Given his promise during his election campaign, US President Trump has fulfilled his promise to quit the Paris climate accord. While this move is clearly bad for the world, we also think that move will not help the US economy nor its global leadership.
Further, looking at the numbers, we do not agree that the coal industry will produce the jobs the president hopes it will. Large parts of the employment in the US energy industry stems from the oil sector, followed by the solar and natural gas sectors - and only then, we see the coal industry. Further, the low-cost gas, due to US shale boom, will continue to be a stiff competition in the usage of the energy and lastly, given the improving productivity in the coal industry, most of the coal mining will not be focusing on labour-intensive areas. We also do not think that this move changes the structural shift in world energy markets towards renewables.
While leaders around the globe have criticised this move, high-profile business leaders, such as Bob Iger or Elon Musk, exited from the President’s Council.
What were the major economic developments this week?
Consumer spending in the US will continue to support the economic development in the second quarter, as personal spending rose the most in 4 months. Investors should bear in mind, that the US economy is a consumer driven economy with nearly 70% of its GDP deriving from the household consumption expenditure. While consumption of services rose less with 0.3%, the recovery in durable and nondurable goods helped and finally, personal income also rose 0.4%. This is also good news for the Fed, as it sees that the economy is bouncing back from the weak first quarter.
As the ADP numbers highlighted again on Thursday, the US is nearing full employment, while core inflation still remains below the Fed’s 2% target. That might continue to cause issues for some of the FED members, although a healthy Job market should support the inflation in the future. Consumer confidence came weaker than expected but still hangs at levels around 117.9, which highlights the resumed trust of the consumers in the economy. We also continue to see higher prices in the housing index across the country as the Case-Shiller Index expanded 5.8% in March.
Manufacturing PMI within the eurozone notched up in May. With Germany, the European powerhouse, leading the bloc’s performance, the index came in at 57.0, which is the highest stand within the eurozone. The good thing about this development is, that increasing numbers of companies going back towards investing in expansion, which will clearly help the continued growth within the bloc.
How did the market perform this week?
Global risk rally continued this week with indices hitting fresh record levels.
The Nikkei 225 Index was up 2.7% for the week and broke the 20’000 point for the first time since December 2015. Since its lows in April this year, the Index is up 11% and posted a 5.77% gain for the year. While various Asian markets are trading around multiyear high, we see the Nikkei as slightly overbought at these levels.
Small caps in Europe and the US advanced this week, however, while the former posted a stellar return of 21.7% YTD, the latter is only up by 2.82% and is trading sideways since the rally in November after the election.
After recovering shortly last week, Brazilian stocks dropped by 2.8% this week. Given the recent political turmoil, uncertainty about the reforms and the impact on nation’s economic recovery remains in the consciousness of the investors.
The performance of leading stock indices.
We will continue to see the global risk rally going forward, given the solid economic growth around the world and supportive central bank measures.
Yields on the shorter end of the curve increased in Brazil and Mexico, while the yields on the longer end of the curve increased in Argentina. We have seen, on the other hand, a decline in yields across the curve in Turkey and Russia. Spreads for emerging market corporate bonds increased slightly to 261bps while the spreads for high yields remained at levels around 374bps. Spreads for bonds with CCC rating or lower are trading at 834bps. Investors and portfolio managers wishing to generate higher returns look for these bonds. While we do not advise investors to chase these bonds, latest data highlights, that even those very risky and distressed bonds are becoming scarce, which highlights again the continued hunt for higher yields by investors.
Which events shall investors focus on in June?
We will have the UK election on the 8th of June, thus investors want to watch the outcome of the election and the reaction of the pound thereafter. Latest polls have shown that Labour continues to win votes and the margin between the Tories and Labour is diminishing.
On the same day, the European Central Bank will meet in Tallinn to discuss the monetary policy. However, we do not expect much changes here, as the ECB will also want to see the outcome of the UK election. We will most likely also not see any changes to the continued purchase of EUR 60bn of securities each month by the ECB. Nevertheless, investors should keep an eye on the guidance and EBCs’ language.
The FED will continue to tighten its policy in June with another 25 basis points to a corridor between 1% and 1.25%. More crucial will be further discussions and explanation about the USD 4tn balance sheet unwinding of the FED. Investors want to carefully watch any further information regarding this.
What will happen to EUR/USD?
While the market has priced in a FED that continues to hike its rate and start reducing the balance sheet starting next year, the ECB announced its continued support for the European economy and not act too fast. On Monday, Mr. Draghi highlighted his stance to continue to stick to its plan and purchase EUR 60bn bonds on a monthly basis. The market expects two more rate hikes from the FED and a communication regarding the reduction of its balance sheet, as we have noted it last week. We believe the move on EUR/USD will rather come from the ECB and its communication. So far, the ECB continues its extraordinary amount of monetary support, while the eurozone economy continues to recover. However, we think that the EUR/USD rate will remain around these levels and not exceed 1.12 in the near term, given also lots of headline risk around Europe (Greece debt situation, Italy election, Germany election, and Brexit).
What’s going on with value stocks?
It is not a good time to be a value investor. In general, the discipline is very difficult and investors following this strategy need to have a longer breath. Since the financial crisis, value stocks materially underperformed the broader market and the difference to growth stocks continue to be larger every year. As we reported last week, within the growth stocks, the majority of these gains arrive from companies like Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB) and Alphabet (NASDAQ:GOOGL).
Naturally, this is an Information Technology and Consumer Discretionary play versus the Financials and Consumers Staples. It is increasingly difficult for value investors to spot good opportunities, as most of them struggle to find decent valued stocks and even legendary investors regret to have missed the tech stock rally, not appreciating its potential. Investors can see the difference in the performance in the highlighted graph below.
Disclaimer: This document has been prepared by Lion Value Partners AG. The information contained in this document is based on sources which are considered reliable but there is no guarantee as to the correctness and completeness of the information. The information could be changed at any time, without any obligation to notify the recipient thereof. Backtested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes only to indicate historical performance had the index portfolios been available over the relevant time period. Past Performance is no Guarantee of Future Results. Unless otherwise noted, all figures are unaudited and not guaranteed. All acts on the basis of the information take place on the own liability and danger of the recipient. This document is for informational purposes only. The information does not release the recipient from his own assessment. © 2017 Lion Value Partners AG. All rights reserved.