Week Ahead: from ‘Trump trade’ to ‘Trump risk’?
Ken Odeluga January 14, 2017 12:53 AM
<p> The President-elect’s press conference on Wednesday was fascinating for many reasons, but for anyone looking to get more detail about the Trump administration’s economic plans, they were left short on detail.</p>
1, Is the Trump trade running on borrowed time?
The President-elect’s press conference on Wednesday was fascinating for many reasons, but for anyone looking to get more detail about the Trump administration’s economic plans, they were left short on detail.
The Trump risk premium
The press conference did highlight a few things that could become a motif of the Trump administration going forward. Firstly, he is still happy to call out entire corporate sectors that he thinks operate unfairly or charge the US government too much for products and services. Healthcare and defence were both in the firing line earlier. This had an immediate impact on the stock market, and healthcare was the worst performer in the S&P 500 and the Dow Jones on Wednesday. For now the pharma and defence sectors are under the Trump microscope, but the risk is that he turns on other sectors down the line, which could cause bouts of volatility.
Could Trump be bad for the dollar?
The second point to note about the press conference is his focus on bringing US production back onshore. He pointed out a few examples of car manufacturers who have decided to open factories in the US rather than in traditional low cost centres like Mexico. Eventually Trump’s focus could shift to the US dollar. If the greenback continues to strengthen then it could become a threat to US competitiveness, and the ability to sell off of the cars and other goods that will be produced on US soil during the Trump Presidency.
This may be one reason why the US dollar slipped more than 1% on Wednesday. However, the decline in the dollar could tell us something about stock markets also. We have mentioned that this press conference was short on details about the Trump administration’s strategy for boosting the economy. Car manufacturing alone won’t make Donald Trump the US’s greatest ever jobs creator, likewise, we didn’t find out anything about the mega fiscal stimulus that he has been promising.
Time is ticking for the Trumpflation trade
Stock markets may have risen on Wednesday, including a fresh record high in the Nasdaq, but will the markets’ continue to give Trump the benefit of the doubt that he can deliver on his economic promises? Since the dollar and US stocks have risen in unison, could Wednesday’s decline in the greenback be a sign of things to come for US stock markets? We think that the pressure could start to pile up after next Friday’s inauguration. If we don’t get more detail on his economic plans by the end of January then the US stock market rally could be toast.
I’ll leave it up to others to muse on the political ramifications of this press conference, but one thing is for sure, the White House has never seen anyone like Donald Trump before. From a markets perspective, Trump better get his plans in order, the market rally may not live on promises alone once he takes office.
2, EM FX: strain turns to panic
The emerging market FX world has come under pressure since the election of Donald Trump to the White House. With less than two weeks’ to go before his inauguration, initial signs of strain in the FX space, is now turning to panic for some countries.
Out of 24 EM currencies tracked by Bloomberg, only the Russian Ruble, for obvious reasons, has managed to post a gain vs. the USD since Trump’s election win. In contrast the Turkish lira and Mexican peso are down 16.35% and 15.2%, respectively.
Since the EM FX space does not move as a unilateral block, we have focused on two EM currencies that could steal the limelight in the coming weeks: the Turkish lira and the Czech Koruna.
The lira: embroiled in a political crisis
The sharp decline in the Turkish currency since last summer’s coup has grabbed the headlines, but as we move into a new year, the question has to be how long the authorities’ will allow the decline to continue before it pushes up inflation to unacceptable levels? Prices rose to 8.5% in December, their highest level since the July coup. The continued decline in the lira is in no small part down to President Erdogan’s reaction to the coup, which has seen an extended state of emergency declared and a constitutional referendum set for April, which would expand the powers of the Presidential office. The independence of the central bank has also been called into question, as the President himself has warned against interest rate increases to try and stem the lira decline, instead blaming a conspiracy on the falling value of the TRY.
On Tuesday, the central bank announced some mild measures in an attempt to shore up support for the lira, including a measure to reduce the amount of FX reserves that banks need to hold, along with further measures to reduce Turkey’s corporate FX risk. This has done nothing to boost the TRY, which again fell to a record low versus the USD and EUR on Tuesday. The market wants more than just words before it is willing to buy the lira once more, in fact Tuesday’s move may have actually enhanced the selling pressure on the lira, as it makes it clear that the central bank is under the influence of the government, which is never good from an FX perspective.
