Writing on the wall?
The prime minister could surely be forgiven a little self-pity after the ordeal that was her Conservative Party Conference speech last week. She might have got over the prankster handing her a P45 (‘from Boris’) and perhaps even the persistent cough that interrupted her delivery. But when the letters of the party motto started dropping down behind her, it felt like the writing was (mostly) on the wall. Even some Tory MPs believed that little of her credibility remained at the end of the day – one former minister went on record to say so.
Traders apparently shared their concerns. The pound quickly fell more than 2% after the speech and refused to arrest its descent over the remainder of the week. However, the weaker pound did at least help stocks, as Tesco posted encouraging results – the FTSE 100 ended up 2%, close to an all-time high. The yield on 10-year gilts rose over the five-day period. Beneath the headlines, the prime minister promised £10 billion for homebuyers and pledged a tuition fee freeze.
Yet there was much for markets to worry about beyond the prime minister’s speech. Ahead of the release of a report by the Office for Budget Responsibility (OBR), it emerged that the chancellor is due to lose around two thirds of his budgetary slack (which currently amounts to £24 billion). The OBR report will say that it has overestimated UK productivity gains for seven consecutive years and is therefore dialling down its forecast this time around – even though in August the UK posted its lowest budget deficit since before the global financial crisis. The institute has already estimated that Brexit will cut the public finances by £15 billion a year to 2021.
Meanwhile, the Bank of England warned that lending to businesses could dry up after Brexit because not enough preparations are being made by companies in the EU to continue operating in the UK after March 2019, given the reauthorisations required post-exit. The London Mayor added his own warnings.
Indicators in the UK did not help the wider mood. Construction indicators suffered their first dip in 13 months – a construction recession could be imminent, according to the latest estimates. There was also a slowdown in UK manufacturing. Services, however, expanded modestly, although new business growth struck a 13-month low. In a report published last week, Capital Economics calculated that the current figures point to headline growth remaining sluggish in the third quarter: “Nonetheless, household spending may have regained some momentum, with retail sales volumes posting a solid rise in August… with survey indicators pointing to export and business investment growth picking up pace, the economy could see a slight acceleration over the coming quarters.”
Yet if politics obstructed the view in the UK, investors globally were largely focused on other issues. September was the 11th consecutive month (i.e. since Trump’s election victory) in which the S&P 500 avoided posting a negative return – since 1928 some 38% of months have seen a decline. One more month of gains and it will be the longest run in almost 90 years.
Last week the index rose a further 1%, striking a new record high. While some onlookers believe markets have entered the hubris stage, it is hard to argue with corporate earnings, especially in the US – last week PepsiCo added its own good news to the roster. In the first quarter of 2017, US earnings growth was 13.9% (annualised), while last quarter it was 10.3%. Even indications of a tougher season in the current quarter may be linked to short-term factors – the energy price flattening out and the impact on insurers (discomfiting as it is to think in this way) of the destructive hurricanes to hit the Americas. Yet the most immediate market impact of the hurricane came last week when Donald Trump tweeted that “you can say goodbye” to Puerto Rican debt in the wake of Hurricane Maria – the value of the nation’s government bonds instantly halved in value. The hurricanes may also lie behind Friday’s payrolls data, which showed that US employment had fallen (albeit by just 33,000 jobs) for the first time in seven years.
Japan’s stock market continued its own rise last week too, striking a new two-year high on Tuesday. The Nikkei 225 rose by an impressive 1.6% last week, despite ongoing uncertainty around the forthcoming Japanese election. The rise took almost all Japanese sectors with it, although utilities and healthcare led the charge. Meanwhile, stocks in mainland China hit a two-year high, helped by a central bank decision to ease regulation on domestic banks and by strong domestic manufacturing levels. Of course, investors do not have to worry about elections in China, but many are focused on the five-yearly meeting of the Communist Party of China starting on 18 October, when the ruling party will enunciate the strategic and economic priorities for the world’s second-largest economy in the coming years.
While corporate earnings offer their own reasons for the relatively strong performance of markets in recent months, there has been a good deal more to it. It has been a strong year for global growth, as emerging markets and Europe have both picked up. Figures released last week showed that Europe’s economic recovery strengthened further in September, while the Markit survey of companies across the eurozone showed corporate sentiment striking still higher and rising at its fastest rate in four months. Job creation, meanwhile, came close to its highest level in a decade.
Investment in the eurozone was €563 billion in the second quarter, new figures showed – the first time it has surpassed the level it reached in the first quarter of 2008, just as the crisis was about to unfold. Investment across the eurozone rose 3.5% (annualised) in the quarter, according to the ECB. Germany’s DAX index struck a new all-time high last week, while the Eurofirst 300 rose 0.37%.
Even the possibility of a constitutional crisis in Spain failed to dent confidence. Early last week the Spanish king took to national television to push for calm and denounce the Catalan referendum. The local government held back from declaring independence within 48 hours of the ‘Yes’ vote, as agreed by its parliament prior to the vote, but pledged to make a declaration in the near future. The IBEX 35, Spain’s main index, dipped 2% after the referendum – hardly disastrous, although the index has limited exposure to Catalonia.
Meanwhile, the European Parliament voted to recommend that the European Council does not permit Brexit negotiations to move to phase two – as scheduled – due to failure to conclude all the business that forms part of phase one. The Council will meet on Saturday but, as things stand, talks look unlikely to progress quickly to trade, as formerly hoped. The next Council meeting will take place in December.
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