January saw another positive month for most major equity markets, but with the UK once again lagging, as the FT All-Share Index lost -2% during the month. The collapse of Carillion and a major profit warning from Capita combined with renewed Brexit uncertainty continued to undermine investor confidence. In the US, markets reacted well to President Trump’s new corporate tax package, and yields on the ten-year US Treasuries rose above 2.70% as economic data continued to point to an ongoing recovery. European data followed the same pattern, leading to further strength in the Euro. Inflation in the EU appeared to have peaked in November, removing some of the concerns that early rate rises might be necessary. Japanese inflation continued to move slowly higher, with the headline rate hitting 1.0%, which is encouraging, but still well below the Bank of Japan’s target rate of 2.0%. Further weakness in the US dollar saw it fall to more than 1.40 against Sterling, reducing US gains for UK investors. Conversely, however, this added to gains in the emerging markets, which benefit from a weaker Dollar due to their large exposure to US$ denominated debt.
After the progress made in the Brexit talks in December, the New Year saw a return to the sense of drift in terms of how the EU negotiations were playing out, with little further progress being made. The perception of a badly handled cabinet reshuffle, the cancellation of non-emergency operations by the NHS through part of the month and the high-profile collapse of Carillion all added to the political pressure on the Prime Minister. Yet despite this, the opinion polls hardly changed, with the average of the polls year to date still showing a small sub 1% lead for Labour. Sterling was strong against the US Dollar, rising from U$1.36 to U$1.41, but this was more a reflection of Dollar weakness.
The UK macro data continues to reflect a tale of two economies, with very strong order books for services, manufacturers and exporters, in part due to the improving global economic outlook. Business and consumer sentiment remains weak, but maybe not as bad as the previous month, with retail sales showing some resilience. The chart below compares the buoyant CBI current order book survey with the weaker GFK measure of UK consumer confidence.
UK 4th quarter GDP came in slightly ahead of expectations at +1.5%, which represented a slowing from the previous figure of +1.7%. This rate of growth remains sluggish when compared to the rapidly improving rates in Europe and the USA. This may be due to the perceived slow progress and uncertainty on Brexit, along with the squeeze on real wages. This trend is set to continue into 2018, with the UK expected to be towards the bottom of the range in terms of Developed Economies growth rates.
Labour market data remains strong, with the January ONS labour market report showing the employment rate of 16-64 year olds at 75.3%, the highest since records began in 1971. Wage growth remains subdued, but there is some evidence that the pace of wage settlements seems finally to be picking up. UK wage growth edged higher to +2.4% (from +2.3%), still below the current 3.0% inflation level. But the gap is beginning to narrow.
Although there was little change in the economic data in the UK, bond yields rose significantly, in line with the trend globally. The yield on UK 10-year gilts went from 1.29% to 1.51%, which in the context of the Gilt market, is a significant move. Rising global bond yields and the weak US$ (which reduces the sterling value of US$ profits) acted as a drag on the FTSE100, which fell by -2%, with most of the fall in the second half of the month.
Rising bond yields and the weak US dollar made defensive dollar earners unattractive to investors, so sectors such as Utilities, Beverages, Food Producers and Tobacco performed poorly. M&A remained strong, with bids for GKN and UBM. Having already had a profit warning in December, Capita had an even bigger profit warning in January and the shares fell by nearly -50% as it cut profit guidance, cancelled the dividend and announced an emergency rights issue, as the outsourcing model that the company had based the business on came unstuck.
European equity markets were strong once again in January, and, as we saw at the end of 2017, it was the peripheral nations that led the charge, with Greek equities gaining +9.5% and Italian stocks rising by +7.6%. The core markets, Germany and France, rose by a more muted +2.1% and +3.2% respectively. Overall, the Euro Stoxx 50 Index of large pan-European companies gained +3.0% during the month, outstripping the MSCI Europe Small Cap TR Index, which managed a rise of only +1.9%. Investors favoured value stocks over growth at the start of the year, perhaps reflecting a more cautious tone, although the Economic lead indicators remain strongly positive for the coming year. Industrial and automotive equipment provided the biggest gains in the market, with water stocks being the only sector to produce a major loss, as Suez announced disappointing results and cited the independence struggle in Catalonia as one reason. Suez claims to have spent an extra $18.7m in 2017 to protect its interests in the region.
Government bonds in the Eurozone returned -0.4% overall, ranging from -1.1% from Germany to +0.4% from Italian issues, which continued to benefit from the recent electoral reform and upgrading of the nation’s credit rating by Standard & Poor’s. This performance was mirrored by the index-linked market, where German bonds returned -1.5% and Italian inflation-linked bonds gave +0.4% on the month. Overall, bond yields rose slightly, reflecting the expectation of QE tapering and possibly even a rise in the base rate this year.
