Market Bulletin - Anxiety lull
Market volatility hit a two-decade low as investors continued to take politics in their stride – and looked to growth and earnings.
“All shall be well, and all shall be well, and all manner of thing shall be well,” wrote Julian of Norwich, the first woman to pen a book in the English language, around 1395. Markets last week appeared to agree, albeit for less spiritual reasons than the East Anglian anchoress. The FTSE 100 recorded its strongest week since December, gaining 1.9% to strike a record high. Yet the more significant landmark lay elsewhere: after 12 months marked by one political surprise after another, volatility on the world’s leading index last week struck its lowest level since December 1993. The VIX, which measures volatility on the S&P 500, dipped to a closing low of 9.77 on Monday, not far off its record-low close, set in 1993 – VIX’s long-term average is 20.
The S&P 500 was no outlier. In fact, volatility is currently at the lowest it has been for some years across bonds, currencies and commodities too. There are major political hurdles ahead, but markets appear either to have taken the view that they have already weathered the biggest challenges, or that some of their former anxieties were overwrought. Fear, it seems, has been unwinding.
Yet politics was far from mundane last week. In the US, Donald Trump sacked James Comey, director of the FBI, initially claiming that he had done so because of Comey’s handling of the Hillary Clinton email probe. Democrats accused the president of sacking him because Comey was investigating Trump’s ties to Russia, and had recently requested more funding for the probe. If Democrats win back Congress at the midterm elections, due in 18 months, Trump may yet rue his decision.
In Europe, meanwhile, the election victory of Emmanuel Macron, who was sworn in as president on Sunday, helped take stocks to a 20-month high; but attention then turned in short order to the challenges Macron now faces, and the Eurofirst 300 ended the week up just 0.4%. Brussels warned last week that Paris needs to rein in spending as French state finances were in a worse state than previously thought. The European Commission’s latest forecast puts France’s budget deficit at 3% this year – the maximum allowed – and 3.2% next year. Moreover, the country’s national debt will be 97% of GDP, the projections showed.
Jean-Claude Juncker, speaking in Berlin, warned that “the French spend too much money and spend it on the wrong things”. Moreover, any hopes that Germany might be more relaxed towards France on EU spending rules (perhaps to boost France’s new pro-EU president) were quickly, and publicly, batted down by Angela Merkel. Yet political jostling and a disappointing eurozone labour market report did not seem to trouble investors, as a record $6.1 billion flowed into European equities over the five-day period – and new figures showed German economic growth gaining momentum, as Angela Merkel’s party won two bellwether regional votes.
One vote that barely appeared to register on markets last week was the forthcoming general election in the UK. Last week Theresa May made a bid for the centre ground with a pledge to set a ceiling on energy prices, a move David Cameron had described as “Marxist” when Ed Miliband proposed the measure last time around. Furthermore, the prime minister proposed a significant overhaul of workers’ rights, which could yet have major implications for business owners. There was also news that Downing Street is looking at raising post-death tax rates in order to pay for social care, another bid to attract the working classes and address the growing financial generation gap.
Yet leaving aside the Liberal Democrats, it looked like May might be left free to roam the centre ground alone. The Labour Party manifesto, which was both leaked and published last week, promised £250 billion of extra borrowing, with plans to renationalise rail and several energy sectors, and to enact substantial spending increases for health and education. Those earning more than £80,000 were also targeted for significant tax rises. Such radical attempts to address inequality may appeal to Corbyn’s base. Yet in the UK more broadly, which sits to the political right of the great majority of developed countries (the US being the most important exception), it is an ambitious message, to say the least. The question most pundits are asking, perhaps unsurprisingly, is how large the Tory majority will be.
Meanwhile, the Bank of England chose to leave interest rates on hold, but warned that UK prices would outpace earnings in the coming year due to the referendum vote – causing real incomes to fall. Mark Carney also said that the Bank might have to change its rate policy quickly in the event of the UK not making a deal with the EU on its exit. He will have been pleased, no doubt, by the mollifying words of Guy Verhofstadt, lead Brexit negotiator for the European Parliament, who wrote last week of the importance of a good EU–UK deal, and by US officials’ comments that the EU might face US retaliatory action if it forced all euro clearing (which London currently dominates) into EU countries after Brexit. He may have been less pleased by EY research published last week, which said that more than a quarter of the 222 largest UK financial services firms will shift resources or change domicile out of London as a result of the referendum result – up by 50% in four months.
Yet Neil Woodford of Woodford Investment Management believes that the UK economic outlook is largely positive, and has been further buoyed by Theresa May’s decision to call a general election. “Since the Brexit vote last June the market consensus has become increasingly cautious about the outlook for the UK economy and I think investors have become far too pessimistic… [about] the impact of the decline in the currency and its impact on inflation… and equally [about] the sort of business and consumer confidence environment going forward up to the Brexit impact date in nearly two years’ time,” he said.
Woodford is also encouraged by the normalising credit environment, which he views as a new and positive dynamic for the UK economy, and which has led him to invest in some banks. “The bearish consensus has resulted in some very big share price falls in some domestic cyclical sectors and that’s offered up some really interesting opportunities.”
Aside from the relative absence of fear on markets – call it confidence or complacency, depending on your view – there was also plenty of good news to be had, notably in the US. The S&P 500 crested above 2,400 points for the first time in its history, although it ended the week down 0.4%, partly on disappointing consumer prices figures. Nevertheless, jobs numbers and corporate earnings in the US offered plenty of highlights – jobless claims have had their best run of figures in almost 50 years.
As earnings season drew to a close, the technology sector could look back on a particularly strong period, albeit one marred by a sustained volley of debilitating cyber-attacks carried out around the world via a single form of malware last Friday. Apple became the first US company to top $800 billion in value, having risen by almost a third this year. The FANGs (Facebook, Amazon, Netflix and Google) have also enjoyed a strong year, and strong results.
In short, the global economy continues to improve, the profitability of the corporate sector is growing, central banks remain supportive (in broad historical terms) and some of the largest political risks have subsided in recent months. New fears will undoubtedly rise before too long but investors seem to believe that, for the immediate future at least, all shall indeed be well.
Woodford Investment Management is a fund manager for St. James’s Place.
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