All at sea

Currencies bounced around last month as investors debated the strength of the UK’s Brexit negotiating position, whether the Federal Reserve (Fed) will slow its rate hikes, and if the European Central Bank will soon cut the number of bonds it buys each month as part of its quantitative easing programme.

The dollar has been particularly weak so far this year (down almost 10%) because investors have, once again, started to doubt the Fed’s fortitude. Inflation has melted away, economic data has been hot and cold, and President Donald Trump is increasingly becoming a lame duck president before his time.

After failing to replace Obamacare or drive through tax reform (it’s still coming, apparently), and forgetting about infrastructure spending, now Mr Trump’s turned his sights to limiting immigration. He has endorsed a bill that would halve US immigration to roughly 500,000 people a year. Given that the job openings in the US are at an all-time high of 5.7 million, this seems a strange way to deliver the American boom he’s promised. It could light a fire under stagnant wages, however, which have been puzzling many economists. Unfortunately, restricting the supply of labour would likely just drive prices higher rather than making workers any better off and reduce real growth in the US.

What a time to be running the Fed. Chair Janet Yellen and her staff must feel like they are playing snooker on a fishing trawler. Every month there’s another plan or tweet that – if enacted or followed through – would affect fiscal policy. But so far each one has flamed up and died away, leaving reams of analysis worthless and things as they were. Perhaps that is why investors are becoming more convinced that the Fed will be slower to raise interest rates than forecast. There are just too many moving parts and if just one gets through at the wrong time, the repercussions could be significant. And as long as inflation is benign, there’s no pressure to act hastily.

For now, it appears that from September the Fed will begin ‘selling’ the bonds it holds. That means it won’t buy any bonds to replace some billions of dollars’ worth of those that mature each month. Another 25-basis-point rise in the Fed Funds benchmark rate in December has only a 40% probability – opinion in the market remains heavily divided about whether the central bank will act.

Index 1 month 3 months 6 months  1 year FTSE All-Share 1.2% 3.0% 7.1% 14.9% FTSE 100 0.9% 3.2% 6.2% 14.0% FTSE 250 2.4% 1.6% 10.7% 17.6% FTSE SmallCap 2.2% 3.9% 11.0% 22.8% S&P 500 0.5% 2.0% 4.2% 16.1% Euro Stoxx 2.3% 6.0% 15.2% 27.3% Topix 0.6% 4.8% 4.6% 16.8% Shanghai SE 1.8% 4.4% 1.1% 9.4% FTSE Emerging 4.3% 6.2% 10.8% 22.4%

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

 

Don’t let me down

Investors can be a moody bunch. They want to know exactly what’s going to happen, especially when it’s impossible to say. And they hate it when earnings are lower than forecast. But for all these foibles, investors usually get equally excited when companies over-deliver. During the past couple of years, that’s started to change. 

This quarter’s earnings season has continued a trend of exceptional punishment for companies that miss their forecasts, even if only by a small margin. But those that delivered better-than-expected performance have been rewarded with only minor outperformance. It could be that investors are expecting even better growth than companies are guiding, so there is less surprise than you would originally think. Or it could be that investors are focusing on the downside: swiftly selling anything that smacks of weakness, while loath to add to winners that are on already spicy multiples. 

As earnings reporting wraps up, about 70% of the S&P 500 has beaten the average earnings-per-share estimate, according to FactSet. The index’s forward price/earnings ratio is 17.7, compared with a five-year average of 15.4. Earnings growth in the second quarter was 10.1%, the second-highest year-on-year quarterly result since late 2011. However, this has been skewed by the energy sector, which has taken a rollercoaster ride alongside the oil price. IT companies delivered an average 14.3%, while financials have benefited from a turnaround, their earnings gaining 11.0%. The consumer discretionary sector was the only one to post a fall in earnings (-0.9%), driven by a large drop in Amazon’s profits as it invested much more in itself than analysts expected.

In the UK, earnings have broadly performed well. However, there were some large falls in several stocks that disappointed. The largest was AstraZeneca, whose price slumped 15% on the day it revealed poor results in its Mystic clinical trial for an immunotherapy cancer treatment. Financials and energy companies led the pack, while consumer staples lagged.

All in all, not a bad quarter. Although, analysts are more conservative about the immediate future. US earnings are expected to rise by only 5.6% in the third quarter, before accelerating again to about 11% in the fourth quarter.

Bond Yields Sovereign 10-year  Jul 31 Jun 30 UK 1.23% 1.26% US 2.30% 2.30% Germany 0.53% 0.47% Italy 2.09% 2.16% Japan 0.08% 0.08%

Source: Bloomberg

 

Julian Chillingworth, Chief Investment Officer