Powell's tough love?
A broad range of US companies reined in estimates of 2019 growth last week, most notably Amazon. Last week, we noted that any corporate concerns about next month’s profit and revenue growth would weigh heavily on stock markets and we were correct.
The S&P 500 slumped 3.9% in dollar terms, putting it 9.3% down from its peak in September. Other markets followed the American bourse downward, although the UK held up better with a cheaper pound lending some support amid Brexit worries.
It’s been another punchy quarter for US earnings growth. Half of the S&P 500 has reported for the third quarter and earnings growth is running at 22%, according to FactSet. But looking to the future has become decidedly murky. Almost twice as many companies have released lower sales growth guidance for the final quarter than have issued higher forecasts. Amazon was probably the most prominent, warning that the Christmas season will likely be disappointing. Even another hefty boost to profits wasn’t enough to placate investors. The shares slumped by a tenth in a day. Defensive companies – consumer staples, utilities, etc – have been doing better than the rest of the index, but are still falling.
This has led to a flight to safety, with US 10-year Treasuries rallying 11 basis points over the week to finish at 3.08%. The move in 10-year gilts was even more aggressive: the yield fell 20bps to 1.38%. The chances of a Federal Reserve interest rate hike in December have fallen back to about 70%, so still probable but with markets holding out some hope that the central bank will ease up. Given record-low unemployment, above-target inflation and buoyant consumer confidence, the Fed would be well within its mandate to continue tightening monetary policy in the coming months. Rates remain extraordinarily low and the US economy has been running hot lately. However, stock markets – and bond markets – have been treated very delicately by the current generation of central bankers. They are used to monetary policy bending to accommodate when investors become flighty. Is Fed Chair Jay Powell different to his predecessors? Will he focus solely on the real economy and consider sharp falls in stock markets as simply a collateral correction to rising real rates? President Donald Trump certainly thinks Mr Powell will continue raising rates – he’s been vocal in his opposition. Mr Trump could row back on his tariffs to ease the pressure on the markets he seems to use as his scorecard. Or by accusing the Fed loudly and ahead of time, he could simply be hedging his bets. Either rising rates punctured the S&P’s strong run with irresponsible policy or Mr Trump’s bold economic nous overcame the Fed’s institutional foolishness. Heads Trump wins, tails Mr Powell loses.
For us, we only worry that the economy may be starting to slow already, reined in by the rate hikes already implemented by the Fed. It takes about 18 months for these moves to filter through to consumers and businesses, so any further hikes may be counterproductive. Especially when you add the greater barriers to global trade which have popped up in the past year to a potentially ailing China. And then there’s a good chance that the European Central Bank will soon start winding up its quantitative easing programme and move its rates back towards positive territory.
There are plenty of risks out there to scare investors and unwary central bankers could overreach in their desperation to reach a “normal” level of rates. We think most companies are in the best shape they’ve been in years. American earnings growth is slowing into the end of the year, but this follows massive jumps in profits that were turbo-charged by tax cuts. US consumers feel confident and there are signs that wages may be starting to tick upwards. Businesses seem well prepared for even higher rates. Somewhat missed in the quarterly reporting was US GDP growth: it beat expectations by 20bps on Friday, coming in at 3.5%.
Compared with the post-inflation returns offered by bonds, equities still offer the best bang for your buck, in our opinion.
Source: FE Analytics, data sterling total return to 26 October
Budget day
It’s supposed to be the final Budget before Brexit. We’re not so sure.
Depending on your definition of Brexit, we could enjoy a good many Budgets before the country settles into its post-split groove. There could be a transitional agreement for years to come or we may crash out in spectacular style, sans deal, on 29 March. The date could come and go with no discernible effect, leaving the UK in stasis for another indefinite period – classic EU policy. Or, perish the thought, there may actually be a deal that comes into force swiftly, tying up the relationship between the UK and the Continent in one fell swoop.
