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Beaufort Analysis 273 – Too big to fail?

The book written by Andrew Ross Sorkin, “Too Big To Fail”, in 2010 and later adapted for a film of the same name, was the inside story of how Wall Street and Washington fought to save the financial system during the Global Financial Crisis.  One of the lessons from the Crisis was that some banks proved too big to fail and the fears of systemic collapse pushed both regulators and governments into bailing out hundreds of failing financial institutions.

Not quite the same, but still in the mindset of too big to fail, we have Big Tech.  Technology companies were the darlings of the stock market last year, with the FANGs* in the US and the BATs** in Asia, commanding the largest share of global returns.   Some of these companies have become so large that investors have become fearful of a growing political backlash, with threats of increased regulation and taxes, which until now, did not seem to have a meaningful catalyst.  Until now.

The trigger for the backlash that has spread through the leading tech stocks and been firmly laid at the feet of the trade tantrum between the US and China, leaving investors facing an uncomfortable, albeit familiar story: nothing is forever and the invincibility of Big Tech can no longer be taken for granted.

The current political climate has not helped matters: there are fears of a White House personal vendetta against Amazon, and a massive leak of personal data from Facebook, has led to Big Tech being on the receiving end of huge losses.  Amazon tumbled almost 6% on the back of the latest Trump tweet, this time focusing on their agreement with the US Postal Service and threatening to level the playing the field with an increase in tariffs.  Why pick on Amazon?  Jeff Bezos, the president and founder of Amazon also owns the Washington Post, which has led much of the reporting about the recent chaos in the White House.

Another FANG member, Facebook, has seen its value drop almost $75 billion as a result of the data of 50 million users being leaked to a data analysis firm, which was allegedly used to help the Trump presidential campaign.  This has created a wave of annoyance among investors, peers and politicians, with other Big Tech companies distancing themselves from the Zuckerberg brand.  In particular, Apple’s chief executive was openly critical of Facebook’s monetisation of its customers and Google’s artificial intelligence expert, François Chollet, tweeted about their use of digital information as a “psychological control vector” and “totalitarian panopticon”.  In plain English, he sees Facebook as ‘Big Brother’ in the way they capture and manipulate personal data.

Outside of the FANGs we have an even more sobering story.  Tesla is being investigated for a fatal crash involving one of its self-driving cars and their share price dropped more than 7% when markets opened in the US yesterday.  March has been the worst month for Tesla in 7 years, with continued negative headlines around its finances and now the news of a fatal crash seeing the company fall more than 30% from last year’s high; that translates to over $22 billion wiped from Tesla’s value.  In what many have seen as brash and offensive, chief executive Elon Musk posted an April Fool’s joke, posing for a photograph with “Bankwupt!” scrolled on a piece of torn cardboard.  Not what we would expect from someone who relies on investors to believe in the company’s expansion plan without profits in the short-term; Tesla posted a loss of almost $2 billion last year.

This tide of bad news for the Big Tech is good news for short sellers, investors who sell shares they do not own (a form of derivative usage) in the hope that prices will fall, from which they profit.  It can be a risky investment strategy, but that has not stopped the FANGs now appearing in the top ten of most shorted US stocks.

It is unnerving to see the market fall this fast on what seems to be news that is not going to change the global economic outlook.  It is an example of having to hold your breath while the short-term sentiment passes, if your long-term view on the economy has not changed.

*Facebook, Amazon, Netflix and Google.

**Baidu, Alibaba and Tencent.

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Beaufort Analysis 272 – Two Tribes

Having briefly reached the once elusive height of 7000 for the first time in the spring of 2015, the FTSE 100 Index remained above that level for the whole of 2017 as the bull market entered its 9th year. The index peaked at 7778 on 12th January but in a matter of only ten weeks has dropped 11%; 3.5% of the fall coming during last week, alone.

There are two main reasons for the current market volatility. Firstly, and probably most damaging, is the trade war which has now developed between the US and China. Further to Donald Trump’s imposed tariffs on steel and aluminium imports, the President has now ordered new 25% tariffs on $50bn of Chinese imports, following an investigation in to intellectual property theft; a long-standing bone of contention. The US also plans to impose new investment restrictions and take action against China at the World Trade Organisation. In response, China has imposed tariffs on just $3bn worth of US imports, but has vowed to ”fight to the end” and “not recoil from a trade war.”

Secondly, both the Federal Open Market Committee (FOMC) in the US and the Monetary Policy Committee (MPC) in the UK made decisions on interest rates. The US central bank raised the federal funds rate by 0.25% to a range of 1.5-1.75% due to the rapidly improving economy, low unemployment and a predicted rise in inflation. GDP growth for this year and next has been revised upwards with it moderating after 2020. The committee announced there would be two more rate rises this year, and a further three in 2019. The MPC kept UK interest rates at 0.5%, although two members of the committee backed an increase. However, with British workers’ pay rising at its fastest pace in more than two years, the expectation is for a rate rise in May with a likely further increase before the end of 2018; this is despite inflation falling to a seven-month low of 2.7% in February, down from 3% in the previous two months.

EU leaders have approved guidelines for the negotiation of future relations with the UK, post-Brexit, clearing the way for the next phase of Brexit talks. Britain has also secured a 21-month transition period to take place from March 2019, when the UK officially leaves, until the end of 2020; this should lessen the impact of Brexit for exporters.

