Review of the week: Gridlock
A logjam in the streets and another in Parliament. Our chief investment officer, Julian Chillingworth, ponders a hectic week ahead.
Hundreds of thousands of people filled the streets of the West End at the weekend, calling for a second Brexit referendum. At the same time, “17 Million F*%k Offs: A Brexit Song”, a parody of an English folk ditty, soared to the top of Amazon Music’s chart demanding leave.
Miles from both camps, in the rolling Chiltern hills, Prime Minister Theresa May was failing to win over pro-Brexit members of her party. Scuttlebutt says Mrs May’s underlings are plotting coups, that she has been told MPs would back her deal as long as she wasn’t fronting it. That’s a strange argument. If Mrs May’s deal is so unpalatable, why would it suddenly appear much tastier under a different leader? Still, there is no doubt that Mrs May’s time is coming to an end – her credibility in Brussels and Westminster is shot to nothing. But it would have to be her choice: Conservative MPs can’t roll Mrs May within a year of the last attempt, which was in December. Will loyalty to the party propel her out the door of No.10? And if not, how long can she ride her determination? Going by her permanent grimace, perhaps not long.
On Wednesday, Parliament will have a series of indicative votes to determine which Brexit options MPs will countenance. Everything is on the cards including a second referendum. The whole thing has a feel of finality now: the EU has agreed to extend the Article 50 deadline to 22 May as long as the UK agrees on an acceptable withdrawal agreement by 12 April. Can the mother of all parliaments sleepwalk into a hard Brexit? Will MPs crumble and go with Mrs May’s deal as the best of a bad bunch? Something completely different? Or will another surprise send the Brexit merry-go-round on one more spin?
Source: FE Analytics, data sterling total return to 22 March
Twilight for the longest boom?
Across the Atlantic, the US treasury yield curve inverted briefly on Friday, a boring technicality that also happens to toll the approaching end of a decade-long global economic expansion.
A yield curve inversion means the yield on 10-year government bonds falls below that of their three-month and one-year counterparts. In usual conditions – when the economy is expected to grow – longer-term debt yields more than shorter-term debt because it makes sense for investors to sell risk-free bonds and use the cash to make a better return from risky assets like stocks and company debts. When these opportunities (and optimism) wane, investors worry about recession and the beginning of falling interest rates. At that point they start buying longer-term government bonds because, if you think interest rates will fall, you want to lock in the greatest return for the longest period you can. If you hold a 10-year bond that gives you 2.5% through a recession, it’s likely that the central bank will cut interest rates to support hard-up businesses and households. As the prevailing market rate of interest drops, your bond becomes more valuable and its price goes up. You gain. If you held three-month or one-year government bonds, they will mature very soon and then you would have to reinvest at the now-much-reduced interest rate. You lose.
That’s a very simplified illustration of the government bond market. There are other factors at work, including expectations of inflation and growth, but they tend to feed into the central point discussed above: do you think interest rates are going up or down in the near future? Because that is the crucial driver of government bond prices.
So, with that out of the way, how did stock markets take this development? Not well. The S&P 500 and FTSE All-Share indices dropped 1.9% on Friday. However, we counsel taking a breath – now is not the time for running for the exits. We have deeply researched past yield curve inversions and how they impact markets. The first lesson is that it’s very difficult to tell how long it will take for the recession to arrive. Our work shows 14 months is the average since 1956. Equity markets tend to peak about four to six months ahead of the downturn, so you could forego quite a lot of return if you sell out straight away. Also, this is just one signal of impending recession, albeit a pretty good one. Other indicators, including the labour market and the housing market, remain in decent shape.
Another finding from our research is that defensive parts of stock markets, consumer staples, utilities and other lower-growth, but vital product manufacturers do better than the higher-growth, discretionary-type businesses. Stylistically, bean canners and water providers are a safer bet than travel companies if we’re heading into a period of shrinking household spending. We have been selling our investments from higher-risk parts of the equity markets and buying lower-risk stocks and bonds issued by very strong companies.
To reiterate, we think it’s not the time to run for the hills, but it makes sense to get your wagons in order.
UK 10-Year yield @ 1.01%
US 10-Year yield @ 2.44%
Germany 10-Year yield @ -0.02%
Italy 10-Year yield @ 2.45%
Spain 10-Year yield @ 1.07%
Economic data and companies reporting for week commencing 25 March
Monday 25 March
US: Dallas Fed Manufacturing, Chicago Fed National Activity Index
EU: GER: IFO Surveys
Final results: Brady, Hansteen Holdings, Microgen, Quixant, Spectra Systems Corporation
Tuesday 26 March
UK: BBA Loans for House Purchase
US: Housing Starts, Building Permits, House Price Index, Richmond Fed Manufacturing, Consumer Confidence, Conference Board Index
EU: FRA: GDP; GER: GfK Consumer Confidence
Final results: Access Intelligence, Alliance Pharma, Barr (AG), Clarke (T), Fevertree Drinks, Gulf Marine Services, Moss Bros Group
Wednesday 27 March
UK: CBI Reported Sales,
US: MBA Mortgage Applications, Trade Balance
EU: ECB President Mario Draghi Speaks in Frankfurt
Final results: Hilton Food Group
Interim results: Bellway
Thursday 28 March
US: Personal Consumption, GDP, Kansas City Manufacturing Activity, Pending Home Sales
EU: Economic Confidence, Business Climate Indicator, Consumer Confidence, Money Supply (M3)
Final results: Arbuthnot Banking Group, Eddie Stobart Logistics
Friday 29 March
UK: GDP, GfK Consumer Confidence, Lloyds Business Barometer, Net Consumer Credit, Mortgage Approvals, Money Supply (M4)
US: Personal Income, Personal Spending, Chicago Purchasing Manager, New Home Sales, University of Michigan Sentiment Survey
EU: GER: Trade Balance, Retail Sales, Unemployment Rate
Final results: Cathay International
Interim results: CVS Group