December 1st Market Wrap – Tax Reform Stumbles – Corbyn Threatens Banks

Dow Rallies while NIFTY Slips
The Dow Jones index had a bullish performance yesterday, closing at 24,272.35 points – yet another new record. This means it’s rallied by over 1000 points in the space of around a month and a half, thanks to hopes of lower corporate taxes, robust economic growth (around the world, not just the US) and impressive corporate earnings – the key driver.

Markets in Asia went higher today too, following the American lead, Though the NIFTY50 took a battering, shedding over -1%. The index fell below 10,200 weighed down by metal stocks and index heavyweights like Reliance Industries and State Bank of India.

It’s not all bad news though. Yesterday we got new data which showed India’s GDP growth rebounded from a 3-year low in the June quarter thanks to stronger manufacturing performance. Still, the NIFTY seems to be struggling with staying above the 10,400 points mark, consistently falling back, this indicates a bearish trajectory for the time being.

European indices are also lower today, with Italy’s FTSE MIB falling the most, down almost -1%. In individual equities, healthcare stocks including UCB and Novo Nordisk got a boost thanks to an upgrade from Morgan Stanley – the latter being flagged as one of the banks favourites in the pharma space.

Tax Reform Stumbles
A little tax reform momentum was lost yesterday, after the Senate delayed a vote on the Republican tax bill until morning in the US today. Several factors were at play, the first being that Senator Bob Corker (R) seemingly held firm on his commitment that he would not vote for a tax bill that increased the US deficit. He said his vote on the bill would be dependent on some kind of trigger, which would automatically increase taxes if the bill didn’t generate the kind of economic growth the party hopes for.

The Senate parliamentarian said that a fiscal ‘trigger’ is not allowed, which has given more reason for skeptics including Corker to back away from the bill. If a few key Republicans vote against the bill, it may not pass, which would be yet another big stumbling block for Trump as he tries to finally get something passed after his failure on healthcare.

Commodities
Oil prices got a small boost from the OPEC meeting yesterday in Vienna. Arguably the vote for an extension of production cuts was already ‘priced in’ as expectations were high that the group would unanimously agree to continue with cuts, and indeed Russia said it would cut its oil output to the end of 2018. Here is a chart of Brent Crude’s movements since the news broke.

Yesterday Gold prices hit their lowest level in over a week, falling after a new round of promising American economic data filtered into the markets. The good news of lower joblessness and higher GDP did little to sway the markets from expectations of an interest-rate hike later in December. Gold prices have been falling consistently since they peaked in mid-summer.

No Love Lost between Labour and Banks
The leader of Britain’s Labour Party Jeremy Corbyn has hit out at banks and called them speculators and gamblers, who are right to be afraid of a Labour government getting into power.

In a video uploaded to Twitter, the socialist leader said, “Bankers like Morgan Stanley should not run our country but they think they do.” He then took a swipe at the Conservative government for protecting financial institutions interests, while adding that it was these banks which crashed the economy in 2008.

He is right, in that the careless actions of overpaid executives and bankers in both the US and the UK prompted the financial crisis, but failed to mention that it was a Labour leader (not Conservative), that encouraged risk taking in the City of London.

In his Mansion House speech in 2006, Labour’s Chancellor Gordon Brown (who would become Prime Minister the next year), said the British economy would succeed through ‘light touch’ regulation, a ‘competitive tax environment’ and ‘flexibility’. Only 2 years earlier, he had praised Lehman Brothers, the bank which had contributed directly to the crisis and collapsed in 2008. Lehman’s bankruptcy filing was the biggest in history, and its demise contributed to the loss of around $10 trillion from global equity markets.

Ed Balls, another Labour cabinet member, said in 2006, “I believe we are right to avoid prescriptive, heavy-handed regulation in Britain.” It turns out they were both wrong.

The concern among businesses is that a Labour government with a strongly socialist bent under Jeremy Corbyn and his Chancellor John McDonnell would seek to curtail businesses ambitions, increase corporate taxation and generally dissuade foreign investors from wanting to do business in the UK.

The problem with this combative approach towards banks is that, despite its past crimes and misbehavior, the financial services sector is one of the strongest assets the British economy has. A report earlier this year revealed that financial and related professional services workers contribute 1.5 times more to the economy than the average UK employee, while showing that the sector makes up over 10% of the UK economy. It also contributes the most amount of tax already, at 11.5% of the total income for the treasury.

Morgan Stanley said this week that a radical left-wing government under Corbyn is a more serious threat to British markets than Brexit, and that a ‘double whammy’ of Brexit and a Labour leadership could prove ‘toxic’ to UK stock markets.

Patrick Jones

Brexit Woes Pile on Top of Poor UK Economic Data

THE DATA

UK retail sales fell by 0.8% in September according to the latest data from the Office for National Statistics.

