Second-guessing

Inflation fears roiled markets in early February after a record stretch of stock market calm. Our chief investment officer, Julian Chillingworth, looks ahead. 

John Maynard Keynes once described the stock market as a beauty contest where all the judges try to guess who the other judges will find most alluring, rather than pick to their own tastes. The inference being, investors don’t focus on fundamental value, they care more about what their peers think. It’s insights like this that help explain why a booming nonfarm payrolls number instils confidence and drives markets higher one month, but sends them careering lower because of inflation worries the next.

Stock markets and bond yields had been rising steadily in January. Bond yields have been increasing around the world due to a mixture of better prospects for GDP growth and higher expectations of inflation. Ten-year gilts jumped 32 basis points to 1.51% last month; the 10-year US treasury yield finished 30bps higher at 2.71%. UK investors may not have benefited as much from the strength in foreign equity markets so far in 2018, however, because sterling has been in the ascendency. That currency headwind will sting yet more as markets sank sharply lower in early February. Starting with a 2.1% one-day fall in the S&P 500, the selling spread to Asia and then hit the FTSE All-Share. When the selling made it all the way round the globe, American stocks plunged more than 4%, with the Dow Jones posting its largest ever intra-day fall (1,600 points).

The trigger was the US jobs report. Nonfarm payrolls – the net number of jobs added in the US (excluding farm workers) – came in at 200,000 for January, 20,000 more than forecast. This notoriously volatile number should have simply been more evidence of a robust American economy with a steadily improving situation for its consumers. But as Mr Keynes wisely noted, trying to second-guess what other people think you think they think everyone thinks can get out of hand. Rather than focusing on the first effect of stronger US jobs growth, investors appeared to fixate on a potential future downturn that may be sparked by faster and steeper interest rate hikes from an attempt by the Federal Reserve to curtail rampant inflation driven by higher wages. US wage growth, also released on Friday, was 2.9% higher than a year earlier. That was 30bps greater than expected and the highest rate since 2009. On a multi-decade view, however, less than 3% annual wage growth is still a pittance. If this pace of increase continues, however, investors could become even more restive.

It was a rude welcome for new Federal Reserve Chair Jerome Powell, whose first day was the Monday of the 4% sell-off. Many investors will be watching to see how he responds. The next inflation print will also be an important milestone when it’s released on Valentine’s Day. US CPI has been hovering around 2.1% for several months, if it breaks significantly higher investors may fall out of love with one of the longest bull markets in history.

Index 1 month 3 months 6 months 1 year FTSE All-Share  -1.9% 1.1% 3.9% 11.3% FTSE 100 -2.0% 1.1% 4.0% 10.4% FTSE 250 -2.2% 0.5% 3.6% 14.6% FTSE SmallCap -0.1% 1.7% 4.8% 16.4% S&P 500 0.5% 2.7% 6.7% 11.2% Euro Stoxx 1.9% 0.2% 4.7% 20.6% Topix -0.8% 1.3% 7.5% 12.5% Shanghai SE 3.6% 0.9% 5.5% 6.6% FTSE Emerging 3.6%  6.1% 10.1% 22.0% Source: FE Analytics, data sterling total return to 31 January

 

Oh! Jeremy Corbyn

The long-simmering and pseudo-secret Conservative civil war is spilling out into the open.

Prime Minister Theresa May is roughly eight votes away from a vote of no confidence while the pro-Brexit wing of her party are pushing for her to cut loose moderate Chancellor Philip Hammond. The threat of a potential no-confidence vote could be a ploy to oust Mr Hammond, who has been softer in his Brexit rhetoric than some Conservatives would like. Or some within the party may truly have tired of Mrs May’s fragile leadership and be pushing for a new head, rather than just a more amenable Cabinet member.

For months, Mrs May has limped on because toppling her could deal a mortal wound to the Conservative-DUP government itself. Many within the party are afraid of capsizing the boat and ushering in a Labour-led government. We are not in the business of predicting elections – either when they will crop up or who will win them. But we are in the business of evaluating the government policies and how they could affect investments.

Our research team has delved deep into Labour’s manifesto and scoured recent history for a precedent that can offer insights about how it will affect stock markets, the pound and bond yields. Their report Oh! Jeremy Corbyn: What a Corbyn-led government could mean for investors, hinges on perceptions. Labour leader Jeremy Corbyn has been propelled upward in polls and in the minds of many by a desire for “radical change”. Almost as many people worry about what this radical change will mean for them, their livelihoods and their investments. But when you study Labour’s most recent manifesto, it’s not really as radical as you’d think. In fact, if they stick to the plan it could actually boost UK GDP growth.

But there’s a disconnect between stump expectations and the cold black and white of the Labour party planning. Most of the heavy cuts to working-age benefits proposed by successive Conservative Budgets – and lambasted by Labour – are kept in place. The Institute for Fiscal Studies estimates that the poorest 10% would suffer a 7.5% fall in annual net income by the end of the next Parliament under Labour. While only the top 5% of earners will experience higher personal income tax rates, higher corporation tax could impact the income of all households if hiring and spending plans fall in response.

Can you really take the Labour manifesto at face value when its relative mundanity belies the radical rethink that Mr Corbyn’s supporters suggest he will bring about?

Bond Yields

Sovereign 10-year Jan 31 Dec 31 UK 1.51% 1.19% US 2.71%  2.41% Germany 0.70% 0.42% Italy 2.02% 2.01% Japan 0.09% 0.04%

Source: Bloomberg

 

Julian Chillingworth, Chief Investment Officer