Market Bulletin - Slow motion
Poor earnings and worries over central bank policy pushed stocks down last week, but many worries were short-term.
Sometimes investing requires nerves, as Vichai Srivaddhanaprabha knows. In 2010, he bought Leicester City Football Club for £39 million. Promoted to the top flight in 2014, the ‘Foxes’ only narrowly avoided relegation last year. On Saturday, however, they lifted the trophy as Premier League champions, proving the worth of the club maxim: ‘Foxes never quit’. A research company in New York estimated the club’s revised value at £436 million – more proof that cashing in early can be a costly mistake.
Poor corporate earnings figures relegated plenty of major companies to less exalted levels last week. The S&P 500 dipped 1.1%, while the FTSE 100 fell 1.9%. In the UK, there were poor earnings announcements at fashion outlets such as Burberry, and at some supermarket retailers, notably Sainsbury’s, where annual underlying profits fell 14%.
Broader UK indicators were also discouraging. Manufacturing slowed for the first time since March 2013 and services hit a 28-month low. Moody’s, the rating agency, warned that British banks are facing higher funding costs, squeezed margins and reduced business volumes ahead of the UK referendum on membership of the EU – such concerns have pushed the Bank of England to offer unlimited liquidity to lenders shortly before and after the vote, to help ameliorate short-term shocks.
Last week, Shinzo Abe, the Japanese prime minister, used a visit to the UK to say that a British exit from the EU would make the UK a less attractive place for Japanese companies to invest in. Yet while sterling has lost significant value in 2016, government gilts continue to enjoy a surge of popularity, with demand at its strongest for 18 months.
Some of the UK’s largest companies struggled last week, not least those in the mining and energy sectors. Shell announced an almost 60% drop in earnings. Last week, its chief executive increased planned cost savings following its February acquisition of BG, a UK oil and gas company, for £47 billion. However effective its cuts, much will depend on the price of oil. Last week provided less encouraging news.
It had looked like a barrel of Brent crude might soon pass $50 but it ended on Friday below $45. It remains far up from its lows – and rose slightly over the weekend – but most oil majors based their business plans on a price of at least $55. Among the chief victims of a falling oil price have been US shale oil companies; despite the uptick of recent weeks, default rates among higher-risk shale oil companies in the US have hit a fresh record. There is still a large surplus of oil globally, making it unlikely that former levels of profitability will return to the sector any time soon.
“At current prices, probably only Saudi Arabia is making money, because you only need to stick your finger into the ground to extract oil there,” says Chris Field of Majedie Asset Management. “In the Gulf of Mexico, on the other hand, it is much more complicated and expensive.”
Another indicator of the problems facing the oil industry in the short term is the latest reading on the Baltic Dry Index, the leading gauge of shipping trends. Last week, the index suffered its sharpest fall since November. Shipping itself is, of course, a major consumer of oil; but so too is the manufacture of many of the hefty products it lugs across the oceans. Last week, reports showed that manufacturing contracts in China had declined once again in April, part of a longer-term trend. Maersk, the largest container ship operator in the world and a major player in the oil sector, last week announced a drop of 95% in net profits for the first quarter.
Off the farm
The most important report of last week came on Friday in the form of US non-farm payrolls data. It showed that 160,000 workers were added to the ranks of the employed in March. The number came in below expectations and was the lowest figure in seven months. The US economy is showing mixed signs. Factory orders rose faster than expected in March, and unemployment held steady at 5%.
US politics is increasingly likely to spill over into markets in coming months too, now that the two chief candidates for the presidential race have been all but confirmed as Donald Trump and Hillary Clinton. While the latter has made plenty of promises to crack down on Wall Street, the former is the more feared of the two. It has been some years since a US presidential election has had such a significant capacity to unnerve markets. Perhaps chief among those fears is simply the possibility of capricious policymaking, in areas from immigration to finance. Last week, Trump commented that he would look to replace Janet Yellen, chair of the Federal Reserve, if elected president.
The dollar hit a 15-month low last week over fears that the US economy may not be able to growth fast enough for the Federal Reserve to meet its interest rate targets. The world’s leading central bank raised rates marginally in December, its first hike in nine years. But it has since reverted to type, worried by both global indicators and subdued inflation.
Elsewhere in the world, negative interest rates continued to vex markets, as did poor corporate earnings. Japanese markets were only open for two days last week (losing 3.4%), but trading volumes on European stock markets dropped by almost a fifth in April. The vast majority of initial public offerings made in the eurozone in 2016 are now trading below their offer price, auguring badly for corporate profits in the second quarter. The FTSEurofirst 300 ended the week down 2.9%.
UBS and other European banks were especially hard hit by poor profits – and by the inevitable sell-off that ensued. What tends to be a highly profitable quarter for banks has instead seen them squeezed by low rates, as well as facing increasing scrutiny over their holdings of non-performing loans. Manufacturing also faces headwinds; surveys for April showed the weakest level of manufacturing activity since the eurozone crisis in early 2013.
As earnings, stock prices and, occasionally, dividends suffer, it is no surprise to see shareholders placing increased pressure on companies perceived to be excessively generous to their chief executives. The French government added its own voice to the chorus of angry shareholders last week, complaining at the compensation policy of Renault, in which it owns a significant stake. Norway’s vast sovereign wealth fund also chose last week to announce a change of tack; henceforth, it will place pressure on companies deemed to be over-compensating management. Its voice will be significant – it owns, on average, 1.3% of every single stock in the world.
Meanwhile, old arguments rumbled on in the eurozone. The IMF put pressure on the European Union to resume talks with Greece in order to resolve the country’s ongoing debt problems, while in Greece there was a general strike over changes to the country’s pension and tax systems – bailout funding from the EU is contingent on the reforms being implemented.
On Wednesday, the ECB announced that it would stop printing €500 euro notes – the largest denomination it produces. Although ostensibly doing so to prevent “illicit activities”, a number of German and Austrian politicians and economists accuse it of trying to launch an attack on anyone trying to squirrel away their savings.
It was broad themes that pushed stock markets downwards last week, perhaps chief among them corporate earnings, the effects of negative interest rates, and the US payrolls report. But individual companies continue to prosper. Moreover, volatility on the S&P 500 remained below the long-term average, global growth continued, and average earnings have historically bounced back in the second quarter. As any Leicester City fan could tell investors, foxes know the value of biding their time.
Majedie is a fund manager for St. James’s Place.
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