Market Bulletin - Guns and steel
Positive US jobs numbers and a dovish Fed Chair stood in marked contrast to sabre-rattling by China and the US.
China may have been producing steel more than 2,000 years ago, but it was in Britain that modern steelmaking began in the 1850s. Last week in Mumbai, the board of Tata announced its decision to sell off Britain’s largest steel producer, the direct employer of some 15,000 workers – potentially another sign of Britain’s industrial age entering its sunset years. Behind the problems lies Chinese industrial policy.
Steel overproduction in China has led its manufacturers to put up a surplus of cheap steel for sale on world markets, a practice known as dumping. By the end of the week, unions and EU politicians alike were blaming the UK government too, as the latter has led opposition to the EU’s imposition of anti-dumping steel tariffs since 2013.
Nationalisation has been ruled out, but Indian businessman Sanjeev Gupta is reportedly in talks with the government about a possible purchase – the sizeable pensions liability could be a stumbling block. As if on cue, another disappointing UK Markit Manufacturing Survey was published last week, and fell significantly below expectations. Continued weakness in export orders suggests troubles in UK manufacturing may not be over yet. The price of steel remains far below its mid-2014 peak.
Services presented a very different picture, as figures released by the Office for National Statistics showed the sector had enjoyed a twelfth consecutive quarter of growth – accounting for 80% of the UK economy, it is now the only major sector that is bigger today than it was before the financial crisis.
Figures for UK GDP showed growth in the last three months of 2015 was stronger than expected. The news was overshadowed, however, by a spike in the UK’s current account deficit, which measures the economy’s monetary inflows and outflows. The deficit has reached 7%, its highest peacetime level since the Bank of England started keeping records in 1772. Overseas earnings may be the major headwind, but holding the worst current account deficit among OECD countries in the run-up to a referendum on membership of the European Union is far from ideal. Balance sheets at UK plc, on the other hand, look in finer fettle.
“The majority of the companies we see have seen their profits are improving and their balance sheets are in really great shape,” said Richard Pierson of AXA Framlington Investment Managers. “There's not a huge amount of earnings growth out there but businesses in general feel happy about what they are doing.”
The FTSE 100 ended the week up 0.65%, as mining stocks enjoyed a rally. Among the index’s more gentle risers was Sainsbury’s (up 0.36%), which last week agreed to spend £1.4 billion buying up Home Retail, owner of the Argos chain. In a challenge to traditional supermarket retail models, Sainsbury’s has announced plans to open Argos stores in many of its outlets.
Last week, factory indices for the maker of half the world’s steel delivered encouraging news. China’s official manufacturing purchasing managers’ index came in at 50.2 for March (where 50 indicates no change), far better than had been predicted by participants in a Reuters poll. That returns the sector to growth for the first time since July. It also helps quell lurking fears about a manufacturing crisis – China’s February PMI result was its worst since 2011.
Nevertheless, the steel sector continues to loom large among China’s troubles. Last week, a major state-owned steelmaker in China’s northern ‘rust belt’ defaulted on its $131 million corporate debt following the suicide of its chairman. Beijing is attempting to close zombie commodities producers, but in doing so it hazards simply passing the risk on to its troubled banking sector.
Worryingly, Chinese copper stocks have reached record highs, after the metal price reached a six-year low in January. China has now stockpiled 400,000 tonnes of copper (worth more than $2 billion). But miners and manufacturers are suffering everywhere – in March, miners around the world bought back some $2.5 billion of debt, in an attempt to reassure markets over their leverage levels.
One area of Chinese manufacturing enjoying a tailwind is defence. Last week two Chinese firsts were announced: its DF-41 missile will enable it to target anywhere in the US with a multi-warhead ballistic missile, and a military base in Djibouti gives the People’s Liberation Army its first foreign base. China has not enjoyed such military significance since the gunpowder age. The country’s President was in Washington last week for a nuclear summit, where Barack Obama has nuclear ambitions of his own – to persuade the US Senate to approve a $1 trillion upgrade of the US nuclear arsenal.
Emerging markets received a friendlier message from the Chair of the Federal Reserve last week. In a speech to the Economic Club of New York, Janet Yellen chose to focus not on positive labour figures but on lagging inflation and, especially, on global headwinds, an approach reckoned to be a pretext for Fed inaction. She said the central bank should proceed with caution in raising rates, a pronouncement which offered stocks a boost, not least in emerging markets.
The S&P 500 rose 1.3% last week, boosted by Labour Department news on Friday that the economy had added 215,000 jobs in March – more than expected. Wage growth remains unspectacular, and energy and telecoms stock suffered, amid signs that energy companies are reducing dividend payments. The Nikkei 225 ended down 4.9%, partly on stronger yen; the business climate in Japan’s manufacturing sector is at a three year low, according to the Bank of Japan.
Like Japan, the eurozone has been struggling with deflationary forces – both central banks have adopted negative rates in a bid to address the issue. Last week, inflation across the eurozone rose slightly to -0.1%, but it remains too early to call it the start of an inflation recovery. The FTSEurofirst 300 ended the week down 0.79%.
Spanish for default
Last month, foreign inflows to emerging markets reached a 21-month peak of $36.8 billion, according to estimates by the Institute of International Finance. While the MSCI World index rose 5.2% in the first three months of the year, the MSCI Emerging Markets index jumped 9.8%. Inflows have even headed for Brazil, last month’s headline laggard due to a mix of deep recession, bad debts, high commodity exposure, and the prospect of an impeachment of the President for corruption.
Commodities continue to struggle, however, and despite hedge funds placing plenty of bets on the oil price rising in the near future, Brent crude ended last week below $39 a barrel. Emerging markets are doubtless not out of the woods quite yet, but last week there was good financial news from Argentina, as the Senate voted to allow Mauricio Macri, the country’s reformist new President, to issue Argentinian sovereign bonds once more.
In return for agreeing to a $6.5 billion cash payment for four holdout creditors it still owes money to, Argentina will finally return to capital markets after a 14-year wait. Long a byword for default (‘impago’ in Spanish), Argentina has suffered eight since it won independence in 1816. Now it has permission to press ahead with a $12 billion fundraiser. As Brazil continues to slide, its largest neighbour is in the ascendant.
AXA Framlington Investment Managers is a fund manager for St. James’s Place.
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