Elsewhere, Facebook came under pressure to explain how data collected on 50 million users was exploited for political gain, following claims that consultancy firm, Cambridge Analytica, used the leaked information to help Donald Trump win his presidency. Facebook CEO, Mark Zuckerberg, admitted that the company had made mistakes and has been summoned to appear before US Congress.

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Beaufort Analysis 271 - Spring Clean

The Chancellor of the Exchequer, Philip Hammond, did not need to dust off his distinguishable red briefcase last week; as this was the inaugural Spring Statement, the briefcase will not make an appearance until the Autumn Budget. In his speech, the Chancellor revised up the UK’s growth forecast figures for this year from the previous figure of 1.4% to 1.5%, whilst inflation was forecast to fall to the target of 2% by the end of the year.

It was revealed that in revising Stamp Duty for first time buyers in November last year, 60,000 people have benefitted from the new tax arrangement. However, whilst this has helped those get a foot onto the property ladder, forecasts indicate that over the next year the UK Government will miss out on £1 billion in tax from first time buyers.

With the aim of keeping the environment clean and reducing degradation further, Mr Hammond also announced a consultation on the taxation of single use plastics, such as coffee cups and water bottles.

Meanwhile, in the US, Donald Trump sacked his Secretary of State, Rex Tillerson, due to continued disagreements but it followed his comments about Russia’s possible involvement in the poisoning of a spy and his daughter here in the UK. Mike Pompeo has been named as Tillerson’s replacement in Trump’s cabinet. Tillerson’s sacking makes him the twentieth person to have been sacked or resigned from the White House since Trump took office.

In Russia, Vladimir Putin won another election victory for his fourth term, garnering over 70% of the vote; but this is not without controversy. There have been accusations of irregularities in the vote, with people unable to enter polling stations and the presence of voting papers in ballot boxes before polls opened.

Looking to the week ahead, the Federal Open Market Committee will be meeting to discuss the current US interest rate. Whilst it is not expected to change, the UK’s Monetary Policy Committee will also be meeting this week to discuss the Bank of England base rate. However, interest rates are on the agenda on both sides of the Atlantic.

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Beaufort Analysis 270 - X marks the spot

The World Health Organisation (WHO) hopes that ‘X’ does not lead to spots.  Last week WHO published an updated list of diseases which pose a serious outbreak threat, which saw a new disease added, dubbed Disease ‘X’.  This is a Donald Rumsfeld, ‘known unknown’ with WHO saying that ‘X’ represents the knowledge that a serious international epidemic could be caused by a pathogen currently unknown.

So, uncertainty is not just reserved for financial markets and politics.  This was demonstrated with the agreed meeting between Donald Trump and Kim Jong-un, which did not make anyone’s list of plausible probabilities for 2018.  What was arguably on the top of most people’s lists, was Donald Trump causing a fair degree of ambiguity in his policies, which coalesced in the form of trade tariffs for steel and aluminium imports.

The silver lining was that the White House adviser Gary Cohn would be organising a meeting between steel and aluminium consumers; he is the voice of reason on trade policy.  Unfortunately, he resigned the very next day, which was a blow to anti-protectionism and adds to the unusually high turnover of senior staff in Trump’s administration.  This undermines the policy continuity that markets crave.

We believe the economic impact may be fairly limited since steel and aluminium imports account for around 2% of all US imports.  The clear majority of imported metals come from Canada and Mexico, which have been given a temporary exemption.  So, whom is Trump looking to pick a fight with in the trade war?  If it is China, as many suspect, then it will have little effect.

China’s overall exports surged 44% in February, which along with a slight decline in import growth, pushed the country’s trade surplus to $33 billion for the month.  China has now brought itself in line with Germany, France and the UK by abolishing term limits for its head of Government.  This was not a surprise and for the short-term means stability, which markets may look upon favourably.  The flip-side is over the longer-term it may make innovation more challenging, which depends on interesting times to provoke improvements and changes.

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Beaufort Analysis 269 - Five Star result for Di Maio

Economic data releases had a limited impact on markets last week; the same cannot be said for politics.

In the US, J. Powell testified before the House and Senate on Tuesday and Thursday respectively, commenting that the Fed could change its interest rate forecast when they meet in March. In his first address, Powell indicated that there may be four interest rate rises, instead of three; his comments rocked both equity and bond markets which regained ground towards the end of the week. Across the pond, the EU Commission released a draft withdrawal document on how the UK will leave the EU. Unsurprisingly, the status of Northern Ireland post Brexit is the main sticking point. It is unlikely that Mrs May will agree to the current draft which will further protract Brexit negotiations.

Moving onto the main event last week; the Italian general election. Early results suggest a hung parliament but the outcome, although still provisional, delivered a surprising result that will no doubt have bruised the ego of the country’s political establishment. The populist Five Star Movement emerged as the strongest single party with 32% of the vote. The next nearest contender was the Democratic Party led by Matteo Renzi with 18%.

The Five Star Movement is a relatively young party which was founded by comedian Beppe Grillo in 2009. Led by Luigi Di Maio, equally young, at 31, the success at the polls comes from channelling discontent amongst Italy’s political elite and their strong base in southern Italy, especially amongst younger voters. Five Star has been the most popular political party in Italy since early 2017, but they will now face a fresh challenge, as 32% is not sufficient to form a government unless they strike an alliance with other parties. We expect further details to unravel as the week progresses.

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