Bears have always been fond of Icarus. In the old Greek myth, Daedalus crafts wings to enable his escape from Crete with his son Icarus; but Icarus ignores his father’s warning not to fly too close to the sun – and plummets into the sea. Whenever stocks enjoy a good run, it’s not long before Icarus is dusted off once more to act as a warning against hubris.
The current bull run has certainly felt dizzying at times. Last week Japan’s Nikkei 225 struck a 21-month high, rising 2.2% ahead of this Sunday’s general election; the FTSE 100 and the S&P 500 each rose 0.17% and, together with the Dow Jones Industrial Average, posted new record highs; and the FTSE All-World clocked four consecutive days of record highs. Meanwhile, volatility remains low. In 2017, there have only been four days when the S&P 500, the world’s leading index, has dipped by more than 1%. That makes 2017 the calmest year (thus far) for the index since 1994.
Yet momentum has not been confined to the stock market. The IMF last week upgraded its global economic forecasts, saying that output growth would increase from 3.2% last year to 3.6% this year, rising to 3.7% next year. In its World Economic Outlook, the global body noted the recent pick-up in activity in all major Western countries except the UK, although it also offered a warning that corporate and consumer debt levels are too high. The OECD, meanwhile, offered its best annual economic forecasts for the developed world since the global financial crisis, with no contractions expected in any major economies. A report published by Bank of America showed that the variability of economic growth across 43 major economies is running at its lowest in more than 50 years. In fact, while developed market growth is reasonable but unexciting, more than 50% of the market return in 2017 has come from emerging markets, in which the economic growth rate has been rising for the first time in seven years. All this will be grist to the mill of Xi Jinping, as he launches the five-yearly National People’s Congress in Beijing this Wednesday.
The current rally has often been described as “reluctant” yet, even on this score, there are signs of change. Thus, in recent weeks, defensive stocks in the US have underperformed energy, materials and industrial companies, suggesting a possible shift in investor mindset.
The IMF was perhaps wise, however, to warn governments against allowing market momentum to make them complacent. Investors should heed the advice, not allowing a rising tide to blind them to the considerable differences between the constituent companies that make up the major global indices. In this light, perhaps it was appropriate that last week opened with the announcement that Richard Thaler had won the Nobel Prize for Economics. Thaler’s work on behavioural economics serves as a useful reminder that, contrary to assumptions, human economic behaviour is not simply rational by default. Rational investing takes work.
All the same, recent market movements have plenty of indicators to support them. Corporate earnings in the US struck double-digit growth rates in the first two quarters of the year. While the third quarter looks set to deliver a humbler set of numbers, much appears to be priced in already. Moreover, some of the damage comes from the impact of recent hurricanes, which have hit insurers. Markets also seemed unfazed last week when JPMorgan Chase and Citigroup posted falls in their trading revenues.
Pain in Spain?
European banks have largely had a good month, and the MSCI Europe Banks Index has risen by a third in the past 12 months. The rise reflects an improvement in broader earnings performance across the continent. The seven-year high puts the European corporate earnings growth rate above that of the US. Sentiment remains strong.
This might seem surprising, given the crisis facing Spain in the form of the Catalonian independence movement. Thus far the Catalonian parliament has held back from its pledge to declare independence. Although Spanish stocks dipped in the immediate aftermath of the recent Catalan referendum, they have since recovered, and the Eurofirst 300 rose 0.42% last week.
“The implications for Europe appear to be rather limited at this stage,” said Stuart Mitchell of S. W. Mitchell Capital. “Remember: the conflict is not about Europe. Recent polls suggest that support for the European project and the euro is approaching 90% across the country. Economically, however, the crisis may have dented business confidence in the country and impacted upon investment within the region. Indeed, almost all the leading Catalan companies have moved or threatened to move their head offices to Madrid. If Catalonia, however, does break from Spain, the implications are more serious. Catalonia would struggle to thrive as an independent republic and Madrid would lose an important source of tax revenues. We have to hope that a compromise can be found that will allow the Catalans more autonomy and yet keep the region as an integral part of Spain.”
Questions also remained last week over how integral a part the UK government wants to play in Europe after Brexit. Theresa May announced that the government was indeed developing a back-up plan for how the UK would manage its borders in the event of not striking an exit deal with the EU. “It is our responsibility to prepare for every eventuality,” the prime minister told the House of Commons. She also disclosed that the European Court of Justice would retain some oversight for the foreseeable future, prompting criticism from some of the Brexit lobby in her own party. Others were perturbed by her refusal, in a radio interview, to confirm how she would vote if a repeat referendum was held today.
Yet her chancellor faced at least as much flak, as some MPs began to push for him to lose his position and be replaced by a pro-Brexit candidate. Philip Hammond also faced difficulties beyond the party, however, in the form of the latest economic indicators. The Office for Budget Responsibility said that it was likely to “significantly” downgrade the UK’s productivity forecasts, following years of over-optimism – a dip would hit the public finances. Meanwhile, the UK’s trade deficit in goods with the rest of the world struck a record high in August, as imports surged by 4.2% (mostly chemicals, machinery and textiles), while exports rose just 0.7%. Adding to the chancellor’s concerns, BAE announced that it was culling 2,000 UK jobs.
If imbalances are a problem for the public purse, they are perhaps even greater for the private purse, particularly when it comes to pensions. Research published by the Pensions and Lifetime Savings Association last week showed that 78% of people did not even know whether they were on track to afford a comfortable retirement. The research suggested that Australian-style targets might help workers to do a better job of building up an appropriate pension. Research by BlackRock showed that only 32% are confident they will have the income they need and only 39% understand how much they need to save.
Nicky Morgan, chair of the Treasury Select Committee, wrote to Hammond last week to warn about potential pension challenges for UK citizens in the EU. “The possibility that UK providers may not be legally able to pay out pensions or insurance contracts to citizens in the EU – including UK expats – is a stark example of the consequences of a cliff-edge Brexit,” she warned. Hammond replied: “The government is alive to the risk that the UK’s withdrawal could in some cases create legal uncertainties as to the status of existing cross-border insurance, pension and other financial services contracts sold under passporting arrangements.”
S. W. Mitchell Capital is a fund manager for St. James’s Place.
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