13th June 2017

Rathbones weekly review: Not May’s day

There were many losers from Thursday’s general election: Nick Clegg, Alex Salmond and others who lost their seats; the Scottish National Party which lost 21 seats; Theresa May’s advisers Fiona Hill and Nick Timothy who both resigned; Theresa May who lost her majority; the pollsters who once again lost some of their credibility, and the pound which lost ground against the dollar and the euro in the immediate aftermath of the result. 

And the winners? While they lost the third election on the trot, the Labour party and Jeremy Corbyn – with 262 seats – did much better than perhaps even they expected. But perhaps the biggest winner of all was Northern Ireland’s Democratic Unionist Party (DUP) – heralded as ‘kingmakers’. Their 10 seats mean the balance of power, and the future of Theresa May’s minority government, is in their hands.

While she acted quickly and decisively – too quickly for some – on Friday, visiting the Queen and starting discussions with the DUP, Theresa May’s government isn’t being viewed as ‘strong and stable’ at home or by her European peers. The previous Chancellor George Osborne, now editor of the Evening Standard, described her as a ‘dead woman walking’.

Events will continue to unfold quickly and as the minority government braces itself for Brexit negotiations while at the same time holding talks with DUP and preparing for the Queen’s speech. A day, let alone a week, could prove to be a long time in politics.

Source: FE Analytics, data sterling total return to 9 May

The stakes are higher this time

We haven’t found any evidence that any general election since 1964 diverted the economy from its existing course, but Brexit means much more is at stake for the economy this time. This makes the exchange-rate reaction particularly hard to gauge.

The markets were muted in the light of the result. The recent trend is for the FTSE 100 index and sterling to move in opposite directions, as around 80% of FTSE 100 earnings are derived globally. When sterling dips, the index has tended to tick up. If this continues, and the pound stays weaker, the FTSE should continue to benefit.

Equity and exchange-rate volatility are usually lower than average during election years, but our research has shown an increasing sensitivity of investments to economic and policy ‘uncertainty’ over the last two years.

Going soft?

Gauging the vigour of the UK economy is very difficult, with much conflicting data. Market reaction so far suggests that politics will take a back seat to economic fundamentals. While bringing uncertainty in the near term, Theresa May’s loss could even translate into greater uncertainty still, given speculation the DUP may want to stay in Europe’s customs union and its manifesto calling for increased government spending.

An American drama

The US markets seemed unconcerned about the prospect of a hung parliament, with Wall Street opening higher on Friday. They were more focused on their own domestic crisis – Thursday’s much-anticipated evidence of former FBI director James Comey to the Senate Intelligence Committee over his sacking by President Trump. In the event, no concrete evidence emerged of obstruction of justice on Trump’s part, and US shares ended the day higher.

However, questions still remain, and the opposition Democrats are no doubt relishing the prospect of grilling US Attorney General Jeff Sessions about his Russian contacts.

All eyes will be on the Federal Reserve and an anticipated interest-rate hike when its June meeting concludes this week. The expectation is a quarter point increase, with a half point rise being an outside possibility. An announcement about further monetary tightening through the winding down its stockpile of Treasuries is also expected.

The impact on the tech sector will be especially closely followed - it finished 2.7% down on Friday after comments from Goldman Sachs suggesting valuations of major tech shares weren’t accounting for their vulnerability to an economic slowdown. Meanwhile, the VIX index of implied volatility in US shares showed some signs of life as it rose 5.3% from a 23-year low it had experienced earlier in the day on Friday.

A nod to better growth in Europe

Eurozone growth was revised up to 0.6% in the first quarter – the fastest quarterly growth in a year. Britain’s growth of just 0.2% meant it was the worst-performing member of the EU, adding to the sense of gloom heading into Brexit negotiations.

In a nod to the better growth prospects of the euro area, the European Central Bank (ECB) made a subtle shift in its rhetoric, changing its policy statement on the path of interest rates to ‘at their present levels for an extended period of time’ from ‘present levels or lower’. The bank left rates unchanged as expected.   

Bonds

UK 10-Year yield @ 1.01%

US 10-Year yield @ 2.20%

Germany 10-Year yield @ 0.26%

Italy 10-Year yield @ 2.08%

Spain 10-Year yield @ 1.44%

Julian Chillingworth
Chief Investment Officer

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