Market Bulletin (21/02/2017)
Upward momentum
Inflation in the UK reached a 31-month high of 1.8% last week, on rising fuel prices and a sharp slowdown in the fall in food prices. Meanwhile, prices paid by UK manufacturers for imported raw materials and fuel rose 20% in January year-on-year. The Bank of England forecast that UK inflation will reach 2.7% next year, although some economists estimate it could hit 3% in 2017. Mark Carney, the governor, confirmed that there would now be no interest rate cuts in 2017.
The rise in inflation increases the challenges for savers unable to find cash rates capable of maintaining the spending power of their money. The latest blow to cash savers contrasted with the findings of the quarterly Dividend Monitor-, which found that headline dividends rose 11.7% in the fourth quarter of 2016: “Equities therefore show no sign of losing their top spot as the best yielding option among… key asset classes,” the report concluded. In short, dividends have been on the up, and cash returns have been going in the opposite direction.
Sterling’s 10-day volatility fell to a one-year low last week, despite rising inflation fears, and the European Commission revised its forecasts for UK economic growth this year upwards to 1.5%. The Bank of England pushed its own forecast up to 1.4%, although it said that, by the end of 2018, 2.5% of growth would have been forfeited due to the referendum vote.
There are many reasons why markets go up, but positive corporate performance is among the more justifiable. Earnings announcements for the fourth quarter of 2016 in the US have almost run their course, and the signs have been broadly positive. Corporate earnings in the US grew by around 7% in the fourth quarter (annualised), and may be one of the reasons behind the so-called ‘Trump rally’.
Last week Wall Street completed its longest upward run since 2013, marking seven successive sessions of gains, before the S&P 500 finally took a marginal dip on Thursday to end the week up 1.2%. The Russell 2000 Index, which tracks smaller companies, performed especially well, although this was also the result of Donald Trump’s promised corporate tax cuts. On Wednesday the FTSE All-World Index broke the record high it had set in 2015.
Yet by the end of the week, leading markets had lost a little altitude. The FTSE 100 ended the week up only 0.57%, Japan’s Nikkei 225 was down 0.74% and the Eurofirst 300 was up 0.8%. As earnings season wound down, a series of corporate scandals – all at different stages of realisation – weighed on sentiment.
Bids and bribes
Among the high-profile corporate developments last week, Unilever’s decision to reject a $143 billion takeover bid by Kraft Heinz was especially noteworthy. The Anglo-Dutch company is one of the largest listings on the FTSE 100 and its response to the bid took no prisoners: “Unilever rejected the proposal as it sees no merit, either financial or strategic, for Unilever’s shareholders. Unilever does not see the basis for any further discussions.” Kraft Heinz quickly abandoned its plans and the stock market impact was largely short-lived.
Meanwhile Samsung, which accounts for around a fifth of South Korea’s GDP, faced scandal, as the company’s chairman and heir-apparent was arrested on corruption and embezzlement charges. Nevertheless, Samsung posted a 50% rise in profits in the fourth quarter of last year, and has been working hard to improve accountability and transparency – the stock ended the week almost back where it had begun.
“Samsung increased almost 45% last year and we feel it still remains cheap,” said Daniel O’Keefe of Artisan Partners. “In fact, looking out a couple of years, we think the stock is trading at [just] six times earnings. Essentially, you have a market-leading company with a strong balance sheet, with corporate governance that, at least at the margins, is changing for the better, all at an incredibly cheap valuation. The corporate governance issues are improving and we view this as a long-term positive – [it] should allow for more independent directors to be named on the board of Samsung.”
Toshiba’s problems appear less tractable. Last week the Japanese electronics and digital conglomerate announced – via a bungled communication – a significant write-down on its US business following a 2015 accounting scandal. Its chairman resigned and the company faces a huge challenge to rebuild its balance sheet, let alone its reputation. Toshiba’s historical pre-eminence in Japan simply underlines the importance of knowing a company’s internal workings when investing.
Rolls-Royce, meanwhile, announced a £4.6 billion annual loss for 2016, caused by a combination of a weaker pound, bribery charges (for which it has agreed to pay £671 million in fines) and headwinds in key markets. Nevertheless, the company’s pre-tax profit was £813 million, around a quarter more than forecast.
Companies in the UK appear to be pulling their weight in hiring terms, pushing employment to a record 74.6% in the final quarter of the year, although wage growth dipped slightly. Female employment reached an all-time high. Corporate news was mixed: profits at Cobham, the UK aerospace and defence company, fell by a fifth to their lowest level since 2015; Co-operative Bank put itself up for sale; and AstraZeneca announced successful clinical trials of a breast cancer drug. The Anglo-Swedish company’s share price rose in response.
Whose news?
Arguments continued last week in both the US and eurozone over ‘alternative facts’. In the case of the US, Donald Trump used a press conference to attack the media over stories of Russian links: “Russia is fake news,” he said. Meanwhile Mark Zuckerberg, founder of Facebook, issued a public statement to defend the company against a growing chorus of complaints that its laissez-faire approach facilitates the spread of fake news.
Janet Yellen, however, continued the Federal Reserve’s tradition of giving as little concrete news as possible. In her press conference she did, however, adopt a more hawkish tone, and noted that growth, inflation and jobs were all on a strong trajectory: “It’s our expectation that rate increases this year will be appropriate,” she said. After she spoke, market odds that the Fed would make three 0.25% rate rises this year rose to 34%.
Meanwhile, in Continental Europe, arguments continued over the nature of financial reality in Greece. The European Commission announced that the country was on its way to achieving a budget surplus of 2.3%, but the IMF disagreed. Eurozone finance ministers will miss this week’s deadline for an agreement with the IMF to release €7 billion in aid, meaning that the bailout deal will have to be struck amid European election season, which only raises the risk of failure. Moreover, the Hellenic Statistical Authority reported last week that Greek GDP shrank by 0.4% in the final quarter – a sharp and unforeseen drop after nine months of growth.
Meanwhile, the yield on France’s 10-year bond remained elevated last week, and trading volumes for French bonds reached their highest level since the euro crisis of 2010–12. Yet pollsters and bookies alike expect Le Pen ultimately to lose the presidential election. Arguably, the more significant French news came in the form of an EU request last week that France and Italy cut their budget deficits in 2017. France, it said, is on track to breach EU budget rules in 2018.
Artisan Partners is a fund manager for St. James’s Place.
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