As expected, inflation in the country is having a direct impact on the retail sector, as the ONS also reported that prices in shops have risen by 3.3% over the last year – a jump not seen since early 2012.

Consumer spending has been a key driver of growth recently, so this pull back will be seen as a concern, and possibly a factor the Bank of England will keep in mind as it debates over whether to raise interest rates.

All of this bad news is putting downward pressure on the Pound once again. Sterling reached $1.3226 against the Dollar yesterday but plunged this morning.

There is likely to be more volatility in the British currency as Brexit negotiations are in difficulty according to reports. The odds of Britain walking away without a deal from the talks have grown recently, with fingers pointing at both ineffectual Conservative leader Theresa May and the rigidity and stubbornness of the EU’s negotiating team.

THE POLITICS

In a move that may help to smooth negotiations, the Conservative Party has officially announced it will be assuring the right of EU citizens to remain in the UK after Brexit officially happens (and at this rate there’s plenty of doubt over whether it will happen at all). However the question coming from opposition leaders is: why did it take so long for them to do this? We don’t have an answer to the question, but it is yet another example of sloppiness on the part of the Tory party,  whose stance on the negotiations in Brussels and Strasbourg and the future of the EU-UK relationship appears just as confused as their opposition in Parliament.

Speaking of which, the Labour leader Jeremy Corbyn employed a machiavellean tactic today by turning up in Brussels earlier than Theresa May and addressing a gathering of European Socialists, putting on a display of political theatre in order to undermine her position. After being introduced as ‘the next prime minister of the UK’, Corbyn called for the current PM to stand aside and let him take up negotiations, setting out his vision of a Brexit which maintains free access to the single market.

Of course, as anyone who has followed the referendum narrative knows, you can’t stay inside the single market and have Brexit. The two positions are entirely contradictory, for remaining in the customs union means conceeding to the laws that the European Union dictates, while Brexit means leaving all EU institutions, including the single market, European Court of Justice and so on. As a man who was once a noted Eurosceptic amongst the Labour back-benchers, it frankly seems naive for Mr Corbyn to expect such a favourable deal which lets the UK pull out of the Union yet retain tariff-free trading with the EU’s member states. Frankly, his words ring just as hollow as Theresa May’s call for a ‘close’ relationship with the EU. Neither of the leaders seem to grasp the fact that the Union is built on protectionism and not ‘fairness’ as they would so hope.

Indeed, the view from the continent arguably looks as if the EU Commission is trying to keep Britain subdued, as can be seen by the fact they are staunchly against letting the UK discuss the future of its trading relationships with the EU and the rest of the world for the time being – effectively sticking a roadblock right in the middle of negotiations. The EU is totally transparent in its interests. The bloc’s chief goal is its own survival and the promotion of ever closer union. Trying to have a sensible, logical and rational negotiation with such an organisation was always going to be difficult.

But it isn’t just the EU Commission that Theresa May’s Brexit team must be wary of. British members of Parliament are trying to derail the process. 18 Labour MEPs and one from the Liberal Democrats supported a European Parliament resolution critical of the British government’s approach to the negotiations, which said Brexit talks should not move on because insufficient progress had been made on divorce issues. This position is not a surprise, given that many Labour party members have difficulty accepting the outcome of the vote on June 24th last year, and never wanted a referendum to be held at all. Though they may pretend that the reason they attempt to block progress is due to wanting the government to be more accountable, in this writers opinion they are simply hoping to stall negotiations and hopefully force a rerun of the referendum, despite their protestations to the contrary. The EU is no stranger to reruns of this nature. Ireland rejected the Lisbon Treaty in 2008 but the decision was ultimately overturned.

Now that the fifth round of monthly Brexit talks between the UK and the EU has taken place, a decision is due to be taken by the EU later in October on whether or not enough progress has been made on “separation issues” to be able to start talks about the future relationship between the bloc and the UK post-Brexit. Refreshingly, German Chancellor Angela Merkel said there were “encouraging” signs that the Brexit talks could move on to the subject of the future trade relationship as early as December, according to The Guardian today. For the time being however, investors will be hoping for more clarity and a faster negotiation progress from the Commission and the British Government, but it looks like they will be waiting quite a while longer.

Losses for the Pound (seen here against the Euro through 2017) have helped the FTSE100 to rally throughout the year. With this being said, stock market performance is not 100% correlated with economic prosperity. The reason that the FTSE, as well as the Bats Low 50 index have outperformed despite the woeful Brexit situation is simply because firms within these indices make much of their profits overseas.

