Market Bulletin - Sixes and sevens
Mixed economic signals result in an aimless week for markets.
The world’s financial markets have vacillated in recent weeks and the past seven days produced little evidence of a firmer direction. Renewed anxieties over the US economic recovery restored some stability to bond markets, while the S&P 500 index closed at a new – but not dramatic – high.
US industrial production surprised markets by falling in April for the fifth month in a row – economists had expected a small rise. The decrease was partly due to a continued decline in oil and gas drilling, which is down 47% over the year in response to lower energy prices. Markets took the production fall to mean that second-quarter growth in the US economy may be modest, following an underwhelming first three months.
The University of Michigan’s latest consumer confidence index was significantly below forecast, at its lowest for seven months. April retail sales were also a disappointment. Predicted to be 0.5% higher than March, they were actually unchanged, confounding earlier hopes that higher employment would lead to higher consumer spending.
The combined result was to push back expectations of when the Federal Reserve would raise US rates. The dollar traded down accordingly, touching its lowest level since January and showing particular weakness against the euro. But prices on 10-year Treasury bonds recovered slightly after their losing streak. This reinforced the view that the recent bond sell-off has been a repositioning of portfolios in an overbought market rather than a rout. As Capital Economics points out, global bond yields are still remarkably low when viewed against past levels. The S&P 500 index ended the week 0.1% higher.
News from the UK was also mixed, though tending rather more towards the positive. In its latest quarterly Inflation Report, the Bank of England cut its growth forecast for 2015 from 2.9% to 2.5%. It reduced its forecast for next year, again from 2.9%, to 2.6%; and from 2.7% to 2.4% in 2017. The culprits for lower expectations included the strength of sterling, weaker productivity and the likelihood of higher interest rates.
Inflation was 0% in March, for the second month running, thanks to lower food and energy prices and a strong pound. BoE governor Mark Carney said once again that, while the UK economy could dip into deflation in the course of this year, he expected inflation to pick up “notably” by the year’s end. Other highlights from the report included a downgrade in this year’s wage growth forecast from 3.5% to 2.5%, as unemployment continues to fall. The Bank noted that employment growth since mid-2013 has been more concentrated in lower-skilled occupations.
There were signs of increased vigour in certain parts of the economy. UK industrial production rose by more than expected in March, and at its fastest rate for six months. Monthly figures from Barclaycard suggested that discretionary spending on items like entertainment and travel was growing at its highest rate for three years. House prices were rising in every part of the UK for the first time since last summer, according to the Royal Institution of Chartered Surveyors, though it said this flowed mainly from a shortage of supply. Concerns about US, and hence global, growth hit mining and energy shares, and the FTSE 100 Index finished the week 1.2% lower.
BoE’s Carney has warned before that a Greek exit from the eurozone posed a downside risk for UK growth, and he did so again last week. As Greece struggled to make payments on its €240 billion bailout debt, finance minister Yanis Varoufakis said that a cash crunch could be as little as two weeks away. The country managed to make its latest €750 million debt interest payment one day early, but only by raiding its Special Drawing Rights holdings with the International Monetary Fund. It won’t be doing that again, since those holdings are now down to €50 million. The mayor of Thessaloniki, Greece’s second city, revealed that municipal cash reserves had been handed over in response to a government appeal. Syriza has pledged to uphold its anti-austerity manifesto, and Prime Minister Alexis Tsipras has warned he would hold a referendum on any deal whose terms breached its promises.
But Greece weighed less heavily on eurozone capital markets, which had other preoccupations. The currency area actually grew faster in the first quarter than the US and the UK (by 0.4% versus 0.2% and 0.3% respectively). Although in fractions of one per cent, the national growth of France surprised on the upside and Italy finally came out of recession. The fall in government bond prices was arrested, and 10-year German Bund yields touched five-month highs. Equity markets were more worried about the effect of a strengthening euro on exports, and the FTSEurofirst 300 Index was 1.1% down on the week.
All about ads
The M&A deal of the week was US telecoms giant Verizon’s proposed $4.4 billion takeover of AOL. Some said this was because Verizon, like BT, wants to become a one-stop shop for internet and entertainment services. Manulife’s Paul Boyne, sees it a different way. “AOL has three core businesses,” he says. “The original dial-up internet business is dying, but is cash-flow positive. Then there are the content media assets like The Huffington Post. Finally, there’s the mobile advertising technology business, which is what Verizon wants to own.”
Verizon can use that technology to target its own wireless subscribers with advertising which is more relevant or timely, Boyne says. If it can deliver more effective advertising as a result, then it can charge advertisers more. “We had expected Verizon to use cash to pay down debt following the acquisition of the interest in Verizon Wireless that it did not own, so this was a bit surprising,” he notes.
At only 2% of Verizon’s equity value, the deal is relatively small. “We would have been more concerned if Verizon was moving toward a strategy of owning more content media,” Boyne concludes. “But the primary use of capital here is to bolster wireless advertising capabilities, which we believe is sensible.”
Back to the Budget
The Conservatives have been settling in for another term of office, this time on their own. That will give them a freer hand, most notably with a referendum on the UK’s membership of the European Union. BoE governor Mark Carney encouraged the government to act with “appropriate speed”, since the referendum issue had created an uncertain investment climate. Businesses had not yet acted on that uncertainty, he said, but the matter should be resolved as soon as possible.
Rather more imminent is the second Budget of the year, promised by Chancellor George Osborne for 8 July. It will, he says, be a Budget “for working people”. Forecasts for the economy and public finances will be updated and more details of the government’s proposed £12 billion spending cuts will be revealed. These are currently being worked on by civil servants in non-ring-fenced departments such as local government, justice and transport, and one insider was reported as saying they would be “very bloody indeed”. The government is also preparing a law upholding its promise not to increase Income Tax, VAT or National Insurance before the next election in 2020.
One initiative from the government’s previous incarnation has proved a resounding success, though this did not come as a surprise. Its offer of premium-paying National Savings and Investments bonds to the over-65s, which closed last week, has been taken up by more than one million savers. The so-called ‘pensioner bonds’ paid unmatched rates of 4% for the three-year product and 2.8% for the one-year option. While the original allocation was to be £10 billion, HM Treasury announced that over £13 billion of the bonds had been sold.
Manulife is a fund manager for St. James’s Place.
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