Tatton News Archive

New article from Tatton Investment Management: Looking beyond the obvious

6 November 2020, 12:00am

We wrote only last week that markets hate uncertainty. Given that equity, bond and commodity markets are all quite a lot stronger at the end of this week, many investors must have gained clarity, if not optimism.

There are a lot of important things going on, too many to cover adequately even in our weekly, but we suspect most of our readers in the UK will have struggled to relate with the conclusion of our opening paragraph. Readers will be well aware of US presidential politics although possibly the most important battle remains: the fight for control of the Senate. That will now not be finished until at least the last day of Christmas, and much of a Biden Presidency’s wish list hangs on that result, given a Republican-controlled Senate could seriously derail his policy agenda – as he knows from his time as Vice President to Barack Obama.

Given the prospect of a heavily moderated Biden policy agenda, markets have been happy that US companies may not be hit with tax increases (A Republican Senate will prevent this) , while the US central bank may have to provide even more policy support than otherwise (Because Biden’s fiscal stimulus will still need to be financed). Still, overall economic growth and consequent gross profits will be lower if the US political system remains gridlocked. The US would also provide less growth to the rest of the world. US investors did not seem to look that far, they only saw Goldilocks potential from fiscal stimulus but without tax rises further down the line.

Growth leadership is currently passing to Asia and China specifically, because their more effective handling of COVID means they are not suffering a second wave, pushing them ahead of the western world in the recovery. China’s demand stimulus took the lead in the aftermath of the 2008‑9 financial crisis and, now for different – and perhaps more controversial – reasons, it appears to be doing so again. That may be why the most important market move of the week from our perspective has been in the US dollar, which experienced a sharp fall against many currencies, especially against China’s Renminbi.

The political drama in the US this week pushed a number of important events elsewhere out of the limelight. What would have been the largest full Initial Public Offering (Stock market floatation) was cancelled by Chinese authorities. Ant Group, the fintech (or neo-banking) arm of Alibaba would have raised $37 billion at issue price, and was already trading at nearly $50 billion market capitalisation in the ‘grey’ (aka forward settlement) market.

Some commentators viewed the peremptory action taken by Chinese regulators as a sign of weakness. If the decision was based on reactionary fear, that would indeed have made it a poor decision. However, swift and decisive action is not in itself a bad thing (as the German financial regulator would probably attest to, when reflecting on its own oversight deficiencies over the failed Wirecard fintech business). That said, while investors will remain wary of China’s potential arbitrary regulation, the investment opportunities are clearly there.

There is no chance of political gridlock stopping fiscal expansion in China either. Earlier this year, the administration downplayed the possibility of setting long-term growth targets. In last week’s leadership forum, according to Reuters, Xi Jinping and others laid out a blueprint for China’s five-year plan and key objectives for the next 15 years. They include a goal to turn China into a “high income” nation by 2025, with per capita gross national income of above $12,535, advancing to a “moderately developed” nation (which implies average annual incomes of more than $20,000 per person) by 2035,. That would imply at least a 4% annual growth target in this plan, a level that most western nations would be delighted at getting close to.

China therefore seems set to resume transmitting growth to the rest of the world, especially if relationships with the West improve in the next four years and the Renminbi continues to strengthen. That would help both emerging markets in general and Europe particularly.

Returning closer to home, policy action has been at the forefront in the UK this week. We write about this in more detail in a separate article. UK markets underperformed substantially during October, coinciding with Chancellor Rishi Sunak’s worries over how to pay for the government’s largesse.

It may appear perverse but the past weekend’s imposition of a month’s lockdown was well-received by markets. Rishi Sunak and Bank of England Governor Andrew Bailey must have encountered the Ghost of Christmas Yet to Come. The debt caused by the extension of worker and business support was funded in its entirety by the “issuance of reserves” to buy more of the UK’s government debt issuance – namely Gilts.

It is also notable that the purchases have been in longer-dated bonds (ones with maturities over ten years). We should expect that the Debt Management Office will shift its issuance profile towards longer-term bonds next year – which, as we recently suggested, would ease any short-term austerity pressures – given that the Bank of England has declared such an appetite.

Lastly, a quick word on the third-quarter corporate earnings (profits) season. JP Morgan tells us 80% of companies having reported in the US, and 71% in Europe (including the UK). In absolute terms, earnings growth has been weak (-7% year-on-year in the US and -19% year-on-year in Europe). The good news is that results have been much better than expectations ahead of the reporting season. All regions surprised positively, from +13% to +17%. For the S&P 500, Q3 “blended” earnings per share (EPS) (the rolling mix of estimates and actuals as they are released) has moved higher by more than 15% over the course of the reporting season. Some 84% of companies beat their (awfully negative) analyst forecasts. In Europe, the Q3 blended EPS is up 14% and a record 70% of companies beat forecasts.

With these results, markets have therefore been underpinned by not-so-awful earnings, lower yields, and stronger policy action – some of the gains in clarity we alluded to at the beginning. The past four years have been truly interesting, if not testing, times. Perhaps we might all be grateful for a really boring 2021.