28th March 2017

Rathbones weekly review: Defiance

The candlelight vigil held in Trafalgar Square, in the aftermath of last week’s terror attack on the heart of our capital, showed solidarity and defiance, and sent a clear message to the world. A reminder of the resilience of the human spirit in the face of adversity.

Resilience wasn’t, however, a word that could describe the equity markets last week. The FTSE 100 experienced its worst weekly decline in two months, down 1.2%. Investors were cautious ahead of the delayed healthcare vote in the US, which weighed on global equity markets. In the end, President Donald Trump suffered a humiliating defeat on his attempt to replace Obamacare, with the House Republicans pulling the bill at the last minute. This was a clear signal of his inability to work with Congress to deliver on the key campaign promises that have buoyed equities since his election victory.

Source: FE Analytics, data sterling total return to 24 March

Black Gold

J Paul Getty’s formula for success was to rise early, work late, and strike oil. For striking oil, read striking it rich. Those countries and organisations boasting significant oil reserves are generally sitting pretty – pretty rich. But where there’s oil there’s complexity: OPEC, oversupply, falling barrel prices, production caps and vested interests. And then there’s a Scottish referendum.

So, why so complicated? Over the past month the Brent Crude oil futures price fell by 10% to $51 a barrel, the result of renewed fears of simple oversupply. But there are many factors beyond demand and supply influencing global oil prices. For starters, there’s current and future supply, and then there are commodity traders – hedgers and speculators – who really set the prices.

The US, which isn’t a member of OPEC, contributed to the oversupply by increasing its shale oil production. This undermined the cuts in production of 1.2 million barrels a day from January 2017, which were agreed by OPEC in November last year. This agreement had helped stabilise prices above $50 a barrel (it was below this figure for much of 2016). And $50 doesn’t sound so great when you consider that OPEC’s target price is $70 a barrel. However, they don’t lose money until the price drops below $20. On the other hand, the shale producers have a higher minimum price, as much as $50 a barrel.

The current OPEC production agreement, which was the first output cut for eight years, is due to run until June 2017. The cartel hasn’t got a great track record of compliance and much of the success of the deal will depend on the world’s biggest oil producer, Saudi Arabia. Oh, and one other thing, while it’s an OPEC agreement, other producers – such as Russia – are expected to cut production too.

One of the countries that should be ‘pretty rich’ is Scotland. Last week, First Minister Nicola Sturgeon announced that she intends to ask for a second referendum on Scottish independence following the Brexit vote. However, any mention of the ‘I’ word (independence) is generally followed closely by the ‘O’ word (oil).

An independent Scotland would be reliant on oil revenues – to what extent depends on which politician you listen to. In 2014, the year of the previous referendum, oil prices peaked at about $115 a barrel. The subsequent falls in the oil price have taken a toll on their North Sea oil revenue. Any reduction in revenue – for a household or a country – makes economic life more difficult. Scotland also has a deficit and slow rate of growth, which all makes independence a riskier prospect now than it was two and a half years ago.

Of course, in the event of an independence vote, having its own currency would leave Scotland setting its own interest rates, making it easier to adjust to fluctuations in the oil price.

On the one hand, oil provides an economic boost, on the other it comes with a headache – how best to maximise revenues when there are so many powerful players and so many other factors that are very much out of your control? Ms Sturgeon no doubt already rises early and works late, she will be hoping she also strikes it lucky.

Ready, steady, negotiate

Prime Minister Theresa May is expected to trigger Article 50 imminently, officially notifying the European Council of the UK’s intention to leave the European Union. This will mark the end of a nine-month period since the referendum decision and the beginning of two years of no doubt fraught negotiations.

The Government’s ability to negotiate successfully and to, for example, secure a free-trade agreement, was always going to be scrutinised closely. The recent and embarrassing National Insurance U-turn following the Spring Budget has gifted ammunition to the doubters, even before the Article 50 starting pistol was fired. Fiascos don’t instil confidence. The possibility that this one conveyed the impression that the Government succumbs to pressure doesn’t send a great message to an EU keen to secure divorce terms, including about £50bn to meet Britain’s liabilities.

It could be a long two years.

Bonds

UK 10-Year yield @ 1.20%

US 10-Year yield @ 2.42%

Germany 10-Year yield @ 0.41%

Italy 10-Year yield @ 2.41%

Spain 10-Year yield @ 1.68%

Julian Chillingworth
Chief Investment Officer

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