MarketMinder Europe 

MarketMinder Europe

MarketMinder Europe provides our perspective on current issues in financial markets, investing and economics. Our goal is to analyse key topics in an entertaining and easy to understand manner, helping you see the news of the day in a unique perspective.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.


Don’t Put Too Much Stock in Monetary Policy Institutions’ Forecasts

Will the European Central Bank (ECB) raise interest rates sooner than expected? That is a question several financial publications we follow asked after Financial Times reported the ECB anticipates hitting its 2% year-over-year inflation target by 2025 based on internal, unpublished research.[i] We have seen some market observers speculate that if this projection lands true, that would fulfill the ECB’s purported conditions for considering raising interest rates—which could mean the ECB hikes rates as soon as 2023’s close. Whilst that timeframe may sound distant relative to the present, we have seen analysts argue it is much earlier than most experts anticipate, sending some scampering to recalibrate their outlooks. However, we caution investors against putting too much stock into monetary officials’ forecasts—they aren’t blueprints for future monetary policy, in our view.

We have seen a broad mix of responses to the revelation of the ECB’s internal research, ranging from recommendations to refrain from concluding anything concrete to questions about the monetary policy institution’s transparency. Our takeaway is much more high-level: Monetary policy decision-making isn’t a clear-cut process. We don’t find it surprising monetary officials consider a host of information, including internal research, and the ECB’s economists are likely running through myriad scenarios and hypotheticals that could influence policymakers’ thinking. However, these additional inputs and perspectives don’t necessarily make the ECB’s forecasts extremely telling, in our view.

We can test this by reviewing their past forecasts to see how they aligned with what actually happened. Consider the Eurosystem staff’s—which comprises both the ECB and the eurozone’s national monetary policy institutions—three-year forecast of gross domestic product (GDP, a government measure of economic output) and inflation (the general rise in prices economy-wide) issued in December 2016. Their estimates for 2017 – 2019 were mixed—occasionally close and occasionally quite off. (Exhibit 1)

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How to Defend Against a Rising Tide of Ponzi Schemes, Identity Thieves and NFT Fraud

Recently, the UK’s Financial Conduct Authority reported British consumer losses due to fraudulent activity have tripled over the last few years to £570 million (at least according to official records).[i] Similarly, America’s Federal Trade Commission logged 2.3 million fraud cases in 2020, totalling $3.4 billion (£2.5 billion) in losses, up markedly from 2019.[ii] Notably, younger folks reported falling prey more often than older people (although the latter’s median loss was much higher).[iii] It seems financial ploys that make off with investors’ cash are, sadly, a recurring phenomenon. Whilst the particular techniques may change, our coverage suggests their underlying structure stays mostly the same over time, which we think you can learn to recognise. Here we run through some of the latest approaches criminals have used to abscond with people’s funds—and offer some lessons on how to protect yourself against this rising tide.

Plain-Vanilla Ponzi: Last month, the US Securities and Exchange Commission (SEC) uncovered an alleged Ponzi scheme (when earlier investors are paid out with new investor money without their knowledge) that swindled over $110 million (£81 million) from more than 400 investors in 20 states.[iv] Just as history’s largest Ponzi run by Bernie Madoff collapsed more than a decade ago, another was apparently taking off.[v] Whilst there isn’t anything particularly innovative about this investment scam, in our view, as Ponzis date back decades and regularly crop up, it suggests they remain all too prevalent despite society’s repeated opportunities to learn better.

As the SEC complaint goes, one John J. Woods hatched the vehicle for his Ponzi—Horizon Private Equity—in 2007.[vi] But what really seemed to get it rolling was in 2008, when he bought an investment advisory firm, Southport Capital, from a wealthy family and took advantage of trust and relationships there that he hadn’t built himself. Southport then began peddling Horizon, Woods’ fictitious fund, which advisers told clients would guarantee them 6% to 7% returns. The SEC alleges Woods used Horizon as “his own personal piggy bank.”[vii]

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Canadians Pick the Status Quo

Editors’ Note: Our political commentary is intentionally nonpartisan. We favour no politician nor any political party and assesses political developments for their potential economic and market impact.

Well, that was anticlimactic. Five weeks after Canadian Prime Minister Justin Trudeau dissolved Parliament and called a snap election in hopes of his Liberal Party winning an outright majority, the results are in: The Liberals remain in power, but they still have a minority government and will have to rely on help—chiefly from the leftist New Democratic Party (NDP)—to get anything done. Moreover, three of Trudeau’s cabinet ministers lost their re-election bids, and many onlookers are grousing about the indecisive campaign, potentially leaving the government with less political capital than they had going in. Most coverage we have seen dwells on the political optics and Canadians’ reported frustration with being asked to vote during the middle of the Delta variant’s surge. For equities, we think that is all sociology and beside the point—what matters for returns to an extent, in our view, is that political uncertainty has eased and gridlock within Canada’s Parliament likely persists for the foreseeable future.

