Weekly Market Update: US government reopens for now

Read our full Market Update Week 4

Market Update

Equities were mostly up in local terms, however down in Sterling which again rallied on expectations for a delayed or soft Brexit. The Pound was up +2.6% vs the US Dollar, +2.2% vs the Euro and +2.4% vs the Yen. In Sterling terms global equities were down -2.1%. US equities saw the biggest negative return, down -2.4% (although down only -0.2% in local terms). UK equities were also down -2.3%. European, Emerging Market and Japanese equities lost -1.4%, -0.8% and -1.6% respectively. News was mixed as corporate earnings reports were generally solid, however there were reports from the World Economic Forum in Davos that business leaders are losing confidence due to Donald Trump’s policies. That said a deal to temporarily reopen the US government was announced on Friday, although with the President insistent on a border wall another shutdown is likely. Globally yields were down, with Gilts returning +0.7% and global bonds +0.6% in local terms. In US Dollar terms Gold gained 1.7%, while Oil fell -0.6%.

CIO Analysis

The market continues to rally and, despite a sluggish start on Monday, investors will probably welcome news of the end of the US shutdown and the progress of talks with China. Of course both can be reversed with a single tweet (Congress funded the federal government for the next three weeks, just enough to arrange back-pay for federal employees) which is why many are still reserved.

British investors, however, will be focusing on another important week for Brexit, with Theresa May due to present an updated Brexit Bill in parliament and face a series of votes. We believe that having focused the debate so much on the British side of things, and day-to-day political sparring, we may be missing the bigger picture: what the EU wants. Ostensibly, European leaders hold the principle of free movement sacred and will side with Ireland’s demand not to compromise the island’s integrity. However, looking at recent history, the EU commission is not always adamant on principles. A year ago, it allowed Italy to flaunt budget rules to bail out its own banks. Possibly it will be allowed some leeway again. Is it a stalwart of smaller states? While all countries have agreed to the need of stemming illegal migration, Greece and Italy have been largely left without significant help these past few years, with countries such as Austria and Hungary even unilaterally closing down borders. Greece is also the only country exempt from QE and subject to a harsh restructuring regime. This means EU rules are flexible and subject to perceived utility.

So it’s not necessarily principles that are at stake, but rather a “win”, against a neighbour with which it has a £60 Billion trade surplus. By redefining the relationship with Britain, impediments to further Euro integration were removed. What EU leaders probably don’t want to remove is the British contribution to the EU budget, which would mean a blanket curtailing of expenses of about 10%. As much economic pain the UK feels from Brexit, the EU also has a lot to lose. Which is why things have come to a point where the UK either capitulates or risks economic disaster (a no-deal Brexit could see the economy contract 10% and unemployment double according to the Bank of England). Given that the current Parliamentary majority is predisposed towards a softer Brexit and Brussels holds most of the negotiating cards, the unilateral withdrawal of Article 50, becomes more enticing by the minute.

No evidence exists rendering political ideology a good long term investment principle. Instead investors need to look at what the negotiation has become: a non-cooperative zero-sum game with the EU betting that it has less to lose than the UK. This leaves Britain with three choices. No deal and enormous economic and political risk, a fudge with uncertain outcome, or capitulation. In an era of identity politics we fear that the outcome remains uncertain, which is why we avoid making investment assumptions on the outcome.

David Baker, CIO

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