised interest rates from 45% to 60% in a bid to stem the precipitous slide of the peso. On Wednesday, the Argentinian president had asked the IMF to expedite its $50 billion bailout payment, sparking a further sell-off; it continued despite the rate rise – the peso has lost half its value versus the dollar this year. Buenos Aires’ troubles echo those of Ankara. The crucial difference is that the Turkish president has expressed hard opposition to rate rises, unnerving investors. Troubles across both markets last week hit emerging market equities more broadly.
Tax relief countdown?
The prospect of a UK Budget in November might seem mundane by comparison, but it could see important changes to the tax system. The latest public finances data came in with a better surplus than expected, and there are high expectations for increases to spending, especially on the NHS. While the unexpected surplus provided an extra £10 billion, the chancellor needs to find the same amount again to meet NHS commitments.
Last week it emerged that Philip Hammond is again considering making cuts to higher rate pension tax relief: £38 billion is paid out annually via the relief, making it an attractive raiding target. There is speculation that the move might only focus on those who put tens of thousands of pounds into their pension each year.
But last week also saw the Centre for Policy Studies, a leading think tank, call for the abolition of pension tax relief altogether. Although the future of pension tax relief has been the subject of previous speculation, those in a position to do so would be well-advised to use their allowances while they can.
Loomis Sayles is a fund manager for St. James’s Place.
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