One direction?

In Iceland, there’s an old saying: if you don't like the weather, wait 15 minutes.  Since the start of this year, the markets have proven just as changeable as the fickle Icelandic climate.  Earlier this month, the VIX index of volatility – Wall Street’s “fear gauge” – briefly hit the heady heights of 50, marking the biggest one-day rise in the history of the index and its highest level since August 2015.

As the needle of the VIX flickered briefly into the danger zone – where investors fear that a potential crisis could be imminent – this sudden return to volatility signalled a dramatic end to an unprecedented stretch of almost unnerving calm in the markets.  Following hard on the heels of the spike, tidal waves of prolific buying – and selling – of equities saw the asset class relinquish its gains for the year to date.  Apart from a Friday rally in the US, major equity markets were little changed last week.  It’s not volatility, but a lack of clear direction that seems to epitomise equity markets at the moment.  

In the UK, a lack of direction is strongly in evidence on the political front.  As this week’s review was going to press, Labour leader Jeremy Corbyn announced a shift in policy to back staying in the EU’s customs union.  Corbyn’s revelation comes just days before Prime Minister Theresa May is expected to lay out more details on Brexit plans.  But markets may be looking in vain for further clarity, and Labour’s move may only add to Brexit-related uncertainty. 

What’s more, as pointed out in a recent article in The Economist, there’s one post-transition model that the UK government seems loath to consider, and ironically, it’s one that the EU would be happy with: UK membership of the European Economic Area (EEA).  There’s an interesting precedent here in recent history.  In November 1994, Norway voted against joining the EU, choosing to rely instead on the fallback option of its membership of the EEA.  Many proponents of Brexit favoured the EEA scenario as a way to retain the economic advantages of single-market membership, without the associated political baggage.  The government’s own analysis shows that this would represent the most cost-effective way for Britain to extricate itself from the EU, says The Economist.  But it could breach many of the “red lines” marked out by Theresa May, such as the risk that Britain would be a rule-taker, not a rule maker in such a relationship.

  Index 1 week 3 months 6 months 1 year FTSE All-Share 0.3% -1.4% 0.0% 4.7% FTSE 100 0.2% -1.6% -3.4% 3.5% FTSE 250 0.8% -0.7% -1.1% 9.1% FTSE SmallCap -0.2% -0.2% 0.6% 10.5% S&P 500 1.1% 0.9% 3.1% 5.8% Euro Stoxx 0.2% -2.5% -3.2% 15.1% Topix -0.8% -1.2% 4.8% 9.6% Shanghai SE 2.9% -3.0% -5.8% -1.4% FTSE Emerging Index 1.7% 2.9% 2.6% 14.8%  

Source: FE Analytics, data sterling total return to 23 February 2018

Uncertainty on many fronts

Then there’s uncertainty over the government; more precisely, uncertainty over the potential implications for investors of Jeremy Corbyn’s Labour Party coming to power at the next election – a question that has become more pressing than ever with Theresa May’s leadership position looking increasingly shaky.  So how could a Corbyn reign affect the markets?  While our analysis suggests that left-leaning governments over the past 30 years have had no tangible impact on global equity and bond markets (see our recent report Oh! Jeremy Corbyn), none of these governments could have been accurately classed as “hard left”, meaning there is no solid precedent in the UK.  What’s more, it’s difficult to assess the impact of Labour’s policies on measures like UK GDP, over five or 10 years, meaning that uncertainty on this front is likely here to stay – at least in the medium term.

Last, but not least, the UK is facing fresh uncertainty on the economic front, just as the government is entering the critical final phase of talks on trade.  Cracks are appearing in the nation’s economic resilience, built up at the tail end of 2017, when a prolonged upturn in global growth helped to bolster economic output.  Figures released last week show that the UK economy grew more slowly than originally thought in the last three months of 2017, with fourth-quarter GDP growth revised down to 0.4% from an initial estimate of 0.5%, putting the UK at the bottom of the G7 league table. 

