Market Bulletin - Halfway house
Markets pulled in different directions, as the UK government was further weakened by events.
To lose one cabinet minister may be regarded as unfortunate; to lose two looks like carelessness – as Oscar Wilde (almost) said.
Last week the prime minister lost her second cabinet minister in just eight days, this time for a solo and unapproved diplomatic mission to Israel. Meanwhile, Boris Johnson briefed a public meeting that a British citizen in detention in Iran had been teaching journalists (which he has since reneged on), raising the possibility that her sentence may be doubled. Michael Heseltine, the former deputy prime minister, said previously that in normal times the current foreign secretary would have been sacked some time ago; last week he added that he might vote for Jeremy Corbyn at the next election in order to prevent Brexit. As the harassment scandal convulsed Westminster, and a tax avoidance story filled the front pages, there were signs the government may be struggling merely to keep up with events.
All the same, it has plenty to do. Michel Barnier warned that the UK now has two weeks to set out how much it is ready to pay in the divorce settlement, or risk running out of time to prepare for the transition deal the UK government has requested. (He also advised EU governments and businesses to start contingency planning for a no-deal scenario.) British officials said they want more certainty that the EU will then reciprocate and agree the outlines of a transition deal at the summit on 14–15 December. Nevertheless, reports last week said that Theresa May and pro-Brexit Cabinet ministers had already accepted that they would need to offer a much higher figure than the €20 billion initially proposed.
Meanwhile, a study published last week by the think tank IPPR North estimated that Brexit would exert double the impact on the North of England that it would on the South. It found that 10.2% of the region’s GDP is dependent on the EU, against 7.2% for inner London. Cumbria, the most severely affected county, would suffer a 13.2% hit to GDP, followed by North Lincolnshire at 12.8%.
Last week, two new landmarks were reached: 500 days since the referendum result was announced, and 500 days until the UK’s exit deadline. Moreover, two of the UK’s closest allies began to talk tough. Irish negotiators reportedly blindsided UK officials at negotiations in Brussels by reopening the question of the Irish border and adopting a more forthright approach. The Irish foreign minister then told the press that achieving an EU–UK trade deal in 2018 was “not realistic”.
In London, Wilbur Ross, the US secretary of commerce, warned the UK to avoid agreeing to “hindrances” to trade in its Brexit negotiations. On his visit, Mr Ross was also briefed by the heads of the largest banks on Wall Street, who complained of the UK government’s failure to offer clarity on either transition or a final deal – and of its instability. The banks warned that they were fast approaching the “point of no return”, after which they would need to trigger contingency plans and start to move jobs, capital and infrastructure overseas. They have, of course, made similar warnings before.
Nevertheless, a Capital Economics report, commissioned by Woodford Investment Management and published last week, anticipated improvements in the negotiations.
“We expect a deal to be struck with the EU in the coming months,” Woodford said in its summary. “[The] report suggests that neither side can be entirely comfortable about the prospect of walking away from the table without an agreement, as do the Bank of England Financial Policy Committee notes released last month. These highlighted that £20 trillion of uncleared derivatives contracts, impacting tens of thousands of counterparties, were potentially at risk of disrupting the functioning of financial markets in the event of no deal. Nevertheless… even in the event of no deal, the long-term prospects for the UK economy are nowhere near as bleak as many have predicted.”
Another view is that the UK will have one of the lowest growth rates of all EU countries in 2018, or so said a report published by… the EU. All the same, it still predicted reasonable growth, and the IMF and Bank of England (BoE) have both offered more positive forecasts of 1.7% growth – hardly the stuff of downturns. Moreover, a BoE company survey published last week offered encouraging news on wages, which have long remained stagnant, forecasting a 2–3% rise in 2018.
Investors were more circumspect. The yield on the two-year gilt was below 0.5% last week, indicating that investors think borrowing costs are likely to go up much more slowly than suggested by the BoE’s interest rate ‘dot plot’. The FTSE 100 slid 1.7% last week but, like the Eurofirst 300, which forfeited 1.9%, corporate results may have been the true cause. AstraZeneca reported a further fall in sales in the third quarter, although the pace of decline had at least slowed, and the CEO was able to point to successful recent clinical trials. M&S, meanwhile, announced a fall in like-for-like food sales, and Archie Norman, the CEO, warned of major challenges faced by the company. Beyond the stock market, it was also a significant week for the UK’s ‘gig economy’, as Uber lost its appeal against a court decision to oblige it to treat its drivers as employees.
Last week also saw MPs launch a formal inquiry into the state of household finances, since personal debt has reached a level not seen since the financial crisis. The Treasury Select Committee will consider whether the £200 billion borrowed by households and consumers via credit cards, personal loans and car deals is excessive – and consider the potential impact of the recent interest rate rise.
Amid the political ruckus, it was easy to miss the fact that the chancellor will next week announce his Budget. There are plenty of reasons for Philip Hammond to play the Grinch. Among them are his lack of fiscal slack and the need to focus on political firefighting – and Brexit negotiations – rather than launching new spending initiatives. Conversely, there has been speculation that businesses may face a VAT hit and that pension savers may be in line for a less generous deal. Could pensions tax relief be targeted?
“There is no doubt Hammond faces pressures on both sides of his balance sheet,” said Steve Webb, former pensions minister. “We can assume pension tax relief will be in his sights. Latest figures show the cost of pension tax relief rose by around £3 billion in the last year, while the cost of not levying National Insurance on pension contributions rose by a further £2 billion. The complex and messy ‘tapered’ annual allowance could also be in the government’s sights.”
Given the chancellor’s concern to see both a balanced budget and an increase in what the government calls ‘intergenerational fairness’, savers would be well-advised to make the most of their available allowances while they still can.
Meanwhile, stocks rose dramatically early in the week on both sides of the Pacific. On Monday, the S&P 500, NASDAQ and Dow Jones Industrial Average all struck record highs. The following day, Japan’s Nikkei struck a 26-year high and ended the week up 0.63%, while the TOPIX reached a 10-year high. The S&P 500 dipped 0.36% over the week, but is having a great year nevertheless. Whatever the demerits of Trump’s presidency, they certainly haven’t hurt stock prices.
Last week the “great huge global brand”, as Boris Johnson recently described him, took a five-nation tour of Asia in which he displayed a somewhat different persona to that presented on the campaign trail. Although he spoke out on unequal trade, Trump has already developed close relations with both Shinzo Abe and Xi Jinping. He even won over his South Korean hosts, who had feared he might seek to stoke the North Korea stand-off, rather than resolve it.
There was less sign of momentum back in Washington, as the tax-plan package faced extended Republican efforts to minimise the harm it could do to the budget deficit. It is not clear that investors are expecting much – a recent study by Goldman Sachs showed that the 50 most tax-sensitive stocks on the S&P 500 have underperformed the broader index in recent months.
Woodford Investment Management is a fund manager for St. James’s Place.
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