Henk Potts' Market Review
Henk Potts – Barclays Global Investment Strategist
Henk Potts joined Barclays Bank in 1998 as a graduate and worked as a Stock Market Analyst for Barclays Stockbrokers, focusing on UK equities. In 2009, he was appointed Director of Global Research & Investments for Barclays Wealth and Investment Management, where he works as part of a team formulating and communicating investment strategy to internal and external clients.
Henk analyses a wide variety of asset classes, including equities, currencies and commodities, as well as ascertaining and explaining the effects of macroeconomic changes on financial markets.
Henk Potts’ end of year review and outlook for 2017
Henk discusses the stories that dominated the headlines in 2016 and also highlights the key events that are likely to dominate during the course of 2017.
The below content has been taken from Henk’s weekly podcast. If you’d prefer to listen to this, you can do so via Stockbrokers TV.
A hard Brexit and the economy
I think a hard Brexit would be bad news for the economy. We know the economy has certainly benefited from having access to the world’s single market: 500 million people, £11trn. That and the associated trade barriers and tariffs that you’d normally expect. UK economy has benefited from free movement of labour and free movement of capital. I think free movement has allowed companies to choose from a much wider talent pool, kept labour market costs down quite considerably. We should also remember that many companies see Britain as the gateway into the rest of Europe, and that’s boosted foreign direct investments.
I think that’s been incredibly important. But also think about where the UK economy has got to compete in the future. It’s not going to be a low cost manufacturer. It’s got to be at the forefront of scientific achievement, of technological advancement. And the extra research and development budgets that we’ve got as being part of Europe that’s going into our universities, has gone into your technology companies, I think has really helped us in terms of that endeavour. But beyond that it’s also about having a seat at the table when determining policy in key areas. Trade, the environment, security, financial services, think how important they are in terms of the UK economy.
We know Europe’s very important to the UK, 44% of our exports go into the European Union. EU/UK trade counts for 12.6% of GDP. So it’s absolutely vital that we get the proper relationship with Europe that we continue to have access to the market. If we get a hard Brexit that reduces our access or adds an awful lot more tariffs and barriers to that, then that’s going to be bad news for the UK’s growth profile.
UK growth in 2017
If you look at the data so far everyone’s been saying actually Brexit hasn’t had much of an impact. And the data has held up probably better than expected. Part of that has been helped by the aggressive policy response that we saw from the Bank of England. It’s been helped by the rapid appointment of Theresa May which reduced some of that political risk. But I think we will see a significant slowdown going into next year. So we still expect the UK economy to grow at around about 2% during the course of this year. But then we start to see the real impact shining through in 2017, where we expect growth to slow down to around 7/10ths of 1%.
Think about the recovery in terms of the UK economy after the financial crisis. It’s been driven by robust household consumption, strong business investment, the construction boom that we saw in London and the South East both residential and commercial. Some of those key drivers I think will start to come under pressure, particularly household consumption. We expect employment growth to turn negative as we go into 2017, and unemployment, which has been very low, starting to tick up. So it’s just below 5% today, we think it will finish next year at around 6%.
Expectations of the Bank of England
There has been criticism for Mark Carney. I don’t think that’s been particularly fair. I think they’ve done a good job of trying to stabilise markets and stimulate growth. Remember they cut interest rates to the lowest level in the Bank of England’s 325-year history. They ramped up the asset purchase facility by a further £70bn, £10bn going into corporate bonds; yet another lending scheme for the financial system. But I don’t think the Bank of England have done their, there’s still the potential for a rate cut next year depending on how the data plays out. We think we could see the bank being cut by a further 20 basis points, taking rates of course virtually down to zero. But I think that will be the lower bound for UK rates. We know Governor Carney’s certainly not a fan of negative interest rates.
Actually the biggest challenge for the Bank of England is not what they’re seeing today, but actually what they could see in the future, because potentially of course they could be faced with an economy that’s slowing down. But given the fact that sterling has sold off so aggressively the cost of importing goods is rising quite dramatically, means inflation is going to be above the target. Potentially then they could be faced with that stagflation scenario, which could mean they may have to raise rates in the future despite the fact the economy’s slowing down.
Foreign exchange markets
As a result of Brexit, there’s no surprise of course that the Pound has sold off aggressively. That’s the big move that we’ve seen during the course of this year. Sterling always more vulnerable to investment flow than other currencies given the high level of debt and deficit that we’ve got in the UK – remember the UK has got a debt to GDP ratio of 90%. The deficit is basically equivalent to somewhere between 5 and 6% of GDP. The Government has abandoned the previous administration’s target as we know of balancing the books by 2020. We should remember sterling was already under pressure coming into the vote, fallen by somewhere around 8% on a trade weighted basis from mid-November. Our analysts anticipated it would fall by a further 10%, and it’s gone a little bit more aggressively than that, although we have seen some recovery in the course of the past couple of weeks.
No surprise where the money’s been flowing into either. Money has been going into those safe haven currencies, been going into the dollar, been going into the Japanese yen, and to a lesser into the Swiss franc as well. We’ve seen the euro rally against sterling, but we think that’s going to be short lived. We think Brexit along with some other issues, political uncertainty across the eurozone, increases the risk of contagion and fragmentation. So our big call in foreign exchange markets continues to be that the dollar will strengthen quite substantially from here and the euro will weaken quite considerably. For example we’ve got euro/ dollar the end of next year back to .99. We think sterling slightly over sold against the dollar. We’ve got it at 1.30 at the end of next year. But we think the euro will be considerably weaker against the pound as well. We think at the end of next year it’s going to be 76p to buy a euro.