Ultimately, we expect the market to win out, and the central bank to embark on more forceful measures such as a large one off interest rate rise, which could cause a sharp reversal in Turkey’s fortunes in the short-term. The risk of a rate hike is growing, especially if we see a series of consecutive sell offs in the TRY this week. Back in 2013 and 2014, Russia’s currency also came under pressure and the central bank embarked on a series of unscheduled rate hikes, eventually pushing interest rates up to more than 14%. While it did not have an immediate effect on the currency, there were periods of recovery in 2015, before the RUB embarked on an impressive rebound last year.
For now, the lira is one of the worst performing currencies in the world as political risks look too great for investors to view the TRY as a bargain. In comparison, the pound’s Brexit premium looks like small cheese.
The Czech Koruna: ditching its peg?
The other currency to watch is the Czech Koruna, which has been capped vs. the EUR at 27 since 2013. This cap is at risk of being disbanded with due to upside pressure on inflation, after Czech prices rose to 2%, the highest level since 2012, last month. The Czech central bank has had to defend its peg aggressively in recent days, as the market tests its resolve to maintain an expensive peg when the Czech economy is doing well. The market is only too aware of the dangers of a disbanded peg, after the Swiss authorities broke their peg with the euro in 2015, causing financial market chaos.
The trouble with pegs, is that central banks don’t always give warnings about when they will come to an end. However, it will be interesting to see if the Czech authorities try to manage themselves out of the peg, something the Swiss authorities failed to do 2 years’ ago. Thus, the first step to getting rid of a peg in a sensible way could be an unscheduled central bank meeting or press conference to inform the public on the Czech authorities’ thinking around the sustainability of the peg.
For now, the spot EUR/CZK rate is stable at 27, however, the derivatives market is where the action is. The 6-month EUR/CZK forward is pricing in a 256 point drop, one of the largest declines since the financial crisis. This suggests that the market believes that there is a very real possibility that the Czech authorities will disband with the peg in the first half of this year.
Due to this, if you trade EUR/CZK, watch out for heightened levels of volatility in the coming days and weeks.
3, Look ahead: USD/JPY
The USD/JPY has spent the best part of the last 4 weeks trying to work off ‘overbought’ conditions after its impressive rally came to a halt at end of last year. That rally stalled at a long-term resistance zone between 117.65 and 118.75. As can be seen on the chart, this was the area between the open and low of the last up candle prior to the down move (circled) which preceded the drop to 100. It was here where the selling had started, in other words. Given the extent of the drop from here and also the size of the rebound, traders were always going to respect this resistance zone: buyers took profit on their longs, sellers initiated new shorts. Consequently, the USD/JPY has pulled back noticeably from this 117.65/118.75 area to drop to a low so far of 114.25.
The break of 116.00 support, if sustained, could see the USD/JPY drop to at least 113.80 and below that the next line of defence is at 111.45. These levels were previously resistance and so they could turn into support upon re-test. At this stage, a weekly close above 117.65-118.75 is needed for the long-term bullish trend to be re-established. Either that, or a distinct reversal pattern at these slightly lower levels (ideally around the above-mentioned supports) needs to be formed before we potentially see the next leg of the up move.
Source: eSignal, City Index
4, Look ahead: commodities
Precious metals are continuing to recover nicely from their bear trend that had started from July of last year. Gold has hit its highest level since the end of November, while silver has reached its best level since the middle of December. The slightly weaker dollar and expectations of rising global inflation have been the biggest drivers behind gold and silver. As well as a perceived safe haven assets, precious metals are also considered to be good hedges against inflation. We think there is potential for the dollar to weaken further as currently there are no fresh catalysts to drive it higher, though it remains well supported in the long-term thanks to a hawkish Fed.
Thus, in the short-term, we could see gold and silver make further progress. From a technical point of view, the grey metal continues to rise inside its bearish channel. Thus, for the time being, one has to be wary of the fact that silver is technically still in a bear trend. However, it is very encouraging to note the key long-term support around the $16 handle has held as support (see shaded area on the chart). Silver now needs to break its trend of lower lows and lower highs in order to confirm a change in direction. This makes the area around $17.20 (the last swing high) very important – if silver breaks through this level then we could see an eventual bullish break outside of the bear channel, potentially leading to some significant gains. Conversely, if short-term supports such as $16.70 and $16.25 break then a revisit of $16 would become highly likely, and perhaps this time the support may give way for a move towards the 2015 lows. This is not our base case scenario, however.
