Market Bulletin - Waves not tides
Markets quickly shrugged off the previous week’s bout of volatility, but inflation proved to be more persistent.
Just 17 days ago investors were finally reminded, after an extended hiatus, that stocks can in fact go down as well as up. Yet if you’d been away for those few days, you might have wondered what all the fuss was about. In the five trading days of last week, the S&P 500 rose by 3.6%, thereby nullifying more than half the losses it suffered in the days following 1 February. On Valentine’s Day, volatility dipped to just below its historical average, and has since remained controlled.
The S&P 500 is now up for the year once more, having risen by 19% in 2017. The FTSE 100 has had a rougher year but it, too, tracked back upwards last week, rising 2.9%. The MSCI Europe ex-UK rose 2.6%, as French unemployment struck a nine-year low and investors’ recent affection for Italian stocks showed no sign of abating, despite the imminent election.
At the risk of dampening spirits, it would be unwise to assume that we’ve seen the back of volatility in 2018. Last week’s recovery served as a lesson that volatility is an inherent feature of stock market behaviour. Those investors who sell out during periods of volatility end up crystallising short-term losses, and missing out on any recovery. Of course, they also end up missing out on dividends; and figures released last week showed that global dividends reached record levels in 2017, and rose at their fastest pace in three years.
Yet if stocks have returned to their previous form for the moment, the recent shift in inflation is proving to be more sustained. Last week, US inflation came in unexpectedly high at 2.1% while, in the UK, forecasts of a dip once again proved premature, as January inflation showed at 3%. For savers, this is simply more bad news – for spenders, too. Sam Ewing, the Chicago White Sox baseball veteran, probably put it best: “Inflation is when you pay $15 for the $10 haircut you used to get for $5 when you had hair.” In short, cash doesn’t age well, and Moneyfacts data continues to show that all savings accounts in the UK offer a rate of return that is comfortably below inflation.
The spectre of inflation continued to loom on bond markets last week, where the yield on the 10-year US Treasury struck a four-year high, ending the trading period close to 2.9%. Moreover, underlying inflation data showed that pretty much everything in the US saw price rises, while a separate report suggested that US house prices were no different. Into this heady mix comes the much-touted Trump tax-cuts package and, of course, its budgetary impact. Last week, the White House announced plans to delay balancing the budget by a decade – 2039, not 2029, is now the due date. (Even then, it might be injudicious to set too much stall by a 21-year political pledge.)
Yet there were also plenty of reminders to be had last week that, behind inflation and rising stocks, lies a humming US economy. One specific tail wind to show itself strongly this year has been the resurgence of the country’s shale oil industry, which is creating many a policy headache in the corridors of OPEC and the Kremlin. The price of a barrel of Brent crude was pretty much $70 at the start of the month, but ended last week at $64. According to the International Energy Agency, US oil production has returned to exceptional growth levels, as oil supply globally moves back towards a surplus. Last year, the world’s five largest oil companies doubled their profits (versus 2016), and the sector has been perhaps the lead contributor to rising inflation. It remains to be seen whether the shale-fuelled price decline has yet run its course.
While inflation remained elevated in the UK, retail sales figures for January came in much lower than expected, continuing December’s poor form. One exception was sports clothing, and the Office for National Statistics suggested that New Year resolutions could be behind it, not least because there was a concomitant fall in food sales.
The foreign secretary, meanwhile, delivered the first in a series of ministerial speeches on the government's Brexit plans, and the prime minister delivered the second over the weekend. Boris Johnson sought to conjure a vision of free-trading post-Brexit, while also looking to win over persistent Remainers. He limited his policy references, however, to saying he would like to achieve regulatory divergence with the EU on medical research, financial services and environmental impact assessments. Later in the week, reports emerged that the UK will seek “mutual recognition” of financial services to maintain the City’s access to the EU. The chief executive of TheCityUK, which lobbies for the Square Mile, said the group had been banking on this plan for the past 12 months.
While the British talked, the Irish acted, as Dublin began preparing its port customs checks for the “inevitable” border controls to come. The Irish government said it is assuming that a hard Brexit is the inevitable outcome and that a transition period is not assured – and that it is therefore keen to be prepared. “We’re not working on the basis of there being any magical political solution,” said the Dublin Port Company’s chief executive. “Once Brexit happens, 200,000 containers [needing customs checks annually] increases to 1 million.”
The UK has already seen a hollowing out of the political centre over the past two years, and there were increasing signs that German politics, which has been marked in recent years by studied non-theatricality, is feeling the full force of a similar shift. Leaders of both the main political parties in the new coalition looked increasingly feeble last week, and senior members of the centre-right CDU started to make more public calls for Merkel’s eventual handover plans to receive greater attention. The German chancellor received widespread criticism for agreeing to cede the finance ministry to the centre-left SPD in coalition negotiations.
A similarly drawn-out process was under way in South Africa last week, as its president sought to cling to power, only to be eased out by his own party and his successor, Cyril Ramaphosa. The new incumbent is a hero of the anti-apartheid movement and was once Mandela’s right-hand man. It is widely hoped that he can set the country on a new economic path, while also cracking down on political corruption. South Africa’s leading index has rallied significantly over the past two months in anticipation of his appointment. In December, Polina Kurdyavko of BlueBay Asset Management sensed that the change in mood could even become contagious.
“Local elections in South Africa also show that the nation’s tolerance for corruption and economic decline has an end,” said Kurdyavko. “These are encouraging signs. They give us optimism that other countries in emerging markets can follow, sooner rather than later.”
While some countries were making plans, Japan could perhaps afford to reflect on past successes last week, as the country posted its eighth consecutive quarter of growth – a 28-year record. Both consumption and business investment were strong, and net annualised profits at companies across the Topix were up 39%. The Nikkei 225 finished the week up 1%, as several markets in Asia shut up shop for the Chinese New Year. At the weekend, the yen received an extra fillip as Haruhiko Kuroda, governor of the Bank of Japan, was nominated for a second term.
BlueBay Asset Management is a fund manager for St. James’s Place.
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