Exhibit 1 shows the latest tally of the results and how they compare to the last parliament. With 98% of votes counted, the Liberals have gained just three seats in the House of Commons, whilst the Conservatives have no net change. The real losers, we guess, were independents, who had five seats in the previous Parliament and have none now. Close on their heels are Green Party leader Annamie Paul, who came in fourth in her race as her party lost support nationally, and the People’s Party of Canada—a right-leaning party started by former Conservatives frustrated with party leadership—which won zero seats.

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Putting China’s Evergrande Saga in Perspective

Editors’ Note: The following discussion covers developments involving individual companies and, as such, please note that MarketMinder doesn’t make individual security recommendations. Specific securities are solely discussed herein to help illustrate and explain our view of the potential broader impact of developments.

A holiday kept China’s equity markets closed on Monday, but that didn’t stop fears of a Chinese real estate developer potentially failing to pay interest on its debt (i.e., defaulting) from roiling sentiment globally, driving global equity markets to drop -1.1% on the day.[i] Many financial commentators we follow globally warned that China Evergrande Group, with its roughly $300 billion (£219.9 billion) in debt, faces default.[ii] Some argue this could be China’s version of Lehman Brothers’ collapse in 2008, triggering a financial crisis that would be a most unwelcome Chinese export. Whilst a default is looking likely, in our view, there are many reasons to question the theory the outcome would be so bad: Our research and study of history show China has the means, motive and opportunity to prevent big fallout; markets are likely well aware of the situation; and we doubt it presents a material global risk.

Evergrande, China’s largest property developer, began life in 1996 as the Hengda Group, headquartered in Guangzhou. The company’s chief business is residential real estate development—it claims to have nearly 2,800 projects in 310 Chinese cities (chiefly, apartments).[iii] But it isn’t limited to this. The company also has businesses engaged in electric vehicle (EV) production, healthcare and a theme park, among others. All in all, Evergrande has roughly 200,000 employees, and many more Chinese investors are likely exposed to Evergrande through its corporate debt securities and other debt investments called wealth management products (WMPs).

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The Great Electricity Shock: Manufacturing Edition

Europe’s electricity woes stayed in headlines globally Thursday and Friday, this time with the news several British factories were starting to cut back due to soaring electricity costs. Two fertiliser plants owned by a US company announced indefinite closures, steel plants revealed they were idling during peak hours, and a survey showed about two-thirds of UK factories worried about energy prices impacting their operations.[i] Analysts at one big US financial firm warned Continental Europe could face similar fallout, especially if winter is colder than usual.[ii] Several financial commentators we follow warned the associated fall in manufacturing output could jeopardise the economic recovery from lockdowns not just in the UK and Europe, but globally. In our view, this thesis falls apart when you gather a few basic facts, and we don’t view the current troubles as a major economic or equity market risk.

It does logically follow that if a factory closes fully or in part for any length of time, it will reduce output. We aren’t dismissing that or the impact on the affected businesses, workers and communities. But we think extrapolating anecdotes into widespread trouble is a well-travelled road to error, as companies can adapt in different ways. Fertiliser companies were likely the first to close outright because chemical production is one of the most electricity-intensive segments of the manufacturing industry—one US research report put it at the top of the list a few years back, responsible for just over 20% of manufacturing’s total electricity use.[iii] Iron and steel were fourth, at just over 6%.[iv] Transportation equipment, which has a heavy presence in the UK (e.g., autos and aircraft), uses a smidge less than that. Food and beverage production, also big in Britain, is much further down the list. (No word yet on how this has impacted electricity-intensive cryptocurrency mining—stay tuned for that, we guess.)

Rather than zero in on specific industries, we think it is more helpful to take a higher-level view and consider a country’s overall sensitivity to electricity costs. One way we do this is to scale manufacturing as a percentage of GDP, then compare it to services, which is overall much less energy-intensive. (GDP, or gross domestic product, is a government-produced measure of economic output.) In the UK, manufacturing was just 8.7% of GDP in 2019, which we use instead of 2020 to avoid lockdown skew.[v] Services, by contrast, was a whopping 70.9%.[vi] Not that services are immune to high electricity prices, but it generally costs a lot less to keep the lights on at a hair salon or keep the computers running at a bank than it does to keep complex automated assembly lines running.