Source: eSignal, City Index
5, Look ahead: equities
UK retail stock comeback has ‘best before’ date
Caution creeps back into sentiment on biggest UK retailers
Tesco halts Aldi and Lidl market share grab
M&S faces another year of slim food sales growth, fragile Clothing & Home
Morrisons sets a high bar; well-defended for year ahead
Argos saves Sainsbury’s Christmas
British retailing names kept up the stream of robust Christmas updates on Thursday, but cautious industry voices were heard too, sending shares of institutions Tesco and Marks & Spencer lower, despite successful trading in the High St’s most important season.
The whole sector paused, having strengthened over 20%, on average, in 2016, reminding investors that the industry had only recently returned to firmer ground, just in time for renewed threats from bêtes noirs Aldi and Lidl, and looming inflation.
Whilst a new year customarily prompts investors to decide whether to rotate within and outside of sectors, we think the particular challenges facing UK retailers could narrow the breadth of returns across the industry even further.
Tesco turns tables on Aldi and Lidl
Tesco’s festive and quarterly trading, like Morrisons‘, hit the sweet spot where buoyant consumer confidence and fine-tuned pricing meet. This enabled the group to confirm that it grew market share for the first time since 2011. It’s a significant victory against incursions by discounters Aldi and Lidl, which have been aggressively appropriating large chunks of Britain’s grocery purse for around three years. If Tesco can sustain this current quarterly pace of low-single-digit percentage underlying sales growth—we are cautiously confident of its chances—it will be on track to meet a retail operating profit growth target of at least 60% earlier than the 2020 date foreseen by CEO Dave Lewis. That would point to continued recovery of Tesco’s shares. However, whilst Q3 sales were robust and, to quote Lewis, “ever so slightly more” than £1.2bn operating profit is now as good as in the bag, after a near-40% advance in 2016, nearby catalysts for more stock price gains are being judged as too flimsy by investors.
Tesco shares were also not helped by further cautious comments by its CEO this morning. Even so, we expect the shares to consolidate rather than deteriorate significantly from here.
We see another respectable double-digit rise by the stock this year as feasible.
A flash in M&S’s pan
In contrast to Britain’s biggest overall retailer, shares of the UK’s biggest clothes seller, Marks & Spencer rose as much as 6% on Thursday after it said it beat forecasts for Christmas trading. The group also saw some milestones of its own, including the first quarterly rise in underlying Clothing & Home sales for two years. It’s significant however that the group itself did not spotlight the achievement in its trading statement, instead noting that “c.1.5%” of a 3.1% gross sales rise was “was due to the shift in reporting period.” Unwillingness to crow, yet, suggests that CEO Steve Rowe is wary about how easy it will be to repeat the feat at a division where sales have persistently sunk despite millions of pounds of investment and several revamps. He is “absolutely clear”, he said this morning that there is lots more to do.
On the food side, Marks remains on firmer ground, posting 0.6% like-for-like growth in the 13 weeks to the end of December, continuing a virtually unbroken run that weathered the grocery sector downturn with fractional growth each quarter in similar modest increments. The challenge for the group’s food business now is to accelerate, particularly as the UK enters an inflationary environment which will challenge all grocers anew, and one for which rivals like Tesco and Morrisons—at least judging by their recent performance—have found a formula for more emphatic sales progress.
Either way, M&S’s likeliest growth driver remains Clothing & Home, a division where it will be the most difficult to protect shoppers from input price rises, as has been discovered by Next and others already.
All told, the balance of uncertainty for the year ahead seems slightly greater at M&S than at Tesco and Morrisons.
Morrisons sets high bar
Supermarket No.4 reaffirmed its transformation last year from an ‘also ran’ into a serious threat to rivals like Sainsbury’s. Morrisons gave Tesco, which emerged as a winner in the latest grocery industry survey by Kantar Worldpanel, a run for its money too.