UK property market
UK property was certainly seen as one sector that was vulnerable to the Brexit vote. We know property prices have been driven up by international investors over the course of the past few years. Momentum again was coming under pressure coming into the vote. If you look at activity levels, if you look at price appreciation, certainly slowed down quite substantially. Now there’s been a rush of analysts coming out forecasting doom and gloom when it comes to specifically the UK housing market. I think it’s too early to say that’s the case. I think what we’ve got is conflicting forces there. So yes you’ve got political uncertainty, Brexit uncertainty, perhaps tighter lending rules, the stamp duty surcharge. But offsetting that of course is the weaker sterling. That’s bringing back international investors into the market. Some very low mortgage deals out there, but a supply and demand imbalance as well.
I was reading a parliamentary report the other day that suggested in order to meet the supply and demand imbalance in terms of the UK housing market, the UK needs to build 300,000 homes per year. In the past decade there hasn’t been any year where we’ve built more than 200,000 homes. So that supply and demand imbalance suggests to me that the housing market will remain relatively resilient over the course of the next few years. There are some areas of course that are seen as more vulnerable. If you look at the high end of the market, the £10m+ properties, Kensington and Chelsea that have done very well, there’s some weakness there. On the commercial side it’s been a little bit harder to get the financing for some of these landmark deals, so skyscrapers, the shopping malls. But the underlying market I think still remains particularly strong.
Future of the UK’s relationship with Europe
We don’t even know whether it’s the prime minister or whether it’s going to be parliament that’s going to invoke Article 50 that we’ve become far more familiar with over the course of the past few months. And then we start to think about what the relationship with Europe is going to be like. There are some models as we know that we could follow. We could become simply a member of the Economic Area, the European Economic Area such as Norway. We could go for a model such as Switzerland and Turkey with a bilateral agreement. The problem with those is of course they both require free movement of travel, they both require payments into the European Union. Well if that is the case what on earth has it all been for we ask ourselves, to the most contentious of that campaigning period.
Without that you’re simply reliant on world trade rules. And one thing that we can say today is the further removed we are from having to that single market the greater the negative impact in terms of the UK economy. We should ask ourselves though is Europe going to give Britain a sweetheart deal? I don’t think so. It seems to me the bureaucrats in Europe worry about the European project breaking up. The quickest way for that to happen is to give further oxygen to the anti-European parties. The easiest way to do that is to give a good deal to the UK. So I think we’ve got to be realistic about that. As a German politician said recently what the UK should remember is when you’re not longer paying the fees to the club you can no longer use the facilities. And that I think is going to be the reality for the UK in many ways.
Brexit’s impact on the European economy
I think the market’s been wrong simply to view Brexit only through the lens of what it means for the UK economy and what it means for sterling. I think as we go through 2017 we’ll start to broaden our vision out on this one. It does have implications for the eurozone’s growth prospects. For me, it opens up a new chapter of high economic and political uncertainty, casts doubt on Europe’s commitment to free trade and to globalisation. I think there’s question marks about how quickly that integration programme can be pushed through. Remember in order for Europe to be successful it’s got to go on a journey of economic, political, fiscal and banking integration. For me Brexit puts a new road block in terms of that journey.
Donald Trump’s election as the 45th President of the United States
I think obviously it was a surprise, the once laughable, the once implausible as we know has become reality. The man who was shunned, the man who was condemned by the Republican Party spent the past few weeks receiving their congratulations and admiration. It certainly sent a shock wave through the established political classes in the United States, and somewhere around six or seven hours in global financial markets. Since then of course President Trump is seen a pro-growth president, certainly been risk on in terms of financial markets.
If you go back to the election campaign of course, there was all sorts of weird and wonderful pledges, many of which were contradictory. Remember this was the man who was pledging to ramp up government spending, at the same time eliminating the Federal debt, which would be an incredible conjuring act to achieve. I mean Donald Trump, like many politicians, doesn’t particularly like to have his stump speech thrown back in his face once confirmed into office. So we’ll have to wait to see whether many of those pledges will be confined to the political rhetoric dustbin. But we are starting to be fair to get an idea about the direction of travel. So we know we’re talking about lower taxes, lower income taxes, lower corporation taxes – we think US taxes will fall by around about 2% of GDP.
Talking about higher investment in areas such as infrastructure but also in terms of defence; talking about lower regulation in some key areas, financials and healthcare, higher trade barriers; certainly less of a focus on climate control issues as well. Remember Donald Trump famously describing global warming as a Chinese hoax, which kind of gives you an idea about where it sits in terms of his priorities. I think what we can say at this stage is that the two main pledges I think will be enacted, that’s stimulus and that’s tariffs, but probably to a much lesser extent than was suggested during the course of the campaigning period.
US growth profile
This has been a year of underperformance. We got off to a very poor start, certainly the first quarter, didn’t see the bounce back in the second quarter that you’d normally expect. If you look at the business surveys, the household consumption surveys have been strong, so that was better by the time that we got to the third quarter with growth coming up to 3% or so. We think the US economy will grow at around 1.6% this, returning back to a more trend level of around 2.2% next year, perhaps getting up to around 2½% as you look out to 2018.
The fundamentals for the US economy still remain good. Unemployment is low as we’ve said before, consumers continuing to spend. House prices still remain reasonably resilient growing around 5% per year. So that’s all seen as some good news coming through. I think when you look at the US economy it will continue to benefit from strong domestic demand, but does remain vulnerable to external weakness.
I hope you’ve found this update interesting and I wish you every success for the trading week ahead.