Economic Update: 10 November 2017

Economic Update: 10 November 2017

The Investment Management team round-up some of this week’s news.

Walking A Tightrope

On 19th June 2017 formal negotiations began between the EU and the UK. What we’ve seen so far, and what most people anticipated, is a tough set of negotiations with both parties expressing strong views in an attempt to influence the negotiations.

This week the US entered the fray. US commerce secretary Wilbur Ross, who is also Donald Trump’s most senior adviser, reminded the UK of their historically strong ties to the US and how these could prove very beneficial once the UK has formally left the EU.

Mr Ross stated, “As the UK stands on the edge of the major changes coming with Brexit, we stand ready to use this opportunity to support our friends across the pond and to deepen our ties even further”.

The two economies have over $1.2trn invested in each other. In addition, the US is one of the few countries with which the UK has a Trade Balance surplus; meaning that a close relationship with the US is vital for UK exporters.

UK Trade Balance (Seasonally Adjusted, £bn)

Source: UK Office for National Statistics, 09/11/2017

Speaking in front of an audience of business leaders in London on Monday, Ross said it was important for the UK’s deal to leave the EU to take into account the US’ “commercial interests”, stating that Trump was “very supportive” of a trade deal between London and Washington. Ross claims a trade deal could be signed within months after the UK leaves the EU, brushing aside claims that it could take 10 years for an agreement to be reached.

However, Ross indicated that if a UK deal with Brussels includes having EU superimposed divergent standards and other EU protectionist measures, a closer post-Brexit US-UK relationship would be compromised. For example, the UK would need to change EU dictated rules in areas such as food safety. Ross also emphasised the importance of maintaining existing arrangements with the EU such as “passporting” rights for UK banks and financial institutions in Europe; which is something the UK government appears keen to ensure. His comments caused speculation that clauses will be attached to any post-Brexit trade deal with Washington which will be controversial politically and socially.

In response, the UK Department for International Trade said, “the US is our largest single trading partner and the comments today from Wilbur Ross reaffirm the clear will on both sides of the Atlantic to strengthen our bilateral trade and investment relationship. As an international economic department, we are laying the groundwork for a potential free trade agreement and remain committed to a mutually beneficial economic trading arrangement with the US. We have been clear that the UK will maintain its own high regulatory standards in future free trade agreements.”

The UK has been a huge beneficiary of foreign direct investment (FDI) from the US which has supported economic growth. However, FDI from the EU has been less consistant.

Net Foreign Direct Investment Inflows into the UK (GBP, Millions)

Source: Bloomberg, data as of 09/11/2017

It is clear that Theresa May and Brexit secretary David Davis will have to balance the demands of Europe with those of their strongest allies. At the same time, having allies such as the US, will strengthen the UK’s hand during negotiations with the EU.

US Earnings – Part 2

Two weeks ago, we wrote about the third quarter corporate earnings season underway now in the US. So far almost 90% of the companies in the S&P 500 have released their results and, out of the companies who have reported, 67% have surpassed expectations.

In the table below we can see that the US is second only to Japan in terms of companies that are performing better than forecast.

Percentage of Companies that Surpassed Expectations

Source: Bloomberg, data as of 09/11/2017

The factors that have contributed most to the earnings surprise emanate from technology companies and the effects from currency. For example, the technology sector makes up over 24.6% of the S&P 500 Index with 72% of companies surpassing expectations.

The weakening of the dollar has also benefitted export orientated companies in the S&P 500. The US dollar fell by 2.7% in the previous quarter against a basket of major world currencies. and it was noticable that these companies with a majority of sales outside the US grew profits by an average of 16.7%, whereas those companies with a more domestic customer base averaged profits growth of only 5.5%. Dollar weakness also benefited US companies supplying commodities priced in US dollars stimulating demand from buyers which in turn drives up prices.

Higher profit is a positive sign that consumers are happy to spend more money on goods and services. This is happening despite interest rate rises in the US. A rise in profits also allows businesses to reinvest in growth related projects, pay higher wages and promote confidence which helps stimulate economic growth. With the US being the largest economy in the world, it has the capacity to exert considerable influence globally.

Finally, when we look at earnings growth forecasts not just in the US but also in Europe and the UK we see a bright picture emerging. If the economic indicators remain strong, 2018 will be another positive year corporate profits.

Earnings Growth and Forecast

Source: Bloomberg, data as of 09/11/2017

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