Expert Voice

The week in review by Ari Towli and Nick Stanhope 04.12.17

Article first published on: 12/04/17 12:10:pm

Markets and key events

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Fortunes diverge within the Global Equity Markets

Global equity markets have diverged this week as investors in the United States (US) have focused on the Republican’s tax bill making its way through the Senate, bringing cheer to investors who have led US equity markets to fresh record highs. This was despite North Korea firing a ballistic missile which it claimed put the entire of the US within range. Chinese equities started the week where they left off, falling further on concerns over a regulatory crackdown on leverage levels, with the Chinese CSI 300 index, which measures the top 300 stocks listed on the Shanghai and Shenzhen stock exchanges, down more than 5% since 22nd November.

European stocks were hit by selling pressure on Friday following news at the 11th hour that the Senate’s Joint Committee on Taxation deemed that the Republican tax bill’s growth projections were too optimistic, and requiring it to be reworked and delayed. This was despite the Eurozone reporting the second highest reading on record for the IHS Markit Manufacturing Purchasing Managers Index (PMI), a lead indicator of the health of the manufacturing sector.

There were no significant moves in government bond yields with the 10 year US Treasury currently trading at 2.38%, UK Gilts 1.27% and German Bunds 0.33%. Gold slipped over 1% to $1,278 as the US’s Federal Reserves preferred measure of inflation, the Personal Consumption Expenditures (PCE) price index rose 0.2% in October to 1.4% year-on-year. Within currency markets, Sterling jumped 1.2% versus the dollar and 1.5% versus the Euro on news that the UK has agreed to honour all its financial obligations with the EU provided trade discussions can begin.

As of 12pm London time, the US Standard & Poor’s (S&P) 500 index was up 1.7% over the week, Japanese Topix index up 0.9%, Australian S&P/ASX 200 up 0.1%, whilst MSCI Emerging Markets were down 2.9%, EuroStoxx 600 down 0.6% and the UK’s FTSE All Share down 1.2%.


Hopes of tax cuts keeps US stocks buoyant

This week saw the confirmation hearing before the Senate Banking Committee for Jerome Powell, President Trump’s nominated Chairman of the Federal Reserve, who will replace Janet Yellen at the beginning of February 2018. As widely anticipated, Mr Powell set the stage for business as usual, with expectations of tighter monetary policy, and potential easing of financial regulations. This, combined with rising hopes for the Republican tax bill, helped to boost financials, as investors rotated out of ‘growth’ stocks into the more cyclically sensitive areas of the market. The S&P 500 recorded its longest monthly winning streak since 2007, with eight positive months in succession.

Eurozone lead indicators go from strength to strength

At the end of the week the IHS Markit PMI lead indicators painted a very healthy picture of European manufacturing with all countries in the Eurozone recording improved readings. This is the best performance for the index since the height of the dot-com boom over 17 years ago. However, political events in the US overshadowed financial markets.

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Sterling jumps as UK promises to honour financial obligations

The UK government unexpectedly agreed to cover all its financial obligations with the EU as it attempts to negotiate its exit from the trading bloc, with a potential net cost of £45bn to the UK being suggested.

For the moment, the hard Brexiteers have been surprisingly supportive of this action, designed to unblock the stalled exit negotiations. Sterling jumped, briefly rising above $1.35. Over the year to date, the pound is up over 9% versus the US dollar, and the latest leg up has cut its decline since Brexit to just under 10%.

The FTSE 100 index fell by 1.3% over the week, as overseas earners were negatively impacted by the currency appreciation.
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Australian royal commission rocks financials

The Australian S&P / ASX 200 edged higher this week by 0.1%. The financial sector was flat over the period as major banks recovered some losses after the government announced a royal commission into the entire financial sector. According to Prime Minister Turnbull, the commission, Australia’s highest form of public inquiry, is intended to examine the behaviour of Australia’s banks and other financial services in light of recent misconduct scandals. Shares in Australia’s big four banks, Westpac, National Australia Bank, Commonwealth Bank of Australia and ANZ bank immediately fell by approximately 1% on the announcement before recovering by the end of the week.

Overall the Chancellor was hemmed in by the growth downgrade and the uncertain outlook over Brexit, with the budget not expected to have any significant impact on the economy. Sterling nonetheless strengthened over the week, as hopes were raised that the impasse over Brexit negotiations could be broken. Rumours suggest that the UK is willing to increase its offer to the EU from €20bn to €40bn provided trade negotiations can start immediately.

Whilst the more domestically focused FTSE 250 only fell 0.1%, as hopes were raised for positive trade negotiations. On Friday, the UK’s manufacturing PMI also climbed, rising to 58.2 in November, its highest level in over four years as manufacturers benefitted from the upturn in the global economy and the weaker pound.


OPEC remains committed

On Thursday, OPEC (Organisation of the Petroleum Exporting Countries) and Russia agreed to extend their oil production cuts to the end of 2018. The agreement included Libya and Nigeria for the first time.

Despite this, Brent crude oil declined 0.8% over the week, now trading at $63.3 and US WTI (West Texas Intermediate) fell 1.8%, now trading at $57.9.


Risks to markets

Whilst the global economy continues to perform well, further confirmed today with the release of upbeat Eurozone PMI lead indicators, we continue to consider what might upset financial markets, with high valuations in themselves historically not having been a barrier to rising markets.

QE withdrawal

The withdrawal of quantitative easing (QE) by the US Federal Reserve is also an unknown risk, with the Fed tapering their purchases by $10bn a month currently, rising to $50bn a month by the end of next year, or an annualised contraction of $600bn. This slack needs to be taken up by the private sector, and the appetite for this is unknown, with the ability to apply upward pressure to bond yields and upset financial markets.

Bond yields move inversely to price, with rising yields equalling falling prices.


Of the many risks that investors face, including geopolitical tensions, we believe that rising inflation is the most obvious risk. However, inflation remains subdued relative to history, especially when you consider how low unemployment has reached in countries such as the US. There is a live debate today over the causes of inflation, with monetarist economists claiming it is the growth of money supply and credit that is significant, with both remaining under control, and factors such as unemployment just being coincident indicators, not the cause.

We remain constructive on financial markets, but cannot help but concede that the risks to investors are rising.

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