On Thursday manufacturing PMIs will be released across the global, giving an indication of how robust the recent recovery in global economic activity remains, and clues on how far the UK may be lagging behind. 

Volatility means opportunity

As 2018 plays out and central banks pursue their path of monetary tightening, we expect market volatility to remain a feature of the investment landscape – particularly as the Brexit negotiations continue to generate uncertainty.  That belief is reflected in our asset allocation strategy. 

In the absence of an abrupt global downturn, equities should continue to offer the most attractive prospects for risk-adjusted returns for selective stock pickers in 2018, although erring on the side of caution rather than exuberance would be advisable.  Meanwhile, nominal gilt yields are looking less unattractive after their recent rise.  We remain on the lookout for opportunities, created by rising volatility and yields, to deploy cash positions that have been built up in recent months on the view that a setback was overdue. 

Bonds

UK 10-Year yield @ 1.52%
US 10-Year yield @ 2.87%
Germany 10-Year yield @ 0.65%
Italy 10-Year yield @ 2.16%
Spain 10-Year yield @ 1.59%

 

Economic data and companies reporting for week commencing 26 February

Monday 26 February

US: Chicago Fed National Activity Index (Jan), New Home Sales (Jan), Fed's Bullard Speaks on U.S. Economy and Monetary Policy
Full-year results: Bunzl, Hammerson, Hiscox, Kosmos Energy

Tuesday 27 February
US: Wholesale Inventories (Jan), Durables Ex Transportation (Jan), Richmond Fed Manufacturing Index (Feb) 
EU: FRA: Consumer Confidence (Feb); SPA: CPI (Feb); EMU: M3 Money Supply (Jan); ITA: Manufacturing Confidence (Feb); GER: CPI (Feb), Retail Sales (Jan)
Preliminary results: Croda International, Elementis
Full-year results: Derwent London, Direct Line, Drax, GKN, Jupiter Fund Management, Meggitt, Persimmon, Provident Financial, Standard Chartered, Virgin Money 

Wednesday 28 February 
US: MBA Mortgage Applications (23-Feb), Chicago Purchasing Manager (Feb), Pending Home Sales (Jan), Fed's Powell Testifies to House Financial Services Committee 
EU: FRA: PPI (Jan), Consumer Spending (Jan), GDP (Q4), CPI (Feb); SPA: Current Account Balance (Dec)
Trading update: Associated British Foods
AGM: Sage Group
Full-year results: Admiral Group, ITV, Man Group, St James’s Place, Taylor Wimpey, Travis Perkins, Weir

Thursday 1 March
US: Personal Income / Spending (Jan), Initial Jobless Claims (24-Feb), PMI Manufacturing (Feb), Construction Spending (Jan), ISM Manufacturing / Prices Paid (Feb), Wards Domestic Vehicle Sales (Feb) 
EU: SPA: GDP (Q4), PMI Manufacturing (Feb); ITA: PMI Manufacturing (Feb), Unemployment Rate (Jan); FRA: PMI Manufacturing (Feb); GER: PMI Manufacturing (Feb); Eurozone wide: PMI Manufacturing (Feb), Unemployment Rate (Jan) 
UK: Net Consumer Credit (Jan), Net Lending Secured on Dwellings (Jan), Mortgage Approvals (Jan), Money Supply (Jan)
Preliminary results: Synthomer, WPP
Half-year results: Close Brothers, 
Full-year results: Bovis Homes Group, Capita, Cobham, Evraz, Hastings, Hunting, IPF, Mail.Ru, Merlin Entertainments, Petrofac, Rentokil, Robert Walters, RPS Group, Schroders, TMK

Friday 2 March 
US: University of Michigan Sentiment (Feb) 
EU: Eurozone-wide PPI (Jan) 
UK: PMI Construction (Feb)
Preliminary results: London Stock Exchange
Full-year results: IMI, Mondi, Spire Healthcare