Staring into the abyss

Staring into the abyss - Alpha Bites by Alpha Portfolio Management
The Cretaceous period extinction event caused by an asteroid strike, in what is now the Gulf of Mexico some 65 million years ago, wiped out most of the dinosaurs. This is perhaps the most well- known mass extinction event but there are believed to have been five mass extinction events in earth’s history. The Permian mass extinction event caused by volcanic activity some 248 million years ago was perhaps the worse and is known as the ‘Great Dying’ as a staggering 96% of earth’s species died out.

Fast forward to today and could there be an internet driven extinction event? The former head of US company Cisco Systems, the largest networking company in the world, predicted that new ‘internet based’ business models could kill about 40% of existing businesses, over a 10-year period. This prompted him to say ‘do not underestimate your competitor of the future-not your competitor of the past’.

For example, think about this. Uber has already transformed the taxi industry but doesn’t own any taxis, Airbnb has done the same with city accommodation but doesn’t own any hotels and now Apple and Google are developing driverless cars but don’t actually manufacture vehicles.

Many internet businesses did not even exist a few years ago and some have grown into global household names and have displaced many traditional business models. We are constantly reviewing new technologies for investment opportunities but likewise are always reviewing the competitive threat to our investments from new internet players.

In evolutionary terms, when I look at investment opportunities I always try to remind myself that it paid to be a crocodile rather than a T-Rex.

What have we been watching?

Sterling felt like it was facing extinction last week. So far this year, it ranks 142nd out of 148 currencies monitored by relative performance against the US Dollar, just ahead of Sierra Leone, Nigeria, Angola and Mozambique! The Bank of England released data showing that Sterling’s effective value, against a trade-weighted basket of currencies, had slumped to a 168 year low and the lowest level on record!

UK investment news - sterling
What does the fall in Sterling actually mean for UK households? Well, given most of the things we consume in the UK tend to be imported, expect prices to start rising, with petrol being the most obvious example. In a further development, Tesco pulled some of Unilever’s brands such as Marmite and Ben & Jerry’s ice cream from sale after a disagreement over who should bear the cost increase due to the fall in Sterling – the retailer or the manufacturer? This suggests that either selling prices have to rise which, is not good for the consumer and inflation or the retailer/manufacturer absorbs it which, is not good for profit margins and shareholders. This is why the shares in many UK consumer facing businesses have tended to lag those of exporters since the EU referendum. The Bank of England is now suggesting that inflation could sharply overshoot its 2% target over the next two years which contributed to a sell-off in UK gilts. According to one member of the Bank of England ‘the days of inflation bouncing around zero are gone’. Markets will now be watching inflation data to be released later this week.

UK investment news
Fortunately, the UK stock market is not the UK economy and with many exporters and overseas earners, weak Sterling helped propel UK equities to new all-time highs last week even though many UK facing companies remain out-of-favour.

PM Theresa May accepted a debate on a motion from the Labour party, who have argued for a full and transparent discussion on the government’s plan to leave the EU. She promised a full and transparent Commons debate, but dismissed calls for its Brexit strategy to be approved by MPs in a vote. In a further twist, a legal challenge to the government’s right to begin the official process of Brexit without parliamentary approval is underway in the High Court with a ruling expected later today.

Sterling weakness continued to reflect market concern about the risk of ‘hard Brexit’ where the UK would no longer have full access to the EU and would default to World Trade Organisation rules for trade. This concern was also reflected in a sell-off in UK government bonds which was dubbed the ‘Great British Bond Off’. The benchmark 10-year gilt gross redemption yield which moved back above 1.1%, compared to a recent record low of 0.52%. The rise in gilt yields also reflects wider global concerns that central banks might be nearing the end of the road on further monetary stimulus in its current form, the prospect of a possible US interest rate hike before the end of the year, higher inflation expectations and the increase in oil prices. If the new Government wants to borrow more short-term to fund an increase in infrastructure spending in the Autumn statement, then this will not be helpful.

We continue to look for Brexit clues. One interesting snippet last week came from a leading UK recruitment company Page Group which, suggested that UK employment activity in IT, logistics and engineering remained good but that job availability in the financial sector is almost 15% lower. As we have suggested before, is Brexit uncertainty hitting financially focused London more than the rest of the UK? The RICS house price survey for September also underlined that London is suffering more than the UK regions post-referendum, as although the overall market saw a modest recovery in demand amongst home buyers, London prices are expected to decline over the next three months.

EU investment news
In Europe, the Financial Times reported that Deutsche Bank which, is facing a potential $14bn fine from the US Department of Justice, received special treatment from the ECB in last year’s bank stress tests. Apparently $4bn of proceeds from the sale of a stake in a Chinese lender was included in the Balance Sheet even though the disposal is still awaiting regulatory clearance. This is likely to raise more questions about the stress tests and the state of the European banking system. Elsewhere, the approval of Italy’s biggest banking merger in almost a decade marks the first step in a process of consolidation urged by regulators to address the sector’s financial stress.

US investment news
In the USA, an acrimonious TV debate between the two presidential election candidates did not produce a clear winner. However, Donald Trump suffered a major blow to his campaign with the most senior elected Republican in Washington saying he would no longer defend or campaign with him. Hilary Clinton appears to have opened up a considerable lead over Donald Trump. The final presidential TV debate is this Wednesday.

The US Fed released the minutes of its September meeting confirming that three committee members had voted to increase interest rates. Several members saw a rate rise relatively soon which would suggest that a December rate rise is still possible in December. US interest rate futures are showing a 67% chance of a 25bps hike in December. Janet Yellen Fed Chair spoke on Friday and added to the likelihood of a rate rise, suggesting that the US needs to be managed as a ‘high pressure economy’ which mighty involve stronger demand and a tighter labour market. The US quarterly results season is also underway and investors were underwhelmed by Alcoa’s results and will now be watching results from the US banking sector.

Chinese investment news
China released trade data that again raised questions about the strength of economic growth. Exports in September were down by 5.6% on a year ago and was the weakest outcome since February. However, more encouragingly, inflation picked up in September with producer prices up 0.1% annually, bringing an end to a period of industrial deflation that has lasted 54 months.

Commodity investment news
The price of Brent oil hit its highest level in a year of over $53 after Russia’s President Putin said he was ready to join a crude oil production freeze being negotiated by members of OPEC. Despite the supportive noises from OPEC on possible production cuts, during September OPEC output hit a record high as did oil inventories. The oil price retreated slightly on this news.

Finally, talking of T-Rex. Most of my younger colleagues in the office think I am a bit of a dinosaur as I seem to have been around a for a very long time.

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