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New article from Tatton Investment Management: A mixture of messages

20 April 2018

As a youngster, our mum would occasionally treat us with a bag of “pick-n-mix” from the sweets counter at the old Woolworths. I say treat; we didn’t get to choose. I loved jelly babies, but the liquorice all-sorts were horrible. I seem to remember the weather being glorious when we went.

This week has felt like that. Economic data has been a bit of a liquorice all-sort. Retail sales were probably affected by the weather but the fall of 1.2% month-on-month was worse than most economists had thought likely. Maybe they didn’t see the snow. Below is a follow-up on last week’s article on the UK.

As I write, the FTSE 100 is trading at 7,350, a full 7% higher than the low of a month ago, and 2% higher than last week. That’s a definite jelly baby.

Last Friday night’s strikes on Syrian chemical-weapon-related targets had little reported collateral damage and, so far, no immediate retaliation despite the further strikes, most likely from Israel. We look at the Israel-Iran issue in more detail below.

Unfortunately, this story is not over, and is deeply tied up with Russia. Russia’s stock market actually did very well this week, up nearly 4% in sterling terms. However, that’s a bounce-back from quite deep lows; stocks are still 8% below the level of a month ago.

Sanctions are biting especially hard on Rusal, the second largest aluminium producer in the world. And that’s having swift and direct impacts on many global manufacturers. Their customers may want supplies but fear at best being bound up in US courts if they transact, and at worst faced with huge fines and loss of business. Rusal has refineries in Ireland and Sweden which are said to be at a standstill. Rio Tinto has been scrabbling for supplies of alumina for its Dutch facilities. German manufacturers have shortages of finished aluminium and say things are getting rapidly worse.

The sanctions imposed after the Ukraine invasion caused European milk farmers a lot of pain, from which they have only really recovered in the last year. It may be that these new sanctions will have some unfortunate impacts on us in home markets as well.

The price of aluminium and nickel for near-term delivery has risen sharply. So too has the price of oil. This seems to be largely due to seller discipline rather than middle-eastern conflict. OPEC and the Saudis have managed the crude price to levels that seemed unlikely at the start of the year.

This has coincided with a rise in yields in longer bonds across the developed world. After the softer patch of data in Europe and, to a lesser extent, the US, yields had fallen. The US 30-year yield dipped below 3% two weeks ago, from a high of nearly 3.25% in February. However, we’re back to 3.15%, amid a rise in both inflation expectations and real yields.

US economic data has also been mixed through this week, with various regional “leading” indicators being softer than anticipated. What has been strong has been demand for credit from businesses, according to weekly loan data from the Federal Reserve. Having languished with almost no growth through 2017, it suggests that business confidence is solid and sustainable. More importantly, it has a direct impact on the way banks buy and sell government bonds and may be behind the rise in yields. Banks clear out government bond holdings when corporate credit demand steps up, and so yields rise.

The same might not be said about China. Here bond yields have fallen sharply this week after authority action. We’ve been mentioning in past weeks that confidence about Xi Jinping’s government is not the same as confidence about economic growth. The signs are growing that the economic out-turn may be slower than many had anticipated. On that point, China’s Shanghai Exchange index has fallen sharply and is flirting with a big psychological support level of 3,000.

Again, we look at China in a piece below.

News from Taiwan Semi that chip demand has been softer than expected knocked on to Apple and other techs, and reverberated across Asia. A large proportion of chip demand now emanates from Asia and China in particular.

Back finally to the UK. Here at Tatton, we have some interesting debates. One of the big ones has been about the Monetary Policy Committee and its dovishness or hawkishness. As a whole, is the committee predisposed towards rate rises or not? Underlying this is a question about the role of “forward guidance”; to what extent should the committee try to indicate their preference for future rates?. Undoubtedly the members have been signalling that they thought rates would be likely to go up in May. Thus, the Governor’s interview with the BBC on Thursday was a surprise to the market, in that he seemed more dovish than expected. The sharp move in the Pound showed this. Yet, as some (including us) have been saying, the economy has not been strong enough through the start of this year to warrant a near-term rate rise.

We think it’s likely that members will be a little more reticent in forward guidance in the next few weeks. They may still have a predisposition to raise rates but they’ll be trusting that the glorious weather will cause enough of a bounce in consumption to help justify it.
 

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