Morrisons was no laggard in Kantar’s independent data, with sales up 1.2% over 12 weeks to 1st January, but the group’s own figures from stores open more than a year over 9 weeks to the same date were up 2.9%.
Whilst a broader strengthening is afoot among all big British grocers after years of painful efficiency drives and soul searching (and a little help from fading deflation) rivals will struggle to match Morrisons’ milestones, including its best underlying sales growth for seven years and unquestionably firm transaction volume. Less positively, the group has still not achieved a compelling rate of Internet growth (only a 0.6% like-for-like contribution at Christmas).
Fresh worries, stale threats
More seriously the group’s sales release also brought the first signs of retailers’ wariness on the return of inflation and its uncertain impact on consumer spending and margins, damping investor enthusiasm after last year’s strong share price rebounds. UK market and consumer inflation expectations are now running between 3%-4% over the next 12 months, pointing to a perceived threat as much as a real one.
The other central worry is that supermarkets’ bêtes noires—discount chains Aldi and Lidl also redeemed themselves over Christmas after 2016 saw their slowest sales growth for years. Aldi sales surged 15% compared to 2015, whilst Kantar’s survey revealed growth of 11.8% and 7.5% respectively. Still, Tesco and Morrisons have come a long way since being challenged significantly by the German upstarts for the first time around three years ago, and their share price gains over the last year–60% and 40% respectively—indicate that investors now see them as capable of withstanding a tougher environment.
All it’s difficult not to be impressed by CEO David Potts’ retooling of Morrisons, which was rewarded by a near-60% share price return last year, the best amongst close rivals.
We also expect the group to outshine peers on free cash flow growth, another important differentiator of retail resilience.
Argos does Sainsbury’s heavy lifting
A weak, but better-than-expected 0.1% quarterly rise in grocery sales at Sainsbury’s set the stock on course for its best day since May 2016—but it closed just 1% higher on Wednesday.
The short-lived bounce is worth scrutinising in given that rivals are building on stronger showings over the last 12 months compared to Sainsbury’s, which had an uneven quarter and uninspiring 2016. For the 15 weeks to 7th January, the group said it trumped forecasts of a like-for-like dip of a similar magnitude to the 1% decline seen over its last half-year. But that’s against a backdrop of what is looking like an outright revival around the other Big 4 grocers, and was also Sainsbury’s first positive like-for-like sales performance since the fourth quarter of its 2015/16 year.
Kantar Worldpanel had a similarly tepid reading on Tuesday of the No. 2 grocer’s recent performance. Its data has Sainsbury’s overall sales ticking 0.1% lower in a retailing environment that showed “the fastest recorded growth since June 2014″.
Under the circumstances, the group’s acquisition of Argos was further confirmed as a strategic success given the slow-motion snap back on the food side. Argos’ like-for-like sales increased 4%, well ahead of The City’s 1.5% expectation, with the home ware and electronics business continuing to offset unresolved concerns over volume growth in food in Q3.
This led CEO Mike Coup to say Sainsbury’s Christmas performance “reinforced the case” for acquiring Argos. It should also not be overlooked that ‘general merchandise’ proved to be the most deflation-resistant retail segment during the High St downturn. That does need to be balanced, however, with likely higher-sensitivity to input price inflation.
And whilst CEO, Coup’s Argos comment was a pat on the group’s own back for getting ahead of increasingly demanding consumer trends, it was also an admission that traditional supermarket sales were a let-down during one of the best Christmas seasons for years. With management directing investors’ attention to the strength of Argos, we can expect increased scrutiny of how well Argos is defended against competition from Dixons Carphone, Amazon among others.
Partly for these reasons, initial relief propelled Sainsbury’s shares 7% higher at one point on Wednesday, but the move faded. It follows a low-flying 6% lift for the stock in 2016, the weakest of the ‘Big 3′ supermarket stocks.
To be fair, Sainsbury’s online and convenience store volume growth were great in Q3: up 9% and 6% respectively. And clothing and general merchandise also jumped: by 10% and 3%, suggesting an outright sales rebound could be close. The group said it was ‘comfortable’ with analysts’ 2016-17 profit forecasts. However, if consensus for underlying pre-tax profit at £587m is accurate, income will just be flat against 2015/16, after two years of falls.