We reckon Brexit will continue to dominate the agenda (and crowding out proper policymaking) for a good while to come. It’s just too complex and divisive for everything to get sorted out simply because we came to the allotted date in a calendar. In our opinion, Brexit will most likely turn into a never-ending story as the two sides (of both the Channel and Parliament) wrangle over interminable details and compromises.
As for the Budget itself, the 3.30pm declaration of the country’s financial plan for the year ahead will probably be one solely for the fans. It will be interesting in the way that snooker is interesting. Chancellor Philip Hammond has done a good job of continuing to improve the nation’s finances, but he seems to be at the end of the line. Over the past eight years, the Conservatives have cut and cut and cut again at everything from welfare to local government, education and the services (fire, police and military). Even the NHS budget has been bled in real per head terms. It did the job, but at a price: homelessness has spiked, prisons are like those of a banana republic, schools are creaking and local councils are buying third-tier shopping malls to earn enough to supply essential services.
Prime Minister Theresa May has announced that Brexit means the end of austerity. A strange statement that seems to strain truth, given that virtually every economist says leaving the EU will incur costs from lessened trade and a large divorce bill. It’s almost like she wanted to see just how good “Spreadsheet Phil” really is. So now Mr Hammond has to somehow conjure a fiscal splurge – or the impression of one – with less money than if Brexit was just a spooky nightmare. At the same time, he has to keep the books in the black while not raising taxes and not running the country into the ground through a lack of investment.
Like we said: one for the fans.
Bonds
UK 10-Year yield @ 1.38%
US 10-Year yield @ 3.08%
Germany 10-Year yield @ 0.35%
Italy 10-Year yield @ 3.44%
Spain 10-Year yield @ 1.57%
Economic data and companies reporting for week commencing 29 October
Monday 29 October
UK: Net Consumer Credit, Net Lending Secured on Dwellings, Mortgage Approvals, Money Supply (M4)
US: Personal Income, Personal Spending
Quarterly results: HSBC
Tuesday 30 October
UK: CBI Reported Sales,
US: S&P/Case-Shiller US Home Price Index, Consumer Confidence Index, Conference Board Present Situation and Expectations
EU: Economic Confidence, Consumer Confidence, Business Climate Indicator, Industrial Confidence, Services Confidence GDP (Q3); FRA: GDP (3Q); GER: Unemployment Rate, CPI; ITA: GDP (Q3)
Final results: Proactis Holdings
Quarterly results: BP, Banco Bilbao Vizcaya Argentaria, Hunting, Reckitt Benckiser
Trading update: Hunting
Wednesday 31 October
UK: GfK Consumer Confidence, Lloyds Business Barometer, BRC Shop Price Index
US: MBA Mortgage Applications, ADP Employment Change, Employment Cost Index, Chicago Purchasing Manager
EU: GER: Retail Sales
Unemployment Rate, CPI
Quarterly results: GlaxoSmithKline, Next, Smurfit Kappa, Standard Chartered
Trading update: Computacenter, Just Group, PPHE Hotel Group, Watkin Jones
Thursday 1 November
UK: Nationwide House Price Change, PMI Manufacturing, BoE Bank Rate and Inflation Report
US: Wards Total Vehicles Sales, Challenger Job Cuts, Nonfarm Productivity, Unit Labor Costs, Initial Jobless Claims, Continuing Claims, Markit Manufacturing PMI, Construction Spending, ISM Manufacturing, ISM Employment, Prices Paid, ISM New Orders
Interim results: BT Group
Quarterly results: Carpetright, Croda International, Indivior, Just Eat, Royal Dutch Shell, Smith & Nephew
Trading update: Hilton Food Group
Friday 2 November
UK: Markit/CIPS Construction PMI
US: Trade Balance, Non-farm Payrolls, Unemployment Rate, Average Hourly Earnings, Factory Orders, Durable Goods Orders, Capital Goods Orders
EU: Markit Manufacturing PMI; FRA: Markit Manufacturing PMI; GER: Markit/BME Manufacturing PMI; ITA: Markit/ADACI Manufacturing PMI
Trading update: Glencore, Paddy Power Betfair