Italian Referendum
On Sunday 4th of December, a constitutional referendum will be held in Italy. The referendum sponsored by pro-EU Prime Minister Matteo Renzi is over the introduction of major reforms to the country’s notoriously slow and costly government. Currently, Italy has a bicameral system, meaning its two chambers have the same powers as each other which often lead to political gridlocks. The policy changes are being criticised as more power would be given to the office of the Prime Minister. For many this reawakens concerns about concentration of power that still haunts Italy long into in its post war era.
If the referendum fails, Renzi has promised to resign. In doing so, many believe this could make way for the Eurosceptic Five Star Movement (MS5) to gain power. This will not happen straight away as an interim appointment is likely until full elections occur in 2018. If MS5 does get into office it will do so on the back of a pledge to call another referendum – this time on leaving the Euro. This will cause upset to markets and will be exploited by many professional investors who are looking to invest in good companies in Europe with decent long term prospects.
OPEC
On Wednesday, OPEC clinched a deal to curtail oil supply, its first limit on oil output since 2008. OPEC, pumps a third of the world’s oil and benchmark Brent crude oil immediately responded, rising 8% to just over $50.
The announcement from OPEC will be a welcome respite for oil companies and US shale oil drillers (and banks extending loans to the oil industry). The industry itself collectively made a $1.2 trillion loss last year forcing companies to cut jobs, reduce capital expenditure and increase debt levels. The financial impact of a rise in oil prices has been quantified by BP, one of the UK’s leading oil producers; for every dollar increase in oil prices, BP will see a $300 million boost to the company’s annual adjusted profit. Oil price shifts transfer wealth between oil producing countries and companies and non-oil producing countries and consumers. This evolving situation is monitored closely by our fund manager partners.
We conclude with an observation that previous OPEC production accords have been characterised by large scale cheating; higher oil prices lead to new marginal supply by producers not tied to OPEC. In other words, non OPEC producers are the main beneficiaries from OPEC production restraint and this will likely to lead to consternation amongst OPEC members further down the line. A secure underpinning to oil prices is generally found from rising economic growth globally rather than supply side constraints.
Brent Crude Oil Price ($ per barrel)
Source: Bloomberg, 2 December 2016
US Growth
Third Quarter US gross domestic product (GDP) indicated growth of 3.2%. This represents a broad measure of the goods and services produced across the economy and is the highest growth rate in two years. Consumer spending, exports and investment in structures all rose faster than anticipated but the President Elect Trump has indicated that a growth figure of at least 5% is needed. While this is good for inflation linked assets like gold, pro-cyclical businesses and even banks, it indicates why nervousness around bond yields has grown since the election. It is something our managers have been pondering for the last few months and explains why they have been lowering portfolio bond duration (sensitivity to interest rate rises).
US 30 Year Bond Yield
Source: Bloomberg, 2 December 2016
Unemployment for November has fallen to 4.6%, a nine-year low in a back of lower participation rate. With unemployment hovering around 5% for more than a year and US inflation appearing to firm, the US Federal Reserve is widely expected to raise interest rates (forecast indicators running at 100%) at its December meeting taking place on the 13th-14th, barring unexpected developments in economic data or the financial markets. The central bank has held its benchmark federal-funds rate at a range of 0.25% to 0.50% since December 2015.
Strengthening Pound
Sterling has continued to attract support since falling sharply after Brexit. David Davis, Brexit Secretary said this week that the UK would consider making contributions to the EU in order to retain access the single market. Davis is the first senior official to acknowledge the possibility of the UK having access to the single market – even if it means the UK adopting a “Pay-to-Play” approach.
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