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Flagstone Weekly Update - 27 November 2018

27th November 2018


Goldman advises equity investors to increase their cash holdings

Goldman Sachs has predicted that cash will continue to increase in importance as an asset class. In its report, forecasting the upcoming year ahead, Goldman advised that mixed-asset investors should increase their cash reserves, while maintaining equity exposure.

The S&P 500 and Dow Jones are currently both 1% lower than at the beginning of 2018, after losing the ground they had made due to a 7% drop in oil prices. A decline in demand for Apple products and a fall in users of Amazon contributed to the Nasdaq dropping 1.7%. The FTSE 100 and FTSE 250 also fell slightly, as oil prices fell on the news that America would stand by Saudi Arabia amidst speculation around its involvement in the murder of journalist Jamal Khashoggi.

The Strategy report stated, “Risk is high, and the margin of safety is low because stock valuations are elevated compared with history. Cash will represent a competitive asset class to stocks for the first time in many years.”

Bank of England's Saunders sees higher rates if Brexit goes smoothly

Interest rates will potentially need to rise at a faster rate than previously expected if Britain manages a smooth exit from the European Union, according to Michael Saunders, one of the nine members of the Bank of England’s Monetary Policy Committee which sets the base rate.

In a speech in Bath on Thursday, Saunders outlined how a smooth transition would likely give a boost to the economy, which would then necessitate further rate increases. “My own hunch is that, conditioned on our Brexit assumptions, capacity pressures will probably build somewhat faster than envisaged in our latest Inflation Report projections, reinforcing upward pressure on pay growth,” he said.

Britain is due to leave the EU on the 29th March 2019, as Theresa May attempts to garner the support of the Conservative Party for the withdrawal deal that she has agreed with Brussels.

Saunders, an early supporter of raising the base rate in November last year, warned that inflation pressure from stronger economic growth could be counteracted by the anti-inflationary effects of a rise in the value of the sterling.

He was less sure about what the Bank of England would do in the event of no transition deal being agreed between Britain and the EU. “The net effect would probably be higher inflation and lower growth, and it may be hard to tell in real time whether any weakness in growth exceeds the deterioration in potential growth,” he said. “The monetary policy implications could go in either direction.”

This is in line with previous statements by Bank of England Governor Mark Carney, and other Bank officials, warning that rates would not necessarily be cut in the event of a "no-deal" Brexit shock to Britain’s economy.

Bank of England Governor backs Prime Minister’s Brexit deal

The Governor of the Bank of England Mark Carney has thrown his support behind the Brexit deal struck by Prime Minister Theresa May, arguing that leaving the EU without a deal would lead to unemployment, low pay, cause a rise in inflation and shrink the economy. He compared the potential effect of leaving without an agreement to the 1970s oil shock.

The Governor argued that the draft withdrawal agreement would give Britain time to prepare for the final Brexit deal, and would therefore be beneficial for the British economy. Speaking to lawmakers on Tuesday, Carney said; “We have emphasized from the start the importance of having some transition between the current arrangements and the ultimate arrangements. So we welcome the transition arrangements in the withdrawal agreement… and take note of the possibility of extending that transition period.”

Carney warned that the “large negative shock” to the economy that would occur if no deal was reached before the March 2019 deadline would create an “unprecedented supply shock” with few historical or international equivalents since the oil embargo by OPEC exporters caused recessions in many western economies in 1973.“ There is a reduction, all things being equal, in the supply capacity of the economy – that means lost output, it means lost jobs, it means lower wages, it means higher inflation.”

Change of publication date for the Financial Stability Report and Bank of England stress testing results

The Bank of England has announced it will bring forward publication of the results of the stress tests it conducted on the country’s largest banks, which will indicate their abilities to cope with the economic shock of a “no-deal” Brexit. The results will instead be published on Wednesday 28th November rather than 5th December, so that the Bank would be able to give an analysis of how it would cope with a “no deal” Brexit before Parliament votes on a deal.

Bringing forward the stress tests and the “Financial Stability Report” was requested by Parliament’s Treasury Committee to provide an analysis of how the draft Brexit divorce deal, “will affect the Bank’s ability to deliver its statutory remits for monetary and financial stability, including in a ‘no deal, no transition’ scenario.”

Lloyds Banking Group, Barclays, Royal Bank of Scotland, HSBC, Santander, Nationwide Building Society and Standard Chartered were all put through extreme scenarios representing anticipated conditions in the event of a no-deal Brexit. The Bank has previously warned that these would include a devalued pound, a shrinking economy and increasing inflation.

The tests were conducted last year with the same premise, which every bank passed.

Recent stress tests were recently carried out on the “big four” British banks, HSBC, Lloyds Banking Group, Royal Bank of Scotland and Barclays, by the European Banking Authority, which found that, along with 44 European banks, all four could withstand the economic shocks of Brexit.


FTSE European 350 Bank Index rose slightly by +0.7% over the last week

The FTSE European 350 Bank Index rose slightly over the week, up by +0.7% to 3,838 from 3,811 on market expectations that China and the U.S. can settle their trade differences when President Xi and President Trump meet at the upcoming G20 summit.

ITRAXX Europe Senior Financials 5-year CDS Index deteriorates by +4.6% over the last week

The ITRAXX Europe Senior Financials 5-year CDS Index spread (series 30) rose by +4.6% over the week, to a more expensive 104.5bps from 99.9bps, in reaction to the disappointing IHS Markit’s Flash Composite Purchasing Managers’ Index (PMI) for eurozone business growth which was much weaker than expected in November.

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