Market Bulletin – Norman Conquest – Monday 3rd September 2018

This week Brexit negotiations returned to the fore in the UK, and the 2018 Budget appeared on the horizon. Meanwhile, US stocks performed strongly following a combination of positive corporate news and the confirmation of a trade deal between the US and Mexico.

Brexit uncertainty

This week’s ‘scallop skirmish’ off the coast of Normandy could perhaps be seen as metaphor for the Brexit negotiations – the British vessels were outnumbered by French fisherman by seven to one, similar to the relative sizes of the economies of the other EU countries versus that of the UK. It was perhaps unsurprising, then, that Brexit secretary Dominic Raab expressed weariness this week, questioning whether a deal could be struck next month as initially planned.

The Head of Keidanren – Japan’s leading business lobby who represent 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. However, markets apparently saw things differently, with the sterling’s largest daily rise against the dollar in two months.

Two encouraging signs came from the French President and Michel Barnier, the former saying that France is “prepared” to help forge a deal with the UK after Brexit and that he would tell EU leaders as much. Furthermore, after a meeting on Friday between Brexit secretary Dominic Raab and Michel Barnier, it was claimed that 80% of the withdrawal agreement is now worked out, and that a deal might be ready for the October summit, despite ongoing areas of discord.

There was, however, a further setback for the PM 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 also made the strength of his opposition to the plan plain in a newspaper column.

Tax relief countdown?

Compared with the turmoil of Brexit negotiations, the upcoming UK Budget might seem less exciting, however here at Wellesley we are interested in the potential changes to the tax system that might occur. This week, the latest public finances data showed a better surplus than expected, providing an extra £10 billion, and there are high expectations for increases to spending, especially on the NHS.

It has emerged that Philip Hammond is again eyeing up making cuts to higher rate pension tax relief: it is undeniably an attractive target, with £38 billion paid out annually via the relief. 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 leading think tank, the Centre for Policy Studies, call for the abolition of pension tax relief altogether. Although the future of pension tax relief has been the subject of previous speculation, at Wellesley we would advise those in a position to do so to use their allowances while they can.

Losing ground

Despite a promising start to the week, the FTSE 100 soon lost ground, hitting a two-week low. This could be partly down to the initial rise in sterling, which made companies’ non-UK earnings less valuable in sterling terms. One company notably bucked the trend – Whitbread 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 to boost the UK’s trade and investment prospects following Brexit, with a three-day tour of sub-Saharan Africa. 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. The tour was undeniably a statement of intent; May is the first British Prime Minister to visit Kenya as head of state since Margaret Thatcher.

Across the pond

While UK stocks struggled, the S&P 500 enjoyed a strong week, and the Nasdaq and Russell 2000 indices also boasted 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), and said the profits were the result of both the President’s tax-cuts package and of the economic growth rate. The figures highlighted the growing fracture 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.

Chris Ralph, Chief Investment Officer at St. James’s Place, commented: “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. It is going to be harder for equities to retain the momentum they gained in the first half of the year.”

Tequila toast

But perhaps the most-discussed event of the week came in the form of a phone call between the US and Mexican Presidents, agreeing a successor deal to the North American Free Trade Agreement. This in turn helped to further bolster the S&P 500.

The new deal is not wildly different but does introduce a few new rules in favour of 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.

Markets have been relatively confident 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.”

Troubles in emerging markets

Trade tension is not the only pressing worry 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. Argentina’s troubles echo those of Turkey. 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.

Loomis Sayles 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 or Wellesley.

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