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Behind the Jolt in Power Prices

If we were to hazard a guess about which single word best sums up UK and European consumers’ feelings right now, that word would be: Ouch. Or perhaps: Oof. Either would be an entirely logical reaction to electricity prices’ astronomical spike this month, which smacked households across Britain and the Continent. Governments across Europe are racing to try and relieve the pressure, and their efforts thus far are largely a mixed bag. Unsurprisingly, financial commentators we follow on both sides of the Atlantic warn this will drive even faster inflation, creating headaches for monetary policymakers at the Bank of England (BoE), European Central Bank (ECB) and equity market. We think it indeed fair to presume this spike will likely show up in eurozone September inflation when the preliminary report hits Friday, but we think it would be folly to extrapolate that into something bigger—or presume monetary policymakers can do anything about it. Our research shows electricity prices in Europe these days stem largely from structural and political factors, not monetary ones, and we think their impact probably is a lot milder than commentators allege.

Not that we are dismissing the pain for households and businesses, which is real. The UK, which has taken the worst of it, saw wholesale power prices hit £475 per megawatt-hour intraday on Wednesday, according to Reuters.[i] FactSet data show they settled by closing to about £415—still over 9 times their pre-pandemic average.[ii] They are lower across the Continent, but not by much, leaving politicians scrambling.[iii] Italy’s government is reportedly planning to use public funds to curb households’ energy costs, according to Bloomberg.[iv] Spain’s government announced a suite of electricity tax cuts, which we think should likely help somewhat, as well as measures to promote clean energy (which makes zero sense as a solution to the current issues, as we will discuss momentarily) and plans to cap utilities’ profits through special taxes, which we think probably do more harm than good in the long run as they dissuade investment.[v] Meanwhile, we think the UK is already proving the proverbial law of unintended consequences, as price caps enacted in 2017 have forced providers out of business—including two that fell last week as prices spiked.[vi] In general, basic economic theory holds that fewer producers mean less competition and, you guessed it, higher prices.

In our view, none of the measures announced thus far address the root cause of today’s high prices: Power supply. Whether you think this push is spot-on or not, European governments are major proponents of lower-emissions energy generation, which has generally meant switching domestic energy production from coal to renewables in recent years.

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What US Inflation Tells Us About How UK Inflation Might Trend

A record-high jump. That is how several financial commentators we follow described the “Consumer Price Inflation” report for August, which showed the the Consumer Price Index (CPI)—a broad measure of goods and services prices—rising 3.0% y/y.[i] That figure is up from 2.1% y/y in July, and as the Office for National Statistics noted, the acceleration in the inflation rate is the largest since official records begin.[ii] Many analysts and industry groups quoted in financial commentary we read warned of further price pain in store for UK consumers. It likely also creates extra work for Bank of England Governor Andrew Bailey, who is required to write a letter to the Chancellor whenever inflation veers at least one percentage point from the BoE’s 2% year-over-year target. For investors wondering how inflation might affect the outlook for shares, however, we don’t think it is necessary to parse an official communiqué—in our view, US inflation trends offer a helpful preview, as they embarked on this course several months before the UK due to the US’s earlier reopening from lockdowns.

Whilst Freedom Day in the UK of course arrived in mid-July (and even then was disrupted by the so-called Pingdemic), most US cities and states had reopened by this past spring. When they did, we think it freed consumers to unleash all the demand pent up from a year of not travelling, shopping or dining out much. At the same time, inventories of several consumer goods were running lean due to lower production during the COVID lockdowns, and many services were understaffed and overwhelmed by the initial influx.[iii] The collision of high demand and weak supply drove prices higher. America’s CPI inflation rate jumped from 1.7% y/y in February to 2.6% in March, 4.2% in April, 5.0% in May and 5.4% in June and July.[iv]

Yet rising prices in those months weren’t solely responsible for the sharp acceleration in inflation. A mathematical phenomenon called the base effect was also at work. This refers to abnormalities in the denominator (aka base) of the year-over-year inflation rate calculation—or, more simply, fluctuations in prices a year ago. In this case, it was the temporary deflation that accompanied America’s lockdowns in March, April and May 2020. This created a low comparison for prices in spring 2021—a higher numerator (prices in 2021) divided by a temporarily smaller denominator (prices in 2020) yields a faster inflation rate.

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To Size Up the Tax Hike and ‘Triple Lock’ Change, Tune Out Political Rhetoric

Editors’ Note: MarketMinder favours neither any politician nor any political party, focusing instead on the potential economic and market impact of developments.