Investors are likely to prefer clear comeback stories to themes of running in place.
Major UK consumer company trading statements for the rest of January
Burberry will release a quarterly trading statement on Wednesday 18th January, as will JD Wetherspoon, Ladbrokes and Experian, whilst Royal Mail will report on nine months worth of business on Thursday 19th. On the 24th January, easyJet will release a statement on its first quarter and Dixons Carphone will update on its third. WH Smith’s statement is set for 25th January, Whitbread’s on 26th, the same day as earnings from SKY Plc. and Unilever. BT’s are due the day after. Ocado full-year earnings will be out on the last day of January.
FTSE’s sterling connection will be ‘live’ on Tuesday
The FTSE 100’s well-known ‘disconnect’ from Britain’s economy, with most FTSE companies not doing most transactions in sterling, has been temporarily suspended, and normal service is unlikely to resume next week.
That’s because the inverse relationship between the pound and the blue-chip index, which works just as much through investor expectations as it does through impact on revenue and profits will be in view again on Tuesday, at least. It’s no coincidence that the FTSE set a series of new record highs in October, December and this month, when the pound was at some of its weakest levels since sterling plunged to 31-year lows last June.
All things Brexit remain key. That was underscored again this week when comments by Prime Minister Theresa May, possibly pointing to the government’s willingness to sacrifice single market access in favour of total control over immigration, sent the pound hurtling on to the $1.20 handle. Almost concurrently, the FTSE set its umpteenth record peak. How long can this pattern continue? The truth is nobody knows for sure. But there’s a good chance that momentum can carry the FTSE 100 higher still in the week ahead, particularly because May will be back for another bite out of the pound on Tuesday 17th.
That’s when the PM is scheduled to present a speech that is likely to draw worldwide attention, because for the first time, she will present her vision for a “truly global Britain”. We will all be listening and hoping for answers to several key questions, regarding immigration, the single market, the customs union, The City’s desperate wish to keep hold of ‘passporting’, a possible transitional EU regime, and more.
Whether or not May answers those questions is almost immaterial from the point of view of sterling volatility—we should expect lots more of it either way. Sterling’s implied volatility, which shows the extent to which option traders expect prices to swing, spiked to the highest levels since October on Thursday and Friday, revealing both increased speculative interest and anxiety.
UK jitters may hit blue chips
In fact, the FTSE itself, whilst tending to benefit from the pound’s misfortunes, has not proved to be entirely immune to such trepidation. However, as seen on the days that followed the Brexit vote, the U.S. election and Italy’s referendum, the benchmark has a consistent knack for rapid recovery. The week will also bring further British macroeconomic stimuli. Whilst typically ‘ignored’ by the top stock index, these releases could indirectly influence equities trading, given that the currency market also remains in thrall to UK data.
If the latest available UK jobs and inflation data, both out on Wednesday, follow the recent pattern of beating expectations, sterling can be expected to hold its ground. If that’s the case, the FTSE could get becalmed, or might even become more sensitive to contemporaneous risks. These include the notorious tendency of traders to read nuances into almost any comment by European Central Bank President Mario Draghi, when he speaks after interest rate decisions. He’ll do this on Thursday 19th, and a typical round trip by the euro is possible, potentially to sterling’s benefit.
Elsewhere, China will release economic growth figures on Friday 20th January. Global market sensitivity to China appears to be increasing again, particularly after data this Friday showed the worst export growth since 2009. A weaker outcome than the 6.7% Gross Domestic Product, informally forecast by the head of the country’s state planning agency this week, could set alarm bells ringing among FTSE investors too, with eyes on global mining and overseas-facing banking constituents.
The disclosure season for top UK stocks will also pick up pace during the week, with highlights from Burberry, Royal Mail, British Land and JD Wetherspoon. The first two shares are ‘high beta’ (more volatile than other FTSE shares) and, depending on the market’s reaction to their trading statements, they could help the index achieve another record, or hinder it from doing so.
From a technical perspective, the most recent leg of the FTSE’s grinding uptrend, shown in the chart below, might be a beautiful thing for those who got in at the beginning, last February. For latecomers, as ever, the challenge is deciding on the most auspicious time to get on board or not, or even when to actively adopt a bearish position on the market.
Source: Thomson Reuters, City Index
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