Why supermarkets could turbo charge the FTSE and other musings...

It’s been a quiet start to the week as the US is out on holiday for Independence Day, indices are slightly lower although with thin volumes it is difficult to gauge direction for the week ahead. However, we think that there are three things to consider when making a trade this week. Firstly, the significance of the decline in the 10-year US bond yields last week, the decline in Chinese PMI data and the drop in the dollar index even though US payrolls were much stronger than expected. The importance of last week’s payrolls on price action for the rest of the month will be discussed below, but overall, the economic data is becoming more confusing to interpret in terms of where asset prices will go next. 

Why payrolls didn’t set the dollar on fire 

Looking at payrolls first, a lot has been made of the “goldilocks” effect, after the US created 850,000 jobs last month, which was well above economists’ expectations. This drove stocks to a record high last week; however, it didn’t help the US dollar, and longer-term US bond yields fell over the week. The dollar index has dropped back from its highs above 92.60 and is down approx. 50 pips on Monday. There is strong support at 91.70, the low from 22/6, which if broken could trigger a sharper decline back to 90.50. Right now, we think that the market’s desire to sell the dollar is down to the strong payrolls report being balanced by an uptick in the unemployment rate to 5.9% from 5.8%, also average hourly wage growth was slightly weaker than expected at 3.6%, the market had been looking for 3.7%. We mentioned last week that wage growth was a key component of the US labour market report for June as it would help to determine whether inflation would be sticky in the coming months. If the wage data had come in stronger than expected, at 4% plus, then we think that risk sentiment would have been impacted – stocks would have fallen, and the dollar and bond yields would have risen. As it stands, current inflation readings are not a problem for risk sentiment, thus, once the US is back from today’s Independence Day holiday, we could see a broad-based rally in US stocks, with both growth and value sectors rising simultaneously. 

How the Fed will explain its Dot Plot decision 

However, before we commit to fresh record highs for stocks and a further weakening of the dollar, we want to see the FOMC minutes from their last meeting. These will be important to glimpse the in-depth discussions from the meeting where the Fed’s dot plot of interest rate expectations pushed forward the first rate increase by a year to 2023. The questions that we would like answered from Wednesday’s FOMC minutes include: is the Fed likely to talk down inflation risks now that it is unlikely further stimulus cheques will be mailed to US taxpayers? Will the Fed talk about the “sluggish” jobs market? How much does the shift in interest rate expectations change the dovish slant at the Fed? We would hazard a guess that the minutes stick to the Fed’s dovish mantra, and play down the shift in interest rate expectations, thus leaving stocks free reign to reach further record highs in the second half of the week. Of course, a less dovish slant could cause another flattening of the yield curve and risky assets to sell off, but we see this as a lower probability event. 

Morrison’s gets a sweetener

In Europe, the UK’s FTSE 100 is leading the way after a bidding war started for UK supermarket Morrison’s. It has been the subject of an intense courting battle in recent months, last month it rejected an offer from US private equity firm Clayton, Dubilier & Rice, at the weekend the board supported a $9.5bn bid from US private equity giant Fortress, but on Monday, Apollo, another US private equity firm, said that it was going to put an offer in. The accepted deal from Fortress includes maintaining the company’s headquarters in West Yorkshire, safeguarding pensions and keeping the £10 per hour minimum wage. Thus, Apollo will have to gold plate its offer if it wants to slip past Fortress in the battle for the northern supermarket giant. However, it could be in with a chance, especially since Morrison’s share price surged on Monday, jumping 11% to 267p per share, significantly higher than the 254p per share offer by Fortress. 

Why UK companies are under-valued, and why that is good news for the FTSE 100 

Our initial thoughts regarding this deal is that it is a sign that shares in the FTSE 100 are massively undervalued, and thus are likely to become the targets of takeovers in the coming months and years, unless the FTSE indices start to pick up pace. This could be seen by some as a buy signal for the FTSE index in general as it suggests that UK assets, under-valued by stock investors, are prize assets for private equity investors and this type of takeover bid could see further upside volatility for the UK index in the coming months. Upside for Morrison’s has boosted the share prices of Sainsbury up 2.2% on Monday, Tesco up 2.5%, and Marks and Spencer up 2.9% so far on Monday. In terms of other takeover targets in the UK market, we think that M&S is ripe for a bid, especially after its tie up with Ocado, added to this BP could also see some takeover/ merger activity in the coming months, as the share price remains strong and its plan for creating a green energy blueprint for the future remains more advanced than some of its rivals; BP’s share price is up nearly 1% on Monday. Watch out for corporate news in the coming weeks, it could mean big price swings for the FTSE 100. 

Is China’s slowdown a worry? 

Elsewhere, the sharp decline in the Chinese Caixin service sector PMI index for June, which fell to 50.3 from 55.1 in May, is worth noting. This tends to be a fairly erratic index, but it does suggest that the PBOC’s clampdown on credit to ward off inflation is working, but it is also denting economic growth. Interestingly, the news had barely any impact on market sentiment, with Chinese indices closing higher for the day, and the Aussie dollar, which is positively correlated with Chinese growth, relatively flat at the start of the week. If we get a spate of bad economic data from China then the market may start to worry, but for now it is willing to brush off one stray bad reading. 

Rounding up 

As mentioned above, the most important piece of economic data will be the FOMC minutes, as we have a fairly good idea of what to expect from the second reading of most Western PMI surveys. The Brent crude oil price remains stable around $76 per barrel, after Opec + could not reach a decision on changes to production. That means that for now, the oil price remains supported and technical indicators suggest that further upside is possible in the coming weeks. Stocks could be range bound in the next couple of weeks as we wait for Q2 earnings releases to get into full swing later this month. Overall, we expect earnings reports to be stronger than economic data during the summer months, which could keep stocks propped up in the medium term.