Economic data continued to provide support for the markets, with GDP growth remaining strong and inflation and wage growth appearing to stabilise at a modest level. Unemployment also remained in a gentle downward trend. This combination helped to strengthen the Euro and the currency rose by +3.4% against the Dollar, creating a potential headwind for the region’s exporters.
European politics was dominated by the ongoing failure of German politicians to form a coalition. Angela Merkel spent much of January in discussions with Martin Schultz’s SPD and other parties, but by the end of the month, an agreement was yet to be reached on a new coalition Government for the EU’s largest economy. This inability to form a Government, four months after the general election, sees Germany in a state of political paralysis, which could potentially delay Brexit talks and Eurozone reforms, as both the UK and France regard German support, or acquiescence, as vital for the UK’s desire for a bespoke Brexit deal and President Macrons’ proposals for reform of the EU.
The economic data continued to surprise on the upside in January. Manufacturing, current order books, business confidence and investment surveys were particularly strong. Even when the economica data came in below expectations, such as the 4th quarter GDP, the underlying picture looked much stronger than the headline number.
Business confidence has continued to remain strong as the full impact of the Tax Reform Bill starts to feed through into the economy. We are seeing capital expenditure and business investment levels picking up after being subdued for a number of years. Domestically focused US corporations should see a material uplift in earnings and cashflows because of the tax cuts and we are already seeing examples of this uplift being passed on by companies such as Walmart to workers in terms of higher salaries and benefits. Analysts are rather slow in upgrading their earnings forecasts to take accounrt of the tax cuts, but these are now beginning to come through. Inventory levels remain very low by historical standards and the strong new order levels being registered by US surveys would suggest that an inventory rebuild is needed.
US 10-year treasury Yields closed 2017 at 2.46% (close to the highest point of the year), but the buoyant data both in the USA and globally, drove bond yields higher as the market began to price in further interest rate hikes and expected inflation increases. Yields went from 2.46% to 2.70% in just one month. More surprising was the weakness of the US dollar across the board, which surprised many investors given the strength of the US economy and the rise in US bond yields. But this may simply be a reflecting of the fact that economic expectations are rising faster in other parts of the world. The weak dollar was one factor which helped push the oil price to new recent highs. Brent briefly touched US$70, but the fundamentals remain supportive with solid global demand growth, falling inventories and OPEC extending its production cuts.
US equity markets continued their progress, with the S&P500 up +5.6% for the month. The S&P 500 recorded positive returns for each month since Oct 2016, the longest winning streak on record. Defensive sectors linked to bond yields, such as utilities were firmly out of favour. Proctor & Gamble fell by -6% on fears over its price-cutting strategy, GE was weak again, down -7% on a SEC investigation into its accounting and the admission that it expects its tax charge to rise, despite the tax reforms. Boeing rose by +20% on strong results, but Netflix did even better, rising +40% on much better than expected subscriber numbers.
Asia Pacific and Emerging Markets
January was a reasonable month for Japanese equities which returned +1.3% in yen terms. Although performance was below that of other developed markets, Japanese equities peaked at over 24,000 on the 23rd January, a level not seen since the early 1990’s. Market gains were led by larger-cap stocks with Toyota +5.6%, and Keyence +5.2%, the key contributors. Weakness in more interest rate sensitive segments of the market, for example, utilities and consumer staples, hindered stronger market performance. Economic data remained robust, with the Bank of Japan’s Regional Economic Report (a comparable document to the Fed’s Beige Book), signalling moderate expansion across Japanese regions and a “virtuous cycle” between income and spending, in the context of tight labour markets. In monetary policy, although inflation has continued to inch up over the course of the past year, readings on core inflation which rose +0.7% year on year, continue to be well below the Bank of Japan’s 2.0% price stability target. Unexpectedly, the Bank of Japan also slightly reduced its purchases of long-term government bonds, leading to a rally in the yen, and uptick in yields over the course of the month.
Emerging market equities had a strong start to the year, generating returns of +6.8% in local currency terms, around 3.0% ahead of developed markets. The Shanghai Shenzhen CSI 300 index was up +6.1% and whilst there was little new economic news during the month, Chinese consumer confidence remains very high by historical standards. January also saw an interesting shift in market leadership with value stocks, for example China Construction Bank (+25.0%) and the Industrial and Commercial Bank of China (+20.4%) recording solid gains, interrupting the outperformance of growth stocks which has been led by technology giants such as Tencent and Alibaba. Russia was the strongest performing major market, benefitting from the robust performance of energy stocks such as Gazprom (+9.9%) as oil prices rose. Brazil also had a positive month, with the BOVESPA Index rising 11.1% in local currency terms. The Brazilian market rose amid positive economic data with retail sales, industrial production and jobs data exceeding market expectations. Korea and India were the weakest major markets. Korea was impacted by a fall in the price of Samsung (which makes up over 25% of the market), following negative broker reports for the stock.
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Past performance is not indicative of future results. The value of your investment may go down as well as up.