Bedrock’s Newsletter for Friday 15th of March, 2019

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 Friday, 22nd of March 2019

“We must live together as brothers or perish together as fools.”

– Martin Luther King Jr.

 

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Markets were on form again this week, as they pared back losses from a rare correction last week and despite all the doom and gloom about slower global growth. The dovishness of central banks, including the Fed which is expected to leave rates on hold at the FOMC meeting next week, as well as the sheer pervasiveness of bearish sentiment is helping equities to find a floor whenever there is a momentary wobble. That being said, data showing a +0.8% recovery in US capital goods orders in January certainly helped drive this week’s rally. After all, businesses only invest in new equipment when they expect additional future demand. Still, there are few signs of any improvement in European and Chinese growth prospects and optimism about the possibility of a US-China trade deal being signed before the end of the month has slowly ebbed thanks to comments from US negotiators. As we enter Q1 results season, this suggests that US companies with significant domestic revenues are more likely to provide positive earnings surprises than their more international competitors. A strong dollar and China tariffs are also weighing on exporters, with the former unlikely to change any time soon thanks to the huge US interest rate differential with other major economies. Manufacturers have been hardest hit according to PMI data and slowed further in February surveys. This creates something of a conundrum for investors used to moving up the cap spectrum into more geographically-diversified firms towards the end of an economic cycle to reduce their portfolio beta. There is no free lunch in markets.

Brexit is now just two weeks away. Or is it? This past week we have witnessed a bewildering cascade of motions and amendments, legal advice and political horse-trading as different parliamentary tribes seek to influence the embattled Prime Minister and shape (or thwart) the UK’s EU exit. On Monday, she secured what were touted as legally-binding changes to the Withdrawal Agreement negotiated in November, only for the Attorney General to advise that should “intractable differences” arise in future talks, the UK could still find itself trapped in an EU customs union indefinitely. Other lawyers in Parliament came to the same conclusion and this convinced 75 Tories to join with the DUP and opposition parties to deliver a second crushing defeat for Theresa May and her plan for an orderly EU withdrawal. This was followed by a vote on Wednesday to rule out a ‘no deal’ Brexit, which passed by a whisker, and a final vote on Thursday which instructed the PM to seek an extension to the Article 50 process by which the UK leaves the EU. These subsequent votes were legally non-binding and the default remains for Brexit to take place on 29 March, deal or no deal. Moreover, all 27 other EU states must agree unanimously to an Article 50 extension. No one wants ‘no deal’, but no one simply wants to delay the inevitable. Many European countries are also not keen on the UK fielding candidates in EU Parliamentary elections in May, given the threat already posed by populist Eurosceptic parties, only to leave shortly thereafter having helped to set EU budgets and priorities for the next four years. As such, any extension will be short and technical for the purpose of implementing the present deal, or long and drawn out with the prospect of a wholly new one being negotiated. Of course, the EU may seek to extract a high price for a long delay and the UK is unlikely to accept this. As such, the PM has promised yet another vote on the Withdrawal Agreement next week. We expect Brexiteer MPs to eventually swing behind the deal, perhaps not next week but soon, once they realise that it is the hardest deal on offer and Parliament will not allow a ‘no deal’. One thing that now seems certain is that Theresa May is on borrowed time. Losing two meaningful votes on your signature policy is not a good look and regicide is a Tory trait.

If and when the deal is passed, the UK economy and GBP are likely to bounce as business confidence returns and investments delayed because of Brexit uncertainty are implemented. The UK Chancellor has also promised a £27bn cash injection given the fiscal space that has opened up thanks to strong tax receipts in recent quarters. The 0.5% GDP print for January, despite all the political noise and a broader global growth slowdown, shows the UK’s remarkable resilience and provides a strong base for the UK to outperform other European G7 economies this year. UK equities, which have been out-of-favour amid the Brexit scuffle, are undervalued on a forward P/E basis relative to Europe as a whole and should also benefit strongly from a thinning of the fog of uncertainty that descended in June 2016. Nevertheless, a no deal Brexit in two weeks would undoubtedly cause economic disruption, at least in the short-term, so outcomes for UK assets look fairly binary at present. Dabble at your own risk.

The crash of a Boeing 737 Max shortly after take-off, the second in a matter of months, has prompted regulators around the world to ground the company’s new flagship model. The blame appears to lie with faulty sensors causing the onboard software to override pilot instructions and suddenly pitch the nose of the plane downwards. The glitch can likely be fixed, but additional systems training will also be needed. More fundamentally, as automation becomes increasingly ubiquitous how does society grapple with assigning responsibility for such accidents? The greater use of cockpit technology has undoubtedly saved lives by reducing the scope for pilot error. But, for many, there is something uniquely frightening about being at the mercy of an algorithm. Food for thought.

We finish this week’s newsletter by paying our respects to the 49 individuals who lost their lives in the despicable terrorist attacks on Friday prayers at two mosques in New Zealand. Our thoughts are with their families and friends on this dark day.