1st August 2017

Rathbones weekly review: Maduro’s monumental mess

Venezuela is disintegrating. The country – once one of the richest nations of South America – is teetering on the worst of precipices. Anarchism is baring its teeth at the most incompetent authoritarian rule.

At the weekend Venezuela’s strong-man President, Nicolas Maduro, forced through a nationwide vote to create an all-powerful upper chamber that would render the opposition-controlled parliament void, rewrite the constitution and dissolve any institution at whim.

In a terrible and dangerous irony, a socialist government elected to prioritise the common man is leaving the state-run supermarkets bare while it pays off overseas bondholders. It has no choice: usually when a nation defaults, creditors are at a disadvantage (annexing a bankrupt state is not really an option). Unfortunately for Venezuela, it has a Texas-based refinery and distribution subsidiary, Citgo, that will likely be forfeit if it defaults. Without petrodollars and access to the bond markets, Venezuela’s trickle of foreign currency will dry up completely.

In fact, it’s even messier than that. Nearly half of Citgo’s equity has been pledged to Russian oil major Rosneft as collateral for loans to Venezuela’s state-owned oil company PDVSA. American lawmakers are not over the moon about a government-controlled Russian oil company owning strategic energy assets. And that was before the US Congress hit Russia with yet more sanctions in response to its Syrian and Ukrainian campaigns and the alleged interference in the US election. In a televised riposte, Russian President Vladimir Putin told the US to cut its diplomatic mission in Russia by two-thirds.

Warren Buffett once said, “You never know who’s swimming naked till the tide goes out.” This applies to governments as well. Venezuela is burning because the swift fall in global oil prices has proven just how horribly mismanaged it has been. The Wall Street Journal estimates that the oil price would need to be $117.50 a barrel for Venezuela to balance its books. Now that the oil price is hovering around $50, the hollowing out of its economy is stark. A once affluent nation has been reduced to nothing more than a poorly run oil company.

North Korea is another nation whose weakness is manifesting itself in violence. After decades of ruinous hereditary rule, the communist pariah state is essentially a nation-sized army surrounded by barren fields. All of its resources have been bent toward building a nuclear warhead and it is finally stumbling toward the finish line. At the weekend, North Korea fired an intercontinental ballistic missile (ICBM) in the direction of Japan. The missile has the range to 

reach major US cities, although whether it can do so along with a nuclear payload is unclear. The US, China, Japan and South Korea have all condemned the launch and America has stepped up military exercises in the Pacific. Exactly how Donald Trump will deal with the danger brings worries of its own. So far he has taken to Twitter to berate North Korean leader Kim Jong-un and attack China for not reining in its troublesome ally. 

Source: FE Analytics, data sterling total return to 28 July

Brightening the gloom

It’s been such a grim week of news that generally strong earnings have been somewhat obscured.

Almost 60% of the S&P 500 has reported second-quarter earnings, with roughly three-quarters beating the mean estimate of their earnings per share, according to FactSet. Even more heartening is that this strong performance has been driven by revenues, not just cutting costs. So far this quarter, 73% of companies beat sales forecasts. If that proportion stands once all companies have reported, that would be the broadest revenue surprise since FactSet started measuring in late 2008. Only one sector has posted a year-on-year earnings decline: consumer discretionary. This would have been skewed by a massive 77% fall in Amazon’s quarterly earnings. The internet giant wasn’t losing its edge – its sales easily beat analyst forecasts – it just shunted hundreds of millions of dollars more than expected into capital expenditure. The company’s disdain for its bottom-line is legendary, but investors appear to have forgotten: Amazon shares slumped 3% on the day of its results.

The FTSE 100’s performance was also distorted by an outlier. AstraZeneca’s long-awaited Mystic trial returned disappointing news last week. The company hoped that a combination of its immuno-therapy drugs would show cancer-fighting properties. Instead, the medication had little effect on test subjects. The company’s share price plummeted more than 15%, rocked the foundations of its strategy and leaves it vulnerable to a takeover bid.

Tobacco companies on both sides of the Atlantic have also taken a hit. The US Food and Drug Administration (FDA) announced it will focus on reducing the amount of nicotine allowed in cigarettes. Many tobacco companies have been pursuing vaping and other low-tar, smokeless

electronic products in the hope of fostering a less-harmful smoke. The regulator’s proposal is likely to hang over the sector for some time.

Coming up

UK mortgage approvals slipped again in June, hitting a nine-month low of 64,684.

Consumer lending has also cooled, while the Bank of England has warned banks about getting complacent over benign default rates. The central bank’s monetary policy committee meets on Thursday, but no change to interest rates is expected. UK GDP has also come off the boil lately and inflation no longer appears to be pressuring the technocrats.

In the US, personal income and spending statistics will be released today, along with PMI surveys that will take the temperature of American manufacturing. Then, on Friday, will be nonfarm payrolls. The range of UK PMIs will be released today, Wednesday and Thursday.

Bonds

UK 10-Year yield @ 1.22%

US 10-Year yield @ 2.29%

Germany 10-Year yield @ 0.54%

Italy 10-Year yield @ 2.12%

Spain 10-Year yield @ 1.52%

Julian Chillingworth
Chief Investment Officer

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