This week, UK Prime Minister Boris Johnson triggered a flood of angst-laden headlines in financial publications we follow when he unveiled the government’s plan to hike various taxes, chiefly to support the NHS. The government also revealed plans to revise the state pension’s triple lock cost of living adjustment—a plan the government passed Wednesday evening. This move met withering criticism amongst financial headlines we reviewed—from both sides of the political aisle: Some pointed out the moves violated promises from the Tories’ 2019 election manifesto, whilst others alleged the scope of tax hikes is too small to provide the funding needed. Maybe there is truth to these points. Maybe not. Either way, for investors, we think those politicised narratives are a distraction. There are personal finance developments here to note, but overall, we think these changes are quite small relative to the rhetoric.

Taxes

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Why We Don’t Think High Valuations Signal a Dim Future

Globally, headlines we follow tout historically high valuations, measures comparing share prices to fundamental metrics like earnings or sales, as a negative allegedly frothy markets are overlooking. This is particularly true in America, where price-to-earnings (P/E) ratios show markets are at their most expensive since 2000’s dot-com bubble, supposedly foretelling poor returns.[i] Some claim this is about returns immediately ahead—and that a bear market (a typically long, fundamentally driven decline exceeding -20%) may lurk around the corner.[ii] We see others arguing it refers to lower-than-average returns over the long-run future. But to us, this implies valuations are predictive. We think history shows you otherwise, a lesson worth taking note of now.

P/Es come in various flavours depending chiefly on the earnings denominator. Some use the past 12 months’ earnings. Others include those hinging on analysts’ 12-month forward earnings estimates or the, bizarrely distorted in our view, cyclically adjusted P/E (CAPE), which employs a 10-year average of inflation-adjusted earnings. But lately, it is the first—the so-called trailing P/E—fearful headlines we read seem to tout.[iii] Using America’s S&P 500 equity index for its long history, according to data from Global Financial Data, Inc., its trailing 12-month P/E is presently hovering around 35—in the top 3% of readings since 1926.[iv] Whilst UK P/Es are far lower at 18.8, this is still high for British markets, which are value-orientated and tend to trade at lower valuations as a result.[v] Sound alarming? We don’t think so. Here is why.

For one, last year’s lockdown-skewed quarterly results are still influencing the calculation.[vi] According to our analysis, the destruction of firms’ profits last year plus the steep rally in equities—which anticipated better corporate results ahead tied to reopening—inflated P/Es massively. We think this also explains why the current level (35.3) is actually down from June’s peak (45.7)—Q2’s blockbuster earnings helped.[vii] The same holds in Britain, where P/Es touched 35.9 at 2020’s close but have retreated since, tied to earnings’ recovery.[viii] But the current trailing 12-month P/E valuation still includes depressed earnings in Q3 and Q4.[ix] Against this backdrop, we don’t think it is abnormal for valuations to seem elevated.

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The Dividend Divide

With long-term fixed interest yields down modestly from their early-2021’s not-so-high highs, chatter amongst financial commentators we follow has inevitably returned to high-dividend shares as an alternative income generator. Whilst 10-year UK gilts pay a paltry 0.63%, the MSCI World High-Dividend Yield Index boasts a 3.44% yield, spurring an avalanche of headlines like “5 High-Yield Dividend Stocks for Healthy Income” and “6 Dividend Stocks With Big Payouts and Less Risk.”[i] What better time, in our view, to explain why high-dividend shares generally aren’t the magic solution to all your investing dilemmas?

Dividends have long had the reputation as steady workhorses that churn out reliable payments whilst avoiding the brunt of the equity market’s occasional declines. If we were to hazard a guess, we would posit that this stems from days gone by, when dividend cheques came in the mail, there was no CNBC or Internet, and tracking share prices generally required a daily perusal of your newspaper’s Business section. That took deliberate effort, whereas the cheques just showed up, perhaps giving the perception of stability.

It is a quaint, comforting image—and in our view, wrong. We like dividends! But they aren’t special. They don’t add to returns. They aren’t even a return on your investment—they are a return of your investment. Every time a company pays a dividend, the exact amount in pounds is removed from the share price. The company is basically slicing off a small piece of its total value and sending it to shareholders. It can be hard to see due to market volatility, but by rule, every time a company pays a £1 dividend, the share price falls by £1.

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Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

This article reflects the opinions, viewpoints and commentary of Fisher Investments MarketMinder editorial staff, which is subject to change at any time without notice. Market Information is provided for illustrative and informational purposes only. Nothing in this article constitutes investment advice or any recommendation to buy or sell any particular security or that a particular transaction or investment strategy is suitable for any specific person.

Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.