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.

Explaining the UK’s Worst-in-the-World Q2 Contraction

UK gross domestic product (GDP, a government-produced estimate of economic output) fell -20.4% q/q in Q2, which is not only the worst contraction in the country’s history, but also the worst of the major Western nations reporting thus far.[i] That is the headline news you may have seen in your Internet travels. What lies under the surface is rather more interesting, though, in our view. Because the UK reports monthly GDP as well as quarterly, we have more granular results to show how the timing of the country’s gradual reopening affected GDP, which we think can help set expectations for what comes next. Although we think equity markets are likely looking way beyond 2020 economic data, getting a sense of how growth is occurring can help you stay cool in the face of dire headlines.

Exhibit 1 shows the scorecard of major developed nations’ Q2 GDP reports. Japan, Australia and Canada haven’t yet reported, but we think it seems unlikely any will take the dubious distinction as worst of the lot away from Britain, which was relatively more locked down during Q2 than the others. Once again, we show both quarter-over-quarter and annualised results for all countries, in order to make comparison easier. We did this because whilst European nations report quarter-over-quarter numbers primarily, the US’s flagship statistic is the annualised growth rate, which is the rate at which GDP would grow over an entire year if the quarter-over-quarter rate repeated in all four quarters. Displaying both figures makes it easier to spot trends and differences, in our view.

Exhibit 1: The Q2 GDP Scorecard

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The First Q2 GDP Reports Were Historically Awful, but Likely Not a Surprise

Q2 gross domestic product (GDP, a government-produced measure of economic output) results for the first major economies to report emerged last week, and we think it is fair to say they are rather ugly. The US, eurozone and the latter’s four largest economies notched brutal GDP declines, and we don’t think they will be the last nations to do so.[i] As these Q2 numbers hit the wires, we think it is worth remembering equities likely spent February and March reckoning with the lost economic activity that is now registering in GDP—and in our view, markets are now looking far, far beyond what happened between April and June.

Exhibit 1 shows Q1 and Q2 results for the nations reporting thus far. We included quarter-over-quarter figures (the percentage change between the reported quarter and previous quarter) as well as annualised figures (the rate at which GDP would grow or contract over a full year if the reported quarter’s growth rate persisted for four quarters) in order to make comparison between the US and eurozone nations easier. This is because America reports annualised growth, whilst European nations use the quarter-over-quarter numbers.

Exhibit 1: US and Eurozone GDP Results

Source: FactSet, as of 31/7/2020. German GDP growth rate converted from quarter-over-quarter to annualised.

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Unpacking the EU’s New COVID Fiscal Response

Well that was fast. It took just one summit and five days for EU leaders to settle various disagreements and agree on a €1.8 trillion (£1.18 trillion) budget, including €750 billion (£699.9 billion) in grants and low-cost loans for countries needing assistance with the recovery from COVID lockdowns’ economic fallout. If this plan receives national parliaments’ approval, funding for that assistance will come from sovereign debt issued by the European Commission (EC), and repayment would be a line item in the EC’s budget for the next 38 years.[i] As for the new spending money, troubled countries would receive it gradually in 2021, 2022 and 2023. Accordingly, many of the financial commentators we follow warn that the assistance is too little, too late. In our view, this is just one more example of a phenomenon we call the Pessimism of Disbelief—the perpetual search for bad news that our research shows accompanies new bull markets (prolonged periods of generally rising equity markets). As we will discuss further below, our research suggests Europe doesn’t need some massive fiscal stimulus (meaning, government spending and investment intended to spur economic activity) or other quasi-governmental crutch to recover from the recession (lengthy period of declining economic output) that began in Q1 2020.[ii] We think continuing the process of easing lockdowns and reopening businesses, no matter how gradually, should suffice. With expectations still so dreary, we suspect it shouldn’t take much for results to positively surprise.

