Monday Espresso Podcast 30th May 2022

[00:00:00] Sheldon MacDonald: It's the 30th of May after a couple of difficult weeks, it seems like it's been a long time since we've been able to report some decent news. Last week was a pretty positive week for markets. Firstly, let's speak to Raj. What's going on in the UK side, Raj?

[00:00:14] Raj Manon: In the UK, the chancellor of the Exchequer announced a 25% windfall tax on energy companies and that's to help fund support for the cost of living crisis.

[00:00:26] Raj Manon: The tax is expected to raise £5 billion pounds and is expected to be in place in the short term. The announcement also included an 80% new investment allowance, and that means energy companies can reduce the amount they pay if they commit to fresh capital expenditure. Now regarding big oil, such as BP and Shell, the tax will only apply to profit generated in the UK and the bulk of companies such as BP and Shell's earnings comes from overseas operations.

[00:00:58] Raj Manon: The risks to the north sea oil and gas industry is that international companies like BP and Shell might see the UK as less attractive following this type of announcement. Now this type of windfall tax introduces uncertainty and the market does not like uncertainty, not only to the energy sector, but also to other sectors. Which area might the government target next, perhaps, power generators or minors or consumer goods firms.

[00:01:26] Sheldon MacDonald: It's a concern there, I guess, around the precedence analysts will be wondering, what does it mean for profits? How can we forecast profits going forward? So as you say, the uncertainty there.

[00:01:35] Sheldon MacDonald: On the other hand, though, it does put some money back into the pockets of hard pressed consumers, which obviously are the driving force in the economy, certainly in the local economy.

[00:01:44] Sheldon MacDonald: On that front, we saw the PMI numbers released last week.

[00:01:48] Raj Manon: Yes, and those numbers dropped by 6.4 points to 51.8 and that was below consensus expectations. And now that decline was the fourth largest on record and worryingly was mainly driven by the services, PMI. Services being one of the largest areas of the UK economy.

[00:02:07] Sheldon MacDonald: So not a great picture in that it's declined. On the other hand though, at least that number above the 50 level, which indicates contraction, so 51.8 is still indicating a positive picture, a growing economy. So perhaps the fears of recession not yet playing out in the data.

[00:02:24] Sheldon MacDonald: Speaking of recession and fears of that, let's go across to the US side.

[00:02:27] Sheldon MacDonald: Nathan, what are we seeing on that front?

[00:02:29] Nathan Sweeney: So, yeah, we had an exceptional week for US equities last week. The S&P, and this is in dollar terms, was up 6.62%. The NASDAQ was up 7.15%. We had some really strong returns from energy. It was up 8.2% Tech was up 8.1%, Consumer Discretionary 9.3%. And actually even the worst performing sector on the week was up. So Healthcare was up 3.3%.

[00:02:52] Nathan Sweeney: So some really big moves across the week in the US.

[00:02:55] Sheldon MacDonald: Big news, certainly big moves. The news really guided by the Fed last week.

[00:03:00] Nathan Sweeney: There were a couple of things driving markets last week, and one of them was definitely the Fed.

[00:03:04] Nathan Sweeney: We all know that the Fed has been talking about raising interest rates.

[00:03:08] Nathan Sweeney: They released minutes last week from one of their meetings, and yes, they're looking to continue to raise rates at the next two meetings, they want to raise rates by half a percentage point but after that, they want to be flexible.

[00:03:21] Nathan Sweeney: So what you're really seeing here is they're acknowledging that some of the data's coming in, it's a bit better than expected as a result of that, they think we won't have to increase interest rates.

[00:03:31] Sheldon MacDonald: So that, as we mentioned earlier, that perhaps the fears of a recession created by a policy error by the Fed and other central banks, maybe those fears easing, maybe the worst fears won't quite be realized, and we also had an inflation reading, that was pretty good.

[00:03:46] Nathan Sweeney: Yeah, and I think this was one of the reasons why you saw an extension of that rally towards the end of the week, because not only did you have the Fed confirming, actually we're going to be flexible.

[00:03:55] Nathan Sweeney: The whole reason they want to be flexible is because inflation data looks like it has peaked. So the Fed look at a measure of inflation called the Core Personal Consumption Expenditure Index, and they look at this to gauge where inflation is going.

[00:04:12] Nathan Sweeney: So this data reading came out towards the end of the week, and it's now shown two consecutive months of decline. So the question of, is lower inflation a trend or not, or is it something that's going to persist?

[00:04:24] Nathan Sweeney: So I expect, you know, the Fed obviously has sight on some of this data. Hence why the minutes we're talking about the fact that they could be flexible around interest rates because inflation is moving lower.

[00:04:36] Nathan Sweeney: So if we see this trend persist, this will be very good for equity markets, as it will mean less interest rate rises, therefore higher profits, less chance for recession.

[00:04:47] Sheldon MacDonald: One of the areas that had been driving inflationary fears was China, with the lockdown issues there driving a view that, supply concerns, pushing a view for inflation higher for longer. But we did see some good news on that front last week in Shinjin, which is one of the manufacturing hubs, full manufacturing will open up again from this week or next week.

[00:05:06] Sheldon MacDonald: So perhaps again, the inflation fears, not quite as bad as we'd forecast. Wrapping it up a volatile week. Volatility has been high. Remember that volatility works in both directions. So we'd seen the weakness for a couple of weeks. Last week was a pretty positive week. We do expect this volatility to continue as Raj indicated, there's still a lot of uncertainty around a lot of moving parts. A lot of things changing very quickly, a lot of players reacting to, to moves as we see them.

[00:05:34] Sheldon MacDonald: So as always in volatile times, we always say, stay diversified and stay invested. This is a shortened week this week. So next week UK markets will be playing catch up.

[00:05:44] Sheldon MacDonald: So again, scope for further volatility next week. We look forward to speaking to you then. Thank you.

[00:05:50] Nathan Sweeney: Thank you.