Market Bulletin - Art of the deal
The global bull run entered its tenth year, as Donald Trump confirmed his tariff plans, and accepted Kim Jong-un’s invitation to a summit.
Although fighting only lasted from 1950 to 1953, the Korean War has technically never ended. The continuing tensions made the opening ceremony of last month’s Winter Olympics all the more remarkable, as representatives of North and South Korea entered jointly, clutching a single Korea Unification Flag. Last week, the rapprochement continued as Donald Trump, erstwhile Twitter critic of Kim Jong-un, accepted Pyongyang’s proposal for talks. The North had dangled the carrot of a potential end to its nuclear programme, which may have been enough to sway the White House.
Despite the Korean thaw, the US president appeared to be losing friends elsewhere. Last week, he formally signed off on a decision to place tariffs on imports of steel and aluminium products. The immediate impact of the move should not be enormous, particularly as he offered up the possibility of concessions to “our friends”. (It was widely assumed he was referring to Mexico and Canada, with which the US is seeking to negotiate a new NAFTA deal – he was surely not referring to China.) Tariffs are part and parcel of many international trade deals and clubs; most onlookers were more concerned by the direction of travel that the move implied. Gary Cohn, the president’s senior economic adviser, quit the White House in response, thereby rebalancing the president’s economic team away from globalisation and towards protectionism.
The slightest sign of a market-friendly concession – in this case, Donald Trump’s “friends” offer – tends to have a rallying effect on markets; so it was last week. Other factors were more important, however, not least the Friday payrolls report that eased investor anxieties over a spike in US inflation while also showing strong jobs numbers. The last trading day of the week was also a landmark moment, as the current bull run turned nine years old. Last week, the S&P 500 rose almost 4 %; over the course of the current bull run it has rallied by more than 500%.
Stocks in the US have plenty of healthy tailwinds, among them solid growth, low unemployment, buoyant corporate earnings and, more recently, a surging shale oil sector. Since OPEC agreed production cuts a few months ago, thereby pushing up the price of oil, the US’s shale oil industry has been ratcheting up production. Figures released by the Energy Information Administration last week showed that the US oil sector is far outpacing growth expectations; in February, it produced 10.3 million barrels per day. That’s more than half what it consumes – and an extra 800,000 barrels per day in just six months. The dollar price of a barrel of Brent crude has remained in the 60s over the past month.
While relations improve between the two Koreas, the prospects of a political deal on the Italian peninsula appear to remain some way off. The insurgent success of two radical political parties, Five Star Movement and Northern League, has redrawn Italy’s political map; and last week the centre-left party of Matteo Renzi rejected the Five Star Movement’s coalition proposal. As a result, uncertainty persists; Brussels in particular is concerned that both populist parties are Eurosceptic.
Yet stocks in Italy, and across Europe more broadly, enjoyed a positive week, tracking the global market recovery from the correction of a few weeks ago. The MSCI Europe ex UK rose more than 3% last week. Despite the political uncertainty in Rome, investors last week were more interested in parsing the words of the Italian who runs the European Central Bank. When Mario Draghi’s team released its council meeting statement, it was widely noted that the ECB had dropped its explicit commitment to respond to any growth slowdown by expanding its bond-buying programme. Draghi then used the press conference to soften the blow.
The EU also gave the press plenty of Brexit commentary to chew over. Meeting with the Irish Taoiseach in Dublin, Donald Tusk said that Ireland was the priority issue for the EU in negotiations. Meanwhile, the UK government finally released its Brexit impact assessments. As expected, these showed a hit to future growth under all the scenarios considered, ranging from 2% to 8% of GDP. There was positive content all the same: some of the modelling for a trade deal outcome had actually assumed a more distant relationship than the EU itself has recently proposed, while it is likely that some tariffs should be lower than the report suggested, so long as London and Brussels can cut a deal on fishing. However, the report forecast a £60 billion hit to the public finances, effectively nullifying the £350 million-a-week NHS funding pledge that was plastered across pro-exit campaign buses; £60 billion is double the figure that George Osborne had forecast when he was chancellor. It also envisaged only very limited benefits from fresh trade deals – a US trade deal would boost GDP by just 0.2%, it found.
Donald Tusk also responded to Theresa May’s speech of the week before, and said that her proposal was not feasible, since the UK could not have a single-market approach to only some sectors of the economy. The EU’s own negotiation policy document, published last week, said that the union seeks a relationship that is “as close as possible [but must] take into account the repeatedly stated positions of the UK, which limit the depth of such a future partnership.” It omitted mention of a special deal for financial services, prompting the chancellor to respond that the EU would need the City to remain close. In his own speech, Philip Hammond ruled out the City becoming a mere rule-taker, thereby also ruling out unfettered access to Europe’s large financial market. He said he was holding out for a “mutual recognition” arrangement, although Brussels has said such an outcome is not possible; regulatory equivalence, another possible endpoint, would be “inadequate”, Hammond said.
The recent wave of extreme winter weather has now shown itself in the economic data, as John Lewis put a dip in sales down to the big freeze, while burst pipes afflicted both Cadbury and Jaguar Land Rover. More importantly for UK plc, however, Rolls-Royce announced excellent results for 2017, suggesting it could have turned a corner – its share price ended results day up by more than 10%. It was less good news for online service Just Eat, as its CEO suggested its core delivery service may be growing more slowly. Yet if anything, recent weeks have shown the threat faced by High Street outlets, not digital ones; in recent weeks Prezzo announced the closure of a third of its branches, and New Look said it aims to shut 60.
“Retailers are finding it hard as shopping patterns change,” says Philip Gadsden of Orchard Street Investment Management. “New Look has been a reasonably standard name on the High Street for some time, but a lot of millennials prefer to buy online at, say, Asos or Boohoo. Thus the time people are spending around the shops is falling. What keeps people there is a leisure experience but if people aren’t there in the first place, then a company like Prezzo will struggle to sell Italian meals.”
Over the week as a whole, the FTSE 100 rose by more than 2%. Meanwhile, a Bank of America Merrill Lynch survey of 163 fund managers globally found that UK equities are currently the least popular mainstream asset class amongst foreign investors; although some investors are scenting an opportunity, especially as Brexit terms become clearer.
The government was still enjoying its improved debt numbers last week, but new data revealed that pension liabilities in the UK grew to £7.6 trillion by the end of 2015 – five-year growth of £1 trillion. This will only add to fears that pension tax relief and allowances may soon be targeted by the chancellor.
Orchard Street is a fund manager for St. James’s Place.
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