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In this week’s market update: Market levels continue to recover after the sell-off; eyes fall on the dollar and minutes from the Fed; and results arrive from some of the country’s biggest dividend paying companies. Plus, a letter from Warren.
20 February 2018 – In this week’s market update: Market levels continue to recover after the sell-off; eyes fall on the dollar and minutes from the Fed; and results arrive from some of the country’s biggest dividend paying companies. Plus, a letter from Warren.
Markets in the US remained closed on Monday for Presidents Day but elsewhere the week started in a generally upbeat mood, with equity markets posting further, if modest, gains. The MSCI World Index was gunning for its sixth day of rises in a row on Monday, and at time of writing had recovered about 40% of the losses it had suffered in the recent sell-off.
The rise in share prices has coincided with a return to calm in markets, with the VIX index of expected future volatility dropping back below a reading of 20, having spiked above 36 during the recent market falls. It remains someway above 10, however, where it has spent the majority of last year.
Much of the market commentary as the week got underway was devoted to diagnosing the causes of the recent downward trajectory for the US dollar, which remained near a three-year low against other currencies on Monday.
The dollar index, which pegs the currency against 6 leading global currencies, fell by almost 10% last year, and is down a further 3% this year.
That’s despite traditional fundamentals appearing to offer support to the dollar. The potential for faster tightening of US monetary policy, which has spooked both bond and equity markets this month, should provide support to the currency, yet falls have continued nonetheless.
Fingers are being pointed at US fiscal policy - incorporating Trump tax cuts and higher spending - which, unusually, is coming at a time of economic expansion, and will add to the budget deficit in the world’s largest economy.
Last year’s tax reforms are expected to add as much as $1.5 trillion to the federal debt load, while the agreed budget agreement will increase government spending by almost $300billion over the next two years.
The fiscal plans have been making life even more difficult in the bond markets, which must cope with the issuance of $258bn of Treasuries in the coming week as the US government readies itself for the spending spree.
The yield on benchmark 10-yr Treasuries touched 2.94% last week - a four year peak - but started the week off that level.
This week, the Fed releases the minutes from its January meeting, at which the central bank opted to leave interest rates unchanged but suggested inflation was coming through more strongly than it previously thought.
It was stronger wage data, of course, that provided the trigger for the stock markets fall we’ve seen this month and the official measure of US inflation came in above target last week.
That data was not been in place at the time of the January meeting, but the Fed was already mindful of faster rising prices and had changed the wording of its rates outlook to include reference to “further” gradual interest rate increases.
The market is pricing in three rises this year, starting as soon as next month, but further evidence that the Fed is worried about inflation could make expectations even more hawkish.
A similar conversation is going on within the Bank of England, where the prospect of an early rate rise - as soon as May - is being considered. Last week, CPI inflation was confirmed as being stuck 3%, which was higher than forecast but even without that the mood music from Mark Carney and the other rate setters has been increasingly hawkish.
High inflation seems to be trumping fears of slow growth at the Bank and wage data due later today will add to the picture. Strong labour market figures and faster rising wage will solidify expectations that a rate rise will arrive sooner rather than later.
As mentioned at the top - equity markets have continued to build on the recovery from last week. Asian markets led the way, followed by modest rises at European bourses on Monday.
Gold flirted with an 18-month high yesterday, near $1,348 an ounce. The metal rose 2.4% last week, with investors seeking it out as a safe haven from once-again volatile equities, but it also benefitted from the dollar’s weakness, which makes it cheaper to foreign currency buyers.
The weak greenback has also been helpful to the largest American companies, which have seen a mathematical boost to their overseas earnings but also stronger demand from foreign buyers with more purchasing power.
The S&P 500 was back to 2,732 by the end of last week, having fallen to 2,581 at the start of the month.
Oil prices rose last week and remain elevated, with WTI at $62.4 and Brent Crude at $65.3 a barrel. Adding to upward pressure has been robust language from Israel’s Prime Minister Benjamin Netanyahu, who has warned the country would act against Iran itself, rather than its smaller Middle Eastern allies.
Military from the two countries have engaged in fighting Syria in the past two weeks. Israel has a long-standing policy of resisting an Iranian presence in the already war-torn country.
Turning to the corporate diary, it promises to be a big week for earnings at some of the country’s largest companies. The banks report this week, while there’ll also be updates from big dividend payers Centrica and British American Tobacco.
At the banks, the headlines are likely to be dominated, as ever, by write-downs. This time it isn’t payment protection insurance - although there might be some of that - but rather loans to the collapsed builder and services company Carillion. Reports suggest that losses could top £1bn across the bank sector.
Income investors will keep an eye on HSBC, where shareholder payments are expected to be stagnant, and Lloyds Banking Group which is expected to modestly increase its dividend, perhaps with an extra boost from share buy-backs.
Other companies reporting this week include Barratt Developments, which will struggle to reassure the market that its current dividend yield of 8.2% is sustainable. Another tempting looking yield is available from Centrica - 9.3% on a forward looking basis - but that’s before numbers this week that are expected to show falling profits at the energy giant. Centrica warned on profits in November.
British American Tobacco also provides an update, and profits are expected to be firmed by improving sales of non-traditional smoking products - vapes and ‘heat-not-burn’ cigarettes.
Finally, to what, for many small investors at least, is the most interesting thing happening this week - and that’s the annual letter to shareholders in Berkshire Hathaway, due to arrive next Saturday.
The letter is authored, of course, by Berkshire Hathaway founder Warren Buffett and it will be pored over by his army of investor-fans. The letter has become a fixture in the investing calendar and is much quoted.
There great investing wisdom in there, of course, but plenty of commentary on the state of America and the worldas as well.
I’ll end with something from last year’s letter last year that that seems relevant right now. He’s talking about periods of panic.
“During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted.”
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