Peak prices

As the Bank of England raises interest rates for the first time in a decade, the baton of economic stimulus is being passed to the government. Fiscal policy will have to smooth the way for UK growth here on in, but Chief Investment Officer Julian Chillingworth wonders if the government can deliver.

The Bank of England (BoE) raised rates in early November from 0.25% to 0.5%. A decent boost from the services sector helped third-quarter GDP grow by a faster than expected 0.4%, a solid enough justification for the hike. The BoE was likely feeling pressured to act on inflation which is biting consumers hard – the CBI retail sales flash survey crashed in October – but by doing so it runs the risk of increasing borrowing costs and dampening demand. Much of the rise in prices was out of the bank’s hands: sterling has slumped since the Brexit vote and recent negotiations have caused more weakness.

Still, we think it will be some time before the bank hikes again. The BoE traditionally errs on the side of caution with its interest rate policy: when in doubt, it tends to support growth and allow inflation to go higher. Our research suggests inflation should peak in October and begin to slide back down. Governor Mark Carney said as much in November’s press conference. He also said the bank expects to raise rates just two more times in the next two years – a comment that sent sterling lower, suggesting that’s a slower tightening path than the market had believed.

With price levels on the decline, the BoE should be able to pander to growth and sit on its hands. Monetary policy remains much looser now than it was before the EU referendum in June 2016. The interest rate is back where it was then, at 0.50%, but the effects of the expanded quantitative easing (QE) programme remain. The BoE had used up virtually all of its £435bn allowance for gilts and £10bn in corporate bonds by early this year, but restricting market supply by holding these bonds will continue to help dampen yields. It continues to reinvest coupon and maturation payments in the market too. At the time, we felt the post-vote expansion of QE and rate cut was akin to using a sledge hammer to crack a nut, and perhaps the 0.25% increase is the BoE coming round to that way of thinking.

While the price of Brent Crude has popped recently, it hasn’t caused any accelerating effects on our inflation model (it’s roughly back to where it was at the start of the year). Although, if the barrel price continues to rise from here – or if sterling weakens significantly against the dollar – that would add to inflationary pressure. If we are correct and inflation does fall from here, it should lead to improving real wage growth (it’s currently negative) and better consumer sentiment. The real pressing issue for Britain and the BoE is a lack of investment growth, something that Governor Mark Carney and his chief economist, Andy Haldane, have both highlighted. They say they need to see better investment spending and a boost to trade to offset consumer spending.

And that’s where Chancellor Philip Hammond comes in. With the crunch year for Brexit looming, he will set out his Budget on 22 November. It will be the first autumn Budget since he dropped the convention of an autumn statement and moved the Budget announcement to the year’s end. It will be a gloomy affair too. Winter is coming, both literally and metaphorically. A punchy cut to the UK’s estimated productivity is expected, which will reduce tax revenues already lagging due to lower growth forecasts. Mr Hammond doesn’t have much cash to work with and it seems to be dwindling by the day. But he needs to take some of the strain from the BoE and inject some favourable fiscal policy into the economy.

Whether he will is unclear. He is hamstrung by his predecessor’s legacy of austerity and “balancing the books”, an inheritance likely to dog him throughout his time at HM Treasury. He seems as likely to hit these targets as George Osborne was. Unfortunately, we don’t see Mr Hammond striking out on a different path. That’s why we prefer FTSE 100 companies, with predominantly overseas earnings, rather than mid-caps that are more affected by weakness – or strength – in the British economy.

Index

1 month

3 months

6 months

1 year

FTSE All-Share

1.9%

4.5%

10.8%

21.8%

FTSE 100

1.8%

2.8%

6.1%

12.1%

FTSE 250

2.0%

3.1%

4.7%

18.5%

FTSE SmallCap

2.3%

3.0%

7.1%

20.6%

S&P 500

3.4%

3.9%

6.0%

13.0%

Euro Stoxx

1.9%

4.5%

10.8%

21.8%

Topix

5.5%

6.2%

11.3%

10.1%

Shanghai SE

2.6%

4.5%

9.1%

2.8%

FTSE Emerging

3.6%

3.8%

10.2%

12.0%

Source: FE Analytics, data sterling total return to 31 October

 

Earnings: mostly good, some bad

On a happier note, quarterly earnings are looking promising around the world. More than half of blue chip companies in Europe and the US have reported and almost 40% in Japan, according to JPMorgan Cazenove.

Japan is doing exceptionally well, with more than 60% of those reporting beating earnings estimates. Earnings per share growth is a staggering 15%, while reported sales are currently around 7% higher than a year earlier, no doubt helped by a weakened yen. Europe has done similarly well: 15% earnings growth (1% higher than expected), driven by energy companies. Its revenue growth is soft, however. Despite being up 5% on a year ago, most of those reporting have only matched or undershot analyst hopes for top-line growth.

About 55% of the S&P 500 has reported, and they have packed quite a surprise: More than three-quarters of the index beat forecasts and EPS growth is currently 7%, 4 percentage points higher than expected. Once all companies have reported, the EPS growth is believed to be closer to 5% (still a decent improvement on pre-earnings season forecasts). According to FactSet, tech, materials, energy and consumer discretionary delivered most of the surprise uplift. Financials, industrials, utilities and consumer discretionary were the disappointments, with their earnings lower than they were a year ago.

FactSet also notes a phenomenon we have talked about previously: earnings beats are not being rewarded as you would usually expect, while disappointments are being punished severely. According to the financial stats firm, positive surprises for S&P 500 firms earn just a 0.1% bump on average to the share price over the two days following the announcement (the five-year average is 1.2%). As for earnings misses, they result in an average 3.2% drop, (longer-term average is -2.4%).

While index-level earnings are better than expected, they aren’t fantastic. Energy businesses are distorted by a rollercoaster couple of years: earnings are 138% higher than a year earlier (forecast growth was 110%). IT company earnings are up 15%, a solid performance. But some other industries are patchier: consumer staples eked out just 1.8%; utilities didn’t live up to their reliable reputation, with earnings down 6.3%; and financials were 8.2% lower.

There’s some sun on the horizon, though. Analysts expect US earnings to improve noticeably and post double-digit growth for the next three quarters.

 

Bond Yields

Sovereign 10-year

Oct 31

Sep 30

UK

1.33%

1.37%

US

2.38%

2.34%

Germany

0.36%

0.46%

Italy

1.83%

2.17%

Japan

0.07%

0.06%

Source: Bloomberg

Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Rate this page:
Average: 5 (3 votes)