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Rathbone Weekly Commentary

Market Commentary
Commentary By: Rathbone Unit Trust Management Limited
Commentary Date: October 16, 2017

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Brexit bluffs

Britain and Ireland are braced for Hurricane Ophelia, but the UK Cabinet’s attention is likely to be firmly fixated on Brexit this week.

To be fair, Brexit has been seemingly the only thing the Government has been able to focus on since the election. Everything else is subordinate to it. Despite all this attention, four months of discussions has led to a deadlock. On Thursday, European Union (EU) chief negotiator Michel Barnier will update leaders of the bloc on the negotiations and formally give his conclusion that discussions on the future relationship between the UK and the EU shouldn’t begin. Meanwhile, Shadow Chancellor John McDonnell says Labour is trying to gather support from moderate Conservatives for a parliamentary veto on leaving the EU without a deal. Prime Minister Theresa May will be lobbying desperately for some kind of compromise from Germany or France to break the deadlock and start building a deal.

With every passing week, the UK’s attempts to leave sink further into the morass. Who has the upper hand? Does the UK need Europe more than the Continent needs it? Which side has to blink first? Whoever you talk to will have a forceful answer one way or the other. Yet no-one knows for sure – such a dramatic disentangling of government, trade and laws has never been tried in modern times. The most worrying aspect for us: the current situation looks a lot like a high stakes poker match where neither player knows its own cards, let alone those of the guy across the table.

Anglo-EU machinations aren’t the only political game in town, however. Japan’s snap election will be held on Sunday, with Prime Minister Shinzo Abe, of the Liberal Democratic Party (LDP), fighting a newly combined opposition. The LDP’s main rival, the Democratic Party, has merged with the newly launched Party of Hope in an attempt to oust Mr Abe. It looks like Mr Abe’s coalition government will win another term, however.

The Chinese Communist Party Congress starts this week. Every five years the nation’s movers and shakers meet to reappoint its leaders and set out priorities for the next term. It will be the first conference run by President Xi Jinping and it is overwhelmingly believed that he will retain control by the end. New Chinese leaders tend to spend their first five years of control unpicking the tentacles of the previous leadership, consolidating power in order to carry out their agenda in their second term. Now that Mr Xi has an iron-grip on power, we believe he will start to steer the country toward his long-held goals: decreasing debt and increasing reform. This would mean a reduction in economic growth, but – if done well – that growth would be of much greater value to both China and the world.

Total nonfinancial debt in China has risen at an alarming pace for over a decade, while economic efficiency has deteriorated chronically. China’s state-controlled economy has so far avoided any systemic crisis because most borrowing is a pass-the-parcel between state-owned banks, local governments and state-owned enterprises. Calling in debts would mean passing assets from one hand to the other, creating no benefit – only disruption. Side-effects of this debt, from asset bubbles in property and share markets to capital outflows, make the balance between growth and stability increasingly precarious. We would prefer smaller, but more sustainable, growth over a longer period of time.

Index 1 week 3 months 6 months 1 year
FTSE ALL-Share 0.3% 3.2% 5.2% 13.4%
FTSE 100 0.3% 2.8% 5.0% 12.5%
FTSE 250 0.5% 5.1% 5.5% 16.5%
FTSE Small-cap 0.3% 4.8% 7.8% 20.2%
S&P 500 -1.7% 1.7% 3.9% 11.3%
Euro Stoxx -0.7% 3.4% 13.3% 23.4%
Topix 0.2% 4.8% 7.9% 10.0%
Shanghai SE 3.0% 5.4% 1.7% 3.7%
FTSE Emerging Index -4.0% 5.4% 8.7% 15.3%
Source: FE Analytics, data local currency (£) total return to 13 October. 

 

Zero-sum game?

Third-quarter US company earnings growth is expected to be much slower than the past few quarters according to analysts.

FactSet puts forecast earnings growth at less than 3% compared with a year earlier; it was 10% in the second quarter and 13.6% in the first.

Less than a tenth of the S&P 500 has reported so far, but almost half of these companies have apportioned poor results to hurricanes. Almost as many have complained about the weak dollar, too. Insurers’ profits are likely to be drastically lower because of natural disaster claims, but other industries are ticking along ok, particularly technology.

S&P valuations are looking high: the forward P/E has hit 18 times for the first time in 15 years and there is some worry among investors about whether profit margins will be eroded. If wage growth finally starts rising, it may have a double effect on companies’ bottom lines: greater expenses would mean lower earnings, but it could also push the Federal Reserve to hike interest rates faster. US consumers appear to be in good spirits, which may mean wage rises are in the pipe: last week the University of Michigan Consumer Sentiment survey jumped to a 13-year high and retail sales rocketed 4.4% higher than a year earlier. But inflation remains lower than expected, reducing the likelihood of there being three (or more) rate hikes next year.

We think investors may be getting a bit too downbeat about wage growth. Western workers have put up with years of stagnant wages – a boost to employees’ earnings may strengthen the US economy, rather than simply increasing business costs. And that would be good for business further down the line.

Bonds

UK 10-Year yield @ 1.37%
US 10-Year yield @ 2.28%
Germany 10-Year yield @ 0.41%
Italy 10-Year yield @ 2.09%
Spain 10-Year yield @ 1.60%

Economic data and companies reporting for week commencing 16 October

Monday 16 October

US: Empire Manufacturing (Oct)

Quarterly results: Rio Tinto
Quarterly production results: Etalon, Polymetal International
Trading update: Novolipetsk Steel, Schroders

Tuesday 17 October

UK: CPI/RPI (Sep), PPI Input/Output (Sep)
US: Import Price Index (Sep), Industrial Production / Capacity Utilization (Sep), Manufacturing Production (Sep), NAHB Housing Market Index (Oct), Total Net TIC Flows (Aug), Net Long-term TIC Flows (Aug)
EU: CPI (Sep), ZEW Survey Expectations (Oct); ITA: Trade Balance (Aug); GER: ZEW Survey Current Situation/Survey Expectations (Oct)

Full-year results: ASOS
Preliminary results: Bellway
Quarterly results: Virgin Money
Quarterly production results: Evraz
Trading update: LSR Group, Merlin Entertainments
Interim management statement: Pearson

Wednesday 18 October

UK: Average Weekly Earnings (Aug)
US: MBA Mortgage Applications (13 Oct), Housing Starts (Sep), Building Permits (Sep), Federal Reserve Releases Beige Book
EU: Construction Output (Aug)

Preliminary results: Softcat
Quarterly results: BHP Billiton, Hochschild Mining, Severstal
Trading update: MHP
Interim management statement: Reckitt Benckiser

Thursday 19 October

UK: Retail Sales Ex Auto Fuel (Sep)
US: Initial Jobless Claims (14 Oct), Philadelphia Fed Business Outlook (Oct), Leading Index (Sep)

Quarterly results: Kcell
Quarterly operations report: South 32
Trading update: Lenta Ltd, Rentokil, Segro, X5 Retail Group
Interim management statement: London Stock Exchange

Friday 20 October

UK: Public Sector Net Cash Requirement/Public Sector Net Borrowing (Sep)

Quarterly results: Acacia Mining, Magnit
Trading update: Intercontinental Hotels, Renishaw, ROS AGRO

 

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