A cheaper Pound allows consumers in other countries to buy their goods for less, improving company profits. In strict contrast, the Bats Brexit High 50 index has underperformed. The Bats Brexit indices were designed to act as barometers for assessing how Brexit is impacting UK companies. They do this by analysing the difference in performance between companies that generate a large portion of revenues in the UK and those that have less revenue exposure to the UK. The High 50 is made up of companies that depend more upon domestic revenues for success, while the Low 50 is those that primarily generate earnings overseas. You can clearly see the discrepancy between the performances of the High 50 (in red), FTSE100 (in yellow) and Low 50 (in blue) indices this year here.

Why should I diversify my investment portfolio?

Shortly before the financial crisis rocked the world economy in 2007/8, optimism amongst US policymakers was high and widespread.

On June 2nd 2005, only 3 years before many of the worlds largest financial institutions were on the brink of insolvency, Christopher Cox stood in a room full of reporters. Cox was the new Chairman of the Securities and Exchange Commission or the SEC, under the Bush administration. The role of the organisation was to protect investors from foul play in financial markets, ensuring a level playing field between customers and asset management firms.

After his public introduction from President Bush, Cox took to the podium to set out the responsibilities of his new role and the state of the economy. He praised the financial sectors contribution to US economic growth, saying “In this amazing world of instant global communications, the free and efficient movement of capital is helping to create the greatest prosperity in human history.”

Statement on the Economy.  Rose Garden
Chairman of the Federal Reserve Ben Bernanke, President George W. Bush, Secretary of the Treasury Henry ‘Hank’ Paulson & SEC Chairman Christopher Cox in the White House Rose Garden. September 19, 2008.

Little did he know what was around the corner, but of course, no one really knew what was coming. Even the Chairman of the Federal Reserve, Ben Bernanke said in January 2008, “The Federal Reserve is not currently forecasting a recession.” It turned out that the SEC and other bodies that were supposed to protect the interests of investors, had stood by while banks were taking greater and greater risks and engaging in dangerous behaviour. Banks were taking enormous risks in the derivatives market, trading highly complex financial instruments like CDOs (collateralised debt obligations) and MBS (mortgage backed securities). Banks were also highly leveraged, which meant they were borrowing huge sums in order to take part in this kind of activity. There was a get-rich-quick culture pervading the financial sector. In this era of widespread irresponsibility on the part of some of the most famous investment management firms in the world, selling more toxic products to unsuspecting investors meant bigger bonuses. As such, it led to the eventual meltdown.

The damage was more serious that anyone could have imagined. In those years, investors lost life savings, while millions of ordinary citizens became homeless and unemployed, in a financial slump that left no country on the planet unaffected.

2935021856_7a8740b0a1_b (2)
Headline montage from media during the peak of the crisis

Why am I talking about the crisis? Well, it’s merely an example to highlight potential risks and why you should hedge against them as much as possible. Risk is a major factor to consider when choosing what to invest in. Financial markets are entities which are linked to human sentiment. Even if the crowd and the talking heads think they are ‘right’ about the way a price, or a company, or interest rates are heading, markets are still, (in the words of billionaire investor George Soros) “inherently unstable”. Due to this instability, it makes sense to hedge your bets and spread your risk across different sectors, asset classes and types of markets when investing.

Financial markets are all interconnected. Even the largest blue chip stocks which we hear about every day are not immune to external forces which can weaken their fundamentals. Geopolitical circumstances out of your control can cause huge sell offs in a single day, putting your portfolio at risk. Perhaps a war breaks out in Asia and suddenly every stock index from Tokyo to Shanghai loses a ton of its value, for example. Even shiny new instruments like cryptocurrencies which are currently all the rage have been known to lose hundreds of dollars off their value in a single trading day. Yes, it would be nice if markets were predictable and human behaviour was also less impulsive, but this sadly is not the case.

How do I diversify?

Diversification is a form of risk management, but it is also a tool you can use to make money as well.

The idea behind diversifying a portfolio is that investors will be less affected by an event that has a strong impact on a particular industry, company or type of investment. Not putting all of your eggs in one basket is another way of thinking about it.

By ensuring you invest in a multitude of sectors and asset classes, you can be more shielded from external shocks to the market (like geopolitical circumstances, economic downturns and the like).

By keeping investments split into different asset classes, (by choosing varying position sizes in different sectors) investors can become fairly well hedged incase of any destabilising news which will cause prices to fall.

Even if the flavour of the month is a bluechip giant in the S&P500 and every analyst seems to be singing it’s praises, going all in on the stock or similar companies within the same sector can be a foolish decision. Trends come and go frequently. Sectors lose steam, indexes that were once riding all time highs lose their edge. We saw recently how a political crisis in Brazil which engulfed the country’s leader Michel Temer, ignited a huge selloff in Brazilian stock markets. The key Bovespa index saw it’s biggest fall in almost 9 years on the same day corruption charges surfaced.

It is not possible to do away with all risk, but by hedging your positions and keeping your risk spread across different kinds of instruments, you can keep protect yourself against large-scale losses and maintain your well earned gains.