Market update – July 2016

Stock Exchange web sitesGlobal markets in June were dominated by the outcome of the UK EU Referendum. However, Brexit in itself is unlikely to put the global economy at risk. In terms of GDP, the UK accounts for just 2.4% of global output and a mere 1.4% share of output growth since the global financial crisis. A slowdown in the UK economy does not have the impact that a slowdown in China or the US would.

The main concern is that Brexit could trigger a confidence shock to the entire EU area, potentially causing another financing crisis at a number of European (particularly Italian) banks. These banks are still sitting on an enormous stock of bad loans that are yet to be written down. Currently the risk looks minimal however – Government bond yields in Spain and Italy have barely moved and the credit spreads demanded of European banks remain well below the levels reached in 2009 or 2011.

In the UK, pronounced weakness in the pound increased the appeal of companies with a high proportion of overseas earnings, providing a boost for the FTSE 100 Index, which ended June in positive territory, posting a monthly increase of 4.4%. Medium-sized companies fared poorly in comparison: the FTSE 250 Index fell by 5.3% during June, dragged down by negative sentiment towards its UK-focused constituents. The FTSE Small Cap Index also declined by 2.7% over the month. The best-performing FTSE sectors over the year to date include industrial metals & mining, mining, oil & gas producers, tobacco, and personal goods. At the other end of the spectrum, the worst-performing sector since the start of the year was real estate investment & services, followed by life insurance, leisure goods, and banks.

UK gilt prices surged during June, suggesting that the main Credit ratings agencies downgrading of the UK has not affected borrowing costs. Sterling and gilt yields fell sharply amid renewed expectations of lower interest rates. Over June as a whole, the yield on the ten-year UK gilt plunged from 1.56% to 1.00%, while the yield on the shorter-dated gilt – maturing in 2018 – dropped from 0.43% to 0.11%.

The UK’s rate of unemployment had eased to 5% between February and April, reaching its lowest level since October 2005. The number of unemployed individuals fell by 20,000 to 1.67 million during the period. Average earnings (excluding bonuses) rose at an annualised rate of 2.3%. However, Brexit is widely expected to lead to a slowdown in hiring as companies review their investment plans. A survey by the Institute of Directors of 1,000 companies found that 24% of firms intend to freeze recruitment, while 5% will make redundancies. Nearly two-thirds of respondents regarded the Brexit outcome as negative for their business, compared with 23% who viewed it as positive.

In the US, markets were unnerved by a poor employment report at the start of June. 38,000 new jobs were added during May, compared with 123,000 in April and 186,000 in March. Despite this, the rate of unemployment dropped from 5% to 4.7%. The Fed expects the unemployment rate to remain around 4.7% at the end of 2016, easing to 4.6% in 2017. Subsequent revisions to the first estimate of GDP more than doubled the original reported rate of growth for the first quarter from 0.5% to 1.1%, and growth in the second quarter is predicted to be strong. More pertinently, exports to the UK and to the broader EU equal just 0.3% and 1.5% of US GDP, so the US is relatively immune to political uncertainty across the Atlantic.

The leading mainstream US equity indices managed to rebound from sharp initial losses after the Referendum to end the month in marginally positive territory. The Dow Jones Industrial Average Index crept 0.8% higher over June as a whole, while the S&P 500 Index edged up by 0.1% overall. In contrast, the technology-heavy Nasdaq Index fell by 2.1% over the month. The Federal Reserve held interest rates steady at their June meeting, however Fed Chair Janet Yellen said “If incoming data are consistent with labour market conditions strengthening and inflation making progress… gradual increases in the federal funds rate are likely to be appropriate”.

Having fallen heavily in the wake of the Referendum, Asian markets experienced a slight rebound as June drew to a close. The yen – which is widely regarded as a safe-haven investment during troubled times – surged to its highest level against the US dollar since mid-2014. The yen’s appreciation affected sentiment towards Japanese exporting companies, and the Nikkei 225 Index and the Topix Index both fell by 9.7% during June. Since the start of the year, the two indices have lost 18.2% and 19.5% respectively. In comparison, the TSE Second Section Index – which has a greater focus on medium-sized companies – fell by 5.9% during June and by 12.5% since the beginning of 2016.

In China, sentiment was dampened by disappointing trade data: exports fell at an annualised rate of 4.1% in US dollar terms during May, while imports fell by 0.4%. Meanwhile, growth in China’s consumer price inflation slowed during May to a lower-than-expected annualised rate of 2% during May. The Shanghai Composite Index edged up by 0.4% over the month, but has lost 17.2% since the start of 2016.

Emerging equity markets generally performed better than developed markets during June. Sentiment towards emerging markets was boosted by supportive statements from leading central banks in the wake of the UK’s Brexit vote, and by signs that interest rates in the US – and elsewhere – are likely to remain lower for longer. Moreover, nervous investors’ flight to “safe-haven” currencies and government bonds drove down yields, boosting the relative attractions of emerging-market yield.

In response to the UK’s Brexit decision, the Governor of the Reserve Bank of India (RBI), Dr Raghuran Rajan, commented: “The Indian economy has good fundamentals, low short-term external debt, and sizeable foreign exchange reserves. These should stand the country in good stead in the days to come”. The RBI maintained its key interest rate at 6.5% during June. The CNX Nifty Index rose by 1.6% over June and has climbed by 4.3% over the year to date.

In Brazil, the Bovespa Index rose by 6.3% over June and has surged by 18.9% over the first half of the year. Brazil’s economy continued to contract during the first three months of 2016, shrinking at a quarterly rate of 0.3% and an annualised rate of 5.4%. Although the decline was less severe than many had feared, the outlook for the country’s economy remains lacklustre, undermined by political instability.

Closer to home, Nationwide published figures showing that Northern Ireland no longer has the lowest house prices in the UK. The average house price here increased by 1.6% in the second quarter of 2016 to £128,562 while the average price in the North of England fell to £123,914.

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