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Rathbone Weekly Commentary

Date: November 12, 2018


All the tea in China

Markets were dominated by US politics last week, with investors first holding their breath and then pondering how America will fare with a split Congress.

As expected, the Democrats took control of the House of Representatives while Republicans held onto the Senate. Both sides have been touting their intentions to put aside differences and work together to improve infrastructure and sort out spiralling healthcare costs. Both sides seem difficult to believe. Perhaps the best measure of expectations is the S&P 500 Healthcare sector: it’s jumped 3.2% since the midterms, compared with 1.6% for the wider index. It seems like the market is expecting little political action for the foreseeable.

We believe the largest risk with this situation is that gridlock in Washington could frustrate President Donald Trump, leading him to redouble efforts to hammer trade partners with tariffs. The world is growing steadily and the US appears robust, but hairline cracks are appearing in certain places. Just how much upheaval global commerce can take is an experiment that only Mr Trump is particularly interested to test.

China is widely seen as a weak link on trade, given how much commerce it does with the rest of the world. Its GDP growth slowed to 6.5% in the third quarter and some data suggest some of its main import partners have slowed noticeably in recent months. China is the hub for Southeast Asian commerce, using components made in Vietnam, Taiwan, South Korea and others, while also gobbling mountains of Australian minerals. And it uses European-made machines to create the mind-bending array of stuff for Western consumers that fills countless shipping containers. Of course the absolute amount of output at 6.5% this year is still greater than what was produced last year at 6.9% because the economy is bigger than it was.

It was the maxim of the 20th century that if the US sneezed the rest of world caught a cold. That is still true, but as the 21st century progressed it became more apparent that China is almost as important. The only problem is, China is a great big black box. Its economic reporting is nowhere near as comprehensive as other nations of similar heft. And the numbers it does release are widely mistrusted. To determine “true” Chinese growth, many economists rig up proxies by poring over the hog market and counting up cubic metres of concrete poured. They study electricity consumption and the amount of rail traffic to divine just how much tea is in China, so to speak. In some ways, you have to take China on faith. You see a population of 1.4 billion people with just 60% living in towns and cities compared with the OECD average of 80% and you make the bet that the economy has a frankly enormous potential.

When there’s so much fog over the numbers, concerns are amplified. That’s why worries about the effect of tariffs on the world’s second-largest economy have had such a disproportionate effect on many markets. Global stock markets have been de-rated partly due to rising US interest rates and partly due to lower growth estimates that you can follow back to reduced forecasts of Chinese demand. Similarly, oil prices have slipped considerably in recent months. Brent Crude was trading at $70.80 this morning, down about 18% from its recent peak of $86. Saudi Arabia has promised to cut supply once again, boosting the price by a couple of percent. But it seems clear that supply isn’t the issue here – demand is key.

We’re relatively confident about China’s ability to muddle through over the coming months and years. We feel both the US and China have more to gain through compromise over trade and intellectual property rules and even more to lose from upending a decades-old partnership that has spread affluence in China and cheaper consumer goods in America. Hopefully Mr Trump agrees…

Index 1 week 3 months 6 months 1 year
FTSE ALL-Share 0.0% -7.5% -5.4% -1.3%
FTSE 100 0.2% -7.5% -5.2% -1.1%
FTSE 250 -1.1% -7.5% -6.3% -2.3%
FTSE Small-cap -0.3% -6.2% -6.0% -2.7%
S&P 500 1.7% -3.4% 8.2% 9.8%
Euro Stoxx -0.5% -10.8% -8.5% -7.9%
Topix -0.2% -6.6% -4.2% -5.1%
Shanghai SE -4.2% -9.7% -21.3% -27.0%
FTSE Emerging Index -2.6% -9.9% -8.2% -9.3%
Source: FE Analytics, data sterling total return to 9 November 2018 


Untying the knot

And then there’s Brexit. Prime Minister Theresa May has had another tough week – to be fair, they kind of roll into one horrible slog with typically just a couple of good days. Good weeks are rare.

After a few days of happy and coy suggestions by ministers that a deal with the EU was imminent – you could almost taste it – the reactionaries of her party lived up to their namesake with equal and opposite rumours: Another raft of ministers were preparing to jump ship rather than swallow the compromises the deal would include. A special Brexit Cabinet meeting scheduled for today had to be canned because of the Mexican stand-off, putting in doubt the timetable of a signed and sealed deal by the end of the month.

Our hunch has always been that a deal between the EU and UK isn’t the hardest part of Brexit. Instead, it will be getting any sort of deal through Parliament. A weak Conservative coalition with hard-line Northern Irish unionists makes the situation even more complicated. The Irish border and the Good Friday Agreement is one of the most fiendishly difficult Brexit knots to untie. Having to rely on DUP votes on any change – because there will have to be changes – is nigh on impossible.

As depressing as all that is, what’s perhaps surprising is that the UK economy – while not stellar – is ticking along ok regardless. Business investment remains low and foreign investors are avoiding the stock market like the plague, but economic growth rose to 0.6% for the third quarter and retail sales have been pretty healthy, running between 3% and 4% year-on-year since May. Economists expect sales expansion to decelerate to 2.8% when it’s released on Thursday, but that’s still much better than most of 2017 and early 2018. The property market has stalled somewhat, and PMIs have stepped down over the past few months, but they all remain in expansionary territory.

Brexit is a cloud hanging over our island, but most people seem to be simply getting on with life. Imagine how well the country might be doing if the cloud was never there to begin with…

UK 10-Year yield @ 1.49%
US 10-Year yield @ 3.18%
Germany 10-Year yield @ 0.41%
Italy 10-Year yield @ 3.40%
Spain 10-Year yield @ 1.60%

Economic data and companies reporting for week commencing 12 November

Monday 12 November
Final results: Carr’s Group
Interim results: Warehouse REIT, McKay Securities, Cropper (James)
Quarterly results: Dignity

Tuesday 13 November
UK: Unemployment Rate, Average Weekly Earnings
US: NFIB Small Business Optimism, Monthly Budget Statement
EU: ZEW Survey; GER: CPI

Final results: McCarthy & Stone,
Interim results: Adept Technology Group, BTG, Codemasters Group Holdings, DCC, Experian, Land Securities Group, Oxford Instruments, Premier Foods, Vodafone Group
Quarterly results: CableVision Holdings
Trading update: Aggreko, BBA Aviation, Taylor Wimpey

Wednesday 14 November
UK: CPI, RPI, PPI, House Price Index
US: MBA Mortgage Applications, CPI, Real Average Weekly Earnings
EU: GDP, Industrial Production, Employment; GER: GDP (Q3)

Final results: AB Dynamics, Avon Rubber, Grainger
Interim results: British Land, Renold, Speedy Hire, SSE, Workspace Group
Trading update: Cobham

Thursday 15 November
UK: Retail Sales
US: Empire Manufacturing, Philadelphia Fed Business Outlook, Retail Sales, Import Price Index, Export Price Index, Initial Jobless Claims, Continuing Claims, Business Inventories
EU: New Car Registrations, Trade Balance

Interim results: Dart Group, Intermediate Capital Group, 3i Group, Investec, Mediclinic International, Royal Mail, Urban Logistics REIT
Quarterly results: Aston Martin Lagonda Global Holdings, Card Factory, TBC Bank Group

Trading update: Bovis Homes, Close Brothers, Safestore Holdings

Friday 16 November
US: Industrial Production, Capacity Utilisation, Manufacturing Production, Kansas City Fed Manufacturing Activity
EU: CPI; GER: Wholesale Price Index


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