Sector rotations and counter trends in currencies

Here are the key questions for markets and investors as the final trading week of the quarter looms.

Can sector rotations drive equity markets higher?

So far this month, US equity investors have been bargain hunters. Some of the most prominent laggards this year, such as energy shares, have assumed a leadership role. Financials have also found buyers, while the high-flying tech sector — including biotechs — has experienced a loss of altitude, with Apple’s share price having just suffered its worst week in 17 months.

Reflecting renewed hopes of US fiscal stimulus, the rotation has also embraced small-caps, while Dow Transports have picked up the pace this month, although that barometer still lags behind the Dow Industrials for the current quarter. All of which has been enough to drive the S&P 500 further into record territory.

A rotation towards energy and autos this month has driven European markets, with investors expecting Angela Merkel to gain a fourth term as chancellor after Germany on Sunday goes to the polls. That has some looking at whether eurozone markets will benefit from Germany, and whether France will inject new life into the eurozone project. President Emmanuel Macron pushed through high-profile labour law changes in France on Friday, designed to bolster the economy.

Others caution that earnings and the performance of the euro hold the key for whether eurozone shares can manage another significant run higher before the end of the year.

A notable outlier in performance terms this month has been UK equities, with the main FTSE benchmarks sitting in negative territory. With the pound at its highest level since the vote for Brexit in June 2016, pressure on UK blue-chips with foreign based revenues, has duly registered. Still, of all the bargains out there, UK shares may have more room to prosper as the economy shows signs of resilience.

Guy Monson, chief investment officer at Sarasin & Partners estimates that UK shares are 10 per cent to 15 per cent undervalued against their foreign rivals and at some stage we may well see a positive re-rating of UK assets.

Another central banking symposium?

Twenty years after the Bank of England gained its independence, the old lady is holding a two-day gathering of papers and panel discussions: Independence 20 Years On. Mark Carney, BoE governor, and Mario Draghi, president of the European Central Bank, close proceedings on Friday afternoon — investors will monitor the tempo.

TD Securities notes that after the ECB’s confab in Sintra in June marked a hawkish turn, “markets may be looking for the same with this gathering, as global growth has continued to improve”.

Is there dollar upside versus the euro?

Strong eurozone data at the end of last week briefly pushed the single currency back above $1.20 and erased the dollar’s rebound after the US Federal Reserve signalled policy tightening and a smaller balance sheet beckon.

It appears that the combination of a stronger euro economy and political stability more than offsets efforts by the Fed in reducing its liquidity punchbowl for the foreign exchange market.

Not so fast, cautions Bank of America Merrill Lynch, which thinks there is scope for a US reflation trade before the end of the year as “some form of tax deal is likely”.

That does not bode well for US bond yields, and while a firmer dollar would hit emerging markets, the case for owning shares in Europe and Japan brighten as the euro and yen weaken.

Where next for the pound?

UK prime minister Theresa May has spoken on Brexit and investors will wait to see whether negotiations gather pace ahead of a planned EU summit in October.

The pound was briefly rattled during Mrs May’s speech in Florence, and after a rebound experienced another bout of selling in late New York trading after Moody’s downgraded the UK’s sovereign credit rating due to uncertainty over its exit from the EU. That left the currency at $1.35 to the dollar and about 88.5p versus the euro. The pound has now made two failed tilts at a rise beyond $1.36 and a break below 88p in the past week.

For the currency market the question is whether interest rate expectations can remain the main driver of sterling. That suggests a serious tilt at $1.36 and 88p, says Neil Mellor at BNY Mellon, although he adds: “We suspect the market may require a little more than an assertive Bank of England”.

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