Market Bulletin – Financial Alchemy – 25th June 2018

Bond yields rose in the US and Italy on economic and policy news, while markets were buoyed by oil striking a three-year high

When it comes to Europe, investors prefer monarchies, or so said a study by CMC Markets. If correct, it would presumably mean Saturday’s Windsor nuptials – which cost taxpayers around £30 million – were a good long-term investment; the squads that faced off in the FA Cup Final a few hours later are worth a combined £3.3 billion.

Theresa May wasn’t at either event, but perhaps had enough on her plate. Having long criticised Labour’s nationalisation policies, the government last week nationalised the East Coast Mainline. Moreover, the prime minister finally conceded the possibility of a customs union – using the EU’s common external tariff – should no solution to the Irish border issue be found by 2021. The EU says that the UK government needs to make “substantial progress” over Ireland at the European Council summit in June, in order for Brexit talks not to stall.

The Irish Taoiseach warned on Friday that he was “yet to see anything that remotely approaches” a way out of the current deadlock. Moreover, Holyrood voted to reject the UK’s Brexit legislation by 93 votes to 30, meaning that Theresa May will now need to push through the European Union (Withdrawal) Bill without Scottish support.

The UK’s economic trajectory may not be on her side. Last week, Ben Broadbent, deputy governor of the Bank of England, said that the current dip in growth and wages resembled the lull experienced at the end of the 19th century – shortly before the age of electricity began. Broadbent said that, with the digital boom now passing its peak, another economic upswing might have to wait on the next major breakthrough, such as artificial intelligence (AI).

Meanwhile, the corporate world showed several signs of answering his challenge. HBSC announced the first trade finance deal using blockchain; Ubtech, a Chinese robotics company, secured $820 million in new funding, the largest amount ever raised by an AI company; and Australia’s Titomic unveiled what it called the world’s largest and fastest metal printer – the size of a bus, the device can print a bike frame in around 25 minutes.

Food and fuel

Yet stocks in the UK were buoyed by earthier matters, notably crude oil. Last week, the price of a barrel of Brent crude rose above $80 for the first time in three-and-a-half years, on instability in Venezuela and plans for US sanctions on Iran. The energy-heavy FTSE 100 struck a new record high, but ended the week up just 0.4%. (It then surged to a new high in early Monday trading, as investor fears of a US–China trade war receded.)

One disappointing sector in recent months has been retail, and ministers last week called for the competition watchdog to investigate the proposed Asda–Sainsbury’s merger. Yet there was better news for Ocado which, despite plenty of siren voices on markets, last week announced a landmark tie-up with Kroger in the US. Ocado, the UK online supermarket, saw its share price briefly rocket 81%, and it still ended the week up more than 40%.

“The UK has de-rated and is unloved by international investors,” said Chris Field of Majedie Asset Management. “But UK shares have only been cheaper once in the last ten years – and that was during the financial crisis. A lot of bad news is now priced in, which means it’s a good time to be finding deals.”

Disappointing retail figures are just one of the reasons why investors don’t expect the Bank of England to raise rates in earnest. In fact, analysts at Berenberg last week said that the UK might well face low rates for another decade, as those in their 50s and 60s slash spending to save up for retirement. The resulting hoarding of cash will keep rates down, making it all the harder for savings accounts to beat inflation. Meanwhile, a report released by Royal London showed that the average person will need £260,000 for retirement to fund a basic income – and £445,000 if they can’t buy property and continue to have to rent. FCA figures released last week showed that the amount of money moved out of final salary pensions schemes more than doubled in 2017 to £20.8 billion; the decision to sacrifice guaranteed retirement benefits should not be taken without due consideration and advice.

Investors were more interested in US retail figures, however, which showed that April was yet another healthy month for sales. Macy’s raised its full-year profit forecast as same-store sales rose 4.2%; Walmart’s online sales jumped by a third. The trend hints at a reasonable second-quarter growth rate in the world’s largest economy (although a dip on Friday for utilities stocks left the S&P 500 down half of one per cent for the week). Retail positivity also contributed to markets now pricing in four interest rate rises in 2018 – up from three just a few days ago. Both factors contributed to a further rise in the yield on the 10-year Treasury – the ongoing rise in the yield has been the story on US markets in 2018. US government debt last week struck its highest yield – or lowest price – in seven years, as the US potentially moves into a later stage of the economic cycle.

“US and European interest rates are likely to continue to diverge into mid-2019 but to start converging after that,” said John Higgins, chief markets economist at Capital Economics. “We believe US rates will rise faster than markets expect in the near term but will then be loosened in 2020 – eurozone rates should only start rising in 2019.”

In former times, rising Treasury yields – which have the effect of lifting the cost of borrowing more broadly and of pushing up the dollar – have been negative for both smaller companies and emerging markets (EMs). Yet the Russell 2000, an index of smaller stocks, is on a tear. EMs, on the other hand, have suffered as the value of their dollar-denominated debt has risen; nevertheless, growth across EMs remains strong.

As the US debt yield rose last week, so it moved to its cheapest versus German Bunds – 10-year German government debt – since German reunification. Yet while US yields rose, the pace of their ascent looked sluggish compared to their equivalent in Italy, where the 10-year yield saw its biggest weekly jump in more than a year. Events in Rome last week were certainly unusual; the mayor proposed bringing sheep into the city’s parks to deal with its overgrown grass, only for political opponents to suggest camels or giraffes instead.

More importantly for markets, however, details emerged of a coalition deal between the Northern League and Five Star Movement. The parties call for the “freezing” of around €250 billion of Italian debt and floated the possibility of an exit from the euro if the EU’s stability and growth pact couldn’t be reformed. As government debt yields rose in response, the parties accused markets of attempting “blackmail”. The FTSE MIB, index of Italy’s stocks, dropped by 3%, hit especially by its heavy weighting towards banks, which own a lot of Italian government debt. Yet the index remains the best performer in the eurozone across 2018, despite Italy’s lack of a monarch.

Past performance is not indicative of future performance.

Majedie Asset Management is a fund manager for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

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