One big talking point we have seen that isn’t so relevant for markets, in our view, is whether the new bonds would qualify as collectively issued EU debt—or so-called eurobonds. In our view, they woudn’t—an assessment most financial commentators we follow seemingly share. They wouldn’t be issued, serviced and guaranteed jointly by EU states. Rather, the issuer is a supranational organisation—a quasi-governmental institution—with its own budget. Funding for that budget comes from EU nations, with each paying a share relative to its size. So these sovereign debt securities wouldn’t really a statement of collective creditworthiness, and they wouldn’t replace member-states’ national debt. In other words, this plan doesn’t aim to turn the EU into a federalised fiscal transfer union like the US or the UK, in which tax revenues and debt proceeds are collected at the national level and permanently transferred to states or constituent countries without obligation of repayment. Whether or not this is beneficial is a long-term academic issue that many have debated for years, not anything for markets to deal with in the here and now, in our view. This deal simply means that academic debate can continue. How enjoyable.

As for the more immediate implications, on the one hand, based on our review of financial news coverage, it does seem to shore up sentiment toward Spanish and Italian debt. Every euro in help these nations get from the European Commission is a euro they don’t have to borrow on open markets, which seems to be easing popular concern that either will encounter funding issues and default. Mind you, we always thought that possibility was exceedingly remote, considering their low long-term sovereign yields and reasonable debt service costs.[iii] But to the extent the assistance eases these fears, so much the better.

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The UK’s Limited Reopening Limited May GDP

The UK released monthly GDP results (gross domestic product, a government-produced estimate of economic growth) for May on Tuesday, giving the first official look at how the broader British economy benefitted from the gradual reopening that began in the month. The results—1.8% month-over-month growth—missed forecasters’ expectations for 5.5%.[i] In our review of financial media, the common reaction was disappointment and worry that renewed lockdowns will derail an already feeble recovery.[ii] Our perspective is rather different. For one, given this unprecedented situation, analysts’ expectations were always guesswork. In the US, for example, financial outlets and government and private research outfits alike have hugely varying expectations for Q2 GDP that range from -5% annualised to -67%.[iii] (Annualised refers to the effective annual growth rate if the quarter-over-quarter rate repeated for an entire year.) Two, upon closer review of the details underlying the headline results, we think modest GDP growth seems consistent with May’s limited reopening.

As in other countries, the UK’s reopening wasn’t universal or all at once. England has reopened more quickly than Scotland, Wales and Northern Ireland. But even within England, May’s reopenings largely covered factories and offices. Amongst retailers, only garden centres reopened in May, and that happened mid-month. All other non-essential retailers didn’t get the green light until mid-June, and most personal services and restaurants weren’t allowed to reopen until early July. Some, namely estheticians and other beauty providers, still aren’t open. Considering UK GDP is about 80% services, a material recovery was always likely to depend on a more complete High Street reopening.[iv]

GDP’s categorical breakdown demonstrates this, in our view. The heavy industry component, which includes manufacturing and mining (primarily oil drilling), grew 6.0% m/m.[v] Looking at heavy industry’s subsectors, manufacturing output jumped 8.4%, whilst mining notched a 5.0% rise.[vi] That meshes well with factories’ May reopening. But services grew just 0.9% m/m, which is more stabilisation at a low level than actual growth, in our view.[vii] It is also what we would expect given the very limited scope of reopened businesses. Even those who returned to office life had very limited options to shop or dine out after hours.

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A May Retail Sales Roundup

A trio of retail sales reports from Britain and two big Commonwealth countries—Australia and Canada—all show a lockdown-driven plunge in April followed by a sharp May rebound as virus-related restrictions started to lift. In our view, their experience contradicts worries we have encountered in financial media of a prolonged spending slump delaying an economic recovery and illustrates the big difference economic reopenings can make.

First, the numbers:

Exhibit 1: Month-Over-Month % Change in UK, Australia and Canada Retail Sales

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How We Think Long-Term Growth Investors Should Consider the Coulds

Financial news headlines have run the gamut lately, but we have encountered many that share a commonality: the operative verb is could. Some are good coulds. Some are frightening coulds. We suspect even the most careful critical thinker could have a hard time sifting through the flotsam and jetsam to determine what is most meaningful for equities. An easy place to start, in our view: Our research finds that over the medium to longer term, markets generally move most on probabilities, not possibilities. The word could grammatically puts a theory squarely in possibility-land. Just because something could happen doesn’t mean it is likely to happen.

The array of possibilities we have seen thrown around over the past several days is dizzying. Among the many we have encountered in the financial news sites we review regularly? The IMF and others warned COVID-19 could reduce living standards indefinitely, with social distancing required until there is a vaccine—potentially years away. Some speculate humans could never get lasting immunity from COVID, or the disease could circulate near-permanently, crippling the world economy indefinitely. Others argue fear of infection could keep people in self-induced lockdown even when governments let more businesses reopen. Or reopening could happen too gradually to enable an economic recovery. The ongoing civil unrest throughout America and Europe has prompted many to speculate that these impromptu mass gatherings could be the catalyst for a COVID second wave—and another round of lockdowns globally. Even under a rosier scenario, where businesses reopen quickly, some warn prolonged mass unemployment could permanently alter people’s shopping habits. We have seen many a headline warning a lack of international travel could kill airlines and tourism-reliant economies. Elsewhere in the reopening is no elixir category, we hear millions of small businesses could close permanently, cementing an L-shaped recovery. Or a wave of bankruptcies could slow the recovery and wreck corporate debt markets. Last but not least, we see at least one headline daily warning the economic damage could last for years without additional financial assistance from governments.

To be fair, we have also seen some positive coulds. With pharmaceutical researchers fast at work, some suggest we could have a working vaccine by autumn. Even if that doesn’t happen, some medical researchers think COVID could fade away like SARS (also a coronavirus) did and never return—a prominent British virologist made this very argument in a Telegraph op-ed published at the beginning of June, explaining why models based on the 1918 influenza outbreak’s second wave may not be the most scientifically sound. He isn’t the only one claiming COVID could fail to resurge with a properly executed reopening. In various interviews we have read, multiple researchers claim the fatality rate could wind up being very low.

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The UK’s Post-Brexit Plan Undercuts Protectionism Fears

Late last month the UK announced its post-Brexit trade policy, shedding more light on one of financial commentators longest-running concerns about the UK economy and equity markets: a no-deal Brexit. Based on our assessment, as we will discuss below, whether or not the UK is able to sign a free-trade deal with the EU, the country looks open for business, not a protectionist nightmare.

On the international trade front, the government unveiled a tariff regime—the UK Global Tariff (UKGT)—that shows what a Brexit on World Trade Organization (WTO) terms would look like. As an EU member, the UK had to apply the tariffs (taxes on imported goods) the EU set for the bloc’s trade with the rest of the world. Once the Brexit transition period expires at year end (provided it isn’t delayed), the UK will be able to set its own tariffs, following the guidelines that accompany its most-favoured-nation status at the WTO. These tariffs will apply to all nations the UK doesn’t have a separate free-trade agreement with.

The result, contrary to what many financial commentators we follow anticipated, is broadly freer trade with simpler terms than the EU’s. The plan eliminates all so-called nuisance tariffs, meaning all those presently set at 2% or lower, and reduces most others. It also reduces the percentage of imported products subject to tariffs from 53% to 40%.[i] In value terms, 60% of imports will be tariff-free.[ii] But there are still carve-outs to “protect” pet industries. For instance, the plan cuts tariffs on car parts and other strategic manufacturers’ components, but levies will apply to competing final goods—such as assembled cars, as well as agricultural and fishing products.

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On the EU’s Allegedly Landmark Budget

As May ticked to a close, the EU announced a coronavirus relief proposal including debt issued jointly by member-states—an expansion of the one France and Germany mooted earlier in the month—as part of its €1.85 trillion 2021 – 2027 budget. Many financial commentators we follow treated it as a watershed moment. But in our view, this reaction looks overstated and hasty. Based on how big issues like this normally go in the EU, the budget likely faces a long, uncertain road to passage, with a lot of compromise along the way. Moreover, it doesn’t look much like stimulus to us—and we don’t think its passage or rejection should materially affect the pace of Europe’s economic recovery or the length of the bear market (long, fundamentally driven equity market decline of -20% or worse).

The budget’s key plank—and the piece that drew so many headlines—is a proposed €500 billion in grants and €250 billion in loans for EU member-state governments. The grants and loans would target those nations (especially