Stocks up, government shutdown

American stocks have matched the longest run of unbroken calm in their history, fittingly at the same time as the US government shuts down due to political impasse.

Barring a correction today, the S&P 500 will set a new record for the longest period without a 5% fall. At 395 days, it will overtake the dot-com boom of the late ’90s, well beyond the long-term average of 92 days. The background for this phenomenal run has been the erratic and largely ineffectual first year of Donald Trump’s presidency. Markets have completely ignored the risks and drama roused by the new administration, from potential nuclear holocaust to trade wars and late-night tweets. Instead, day after day, the market has ground ever higher.

Mr Trump’s tax cut package was rammed through just before Christmas, boosting most companies through lower taxes. However, a Budget for the coming year was a more difficult task. A tide-over deal was defeated in the Senate on Friday and follow-up discussions with Democrats at the weekend were fruitless. This is the first time that a shutdown has happened when one party controls the White House and both chambers of Congress, although this is embarrassing rather than threatening. Government shutdowns have a very small economic effect and stock markets have largely shrugged them off in the past. Oxford Economics estimates every week of furloughed non-essential Federal workers costs about 0.1% of annualised GDP growth. So if it continues for three to four weeks, it would fully negate the forecast uplift to 2018 US growth from the tax cuts. This seems unlikely to us, and a deal should be made over the coming days.

In the meantime, we will be missing our stats! No US economic data is published during a shutdown, they’re considered “non essential” …

Index 1 week 3 months 6 months 1 year FTSE All-Share -0.6% 3.3% 6.0% 12.6% FTSE 100 -0.6% 3.4% 5.9% 11.6% FTSE 250 -1.0% 3.0% 6.2% 16.4% FTSE SmallCap -0.3% 3.7% 7.6% 17.6% S&P 500 -0.3% 5.0% 7.7% 11.9% Euro Stoxx 0.5% 1.8% 6.5% 20.8% Topix 0.2% 6.1% 11.9% 17.0% Shanghai SE 1.6% 2.1% 7.3% 7.3% FTSE Emerging Index 1.2% 6.1% 10.6% 22.3%    Source: FE Analytics, data sterling total return to 19 January

 

Monetary machinations 

With the US labour market running hot, more large retailers are raising wages to hold on to staff.

Some have hiked their minimum pay by 10% to $11 an hour, promising it will be $15 by 2020. Other employers have already pushed their lowest hourly wage to $15 as jobless benefits have cratered to the lowest level since the early 1970s.

Wage growth, long dormant, may be in for a burst of life this year. Inflation would likely rise along with it, given the poor productivity growth in the West and China. This would put pressure on bonds, as yields would rise to account for greater inflation. As problems go, a buoyant economy with the poorest getting better off is not really one. Still, after a record-smashing run for stocks that was driven mainly by falling discount rates and higher P/Es, higher yields could cause a correction. If markets do take a tumble, it would likely be short lived. Market setbacks rarely upset periods of steady economic growth. All major nations appear to be doing well and global commerce looks healthy, so cheaper shares would probably attract new buyers.

Bond yields are a little more difficult to call. You can feel the jitters in the market already. However, despite worries about tightening monetary policy, there are plenty of buyers. People and pension funds looking to match future liabilities are happy to lock in slightly higher yields every time bonds sell off a bit. Of course, that doesn’t mean that they always will. Meanwhile, credit spreads – the extra return for taking on default risk – are extremely low and warnings about “zombie companies” are rising. These firms are only profitable because bargain-basement rates of borrowing have drastically cut their cost of capital. How will they fare once interest rates rise and they have to refinance? Some people ask the same question about highly leveraged households, too.

Tomorrow, the Bank of Japan will announce any changes to its monetary policy. No rate change is expected, but Governor Haruhiko will set out his thinking following this month’s surprise cut to the quantitative easing (QE) programme. Japan’s core inflation rate has been rising steadily, from 0.1% at the beginning of 2017 to 0.9% in November, almost halfway to the target of 2%. The European Central Bank’s (ECB) policy meeting follows on Thursday. Again, the focus will be on the bank’s tone, rather than any changes to its current policy. The euro is at a three-year high against the dollar, despite ongoing QE which should, in theory, weaken the currency. The knock-on effects of such a high euro, including lower inflation in the eurozone and a greater headwind for exporters – a significant chunk of European companies – will no doubt be giving ECB President Mario Draghi a headache.

Bonds

UK 10-Year yield @ 1.34%
US 10-Year yield @ 2.66%
Germany 10-Year yield @ 0.57%
Italy 10-Year yield @ 1.96%
Spain 10-Year yield @ 1.44%
 

Economic data and companies reporting for week commencing 22 January

Tuesday 23 January

UK: Public Sector Net Cash Requirement/Public Sector Net Borrowing (Dec)
US: Richmond Fed Manufacturing Index (Jan)
EU: Consumer Confidence (Jan); GER: ZEW Survey Current Situation/Expectations (Jan)

Quarterly results: EasyJet
Trading update: Dixons Carphone

Wednesday 24 January

UK: Average Weekly Earnings (Nov), ILO Unemployment Rate (Nov)
US: MBA Mortgage Applications (19-Jan), PMI Manufacturing/Services/Composite (Jan), Existing Homes Sales (Dec)
EU: PMI Manufacturing/Services/Composite (Jan); FRA: PMI Manufacturing/Services/Composite (Jan); GER: PMI Manufacturing/Services/Composite (Jan), Import Price Index (Dec); SPA: PPI (Dec)

Full-year results: Staffline
Quarterly results: Antofagasta
Trading update: J D Wetherspoon, Sage Group

Thursday 25 January

US: Wholesale Inventories (Dec), Initial Jobless Claims (20 Jan), New Home Sales (Dec), Leading Index (Dec)
EU: ECB Main Refinancing Rate,; GER: GfK Consumer Confidence (Feb), IFO Business Climate/Expectations/Current Assessment (Jan); SPA: Unemployment Rate (Q4)

Full-year results: St. James’s Place 
Half-year results: Diageo
Quarterly production: Anglo American
Quarterly results: Renishaw, Sky
Trading update: Close Brothers, Daily Mail & General Trust, MHP, Paragon Banking

Friday 26 January

UK: GDP (Q4)
US: Durables Ex Transportation (Dec
EU: M3 Money Supply (Dec); FRA: Consumer Confidence (Jan), Manufacturing Confidence (Jan), Own-Company Production Outlook (Jan) 

 

Julian Chillingworth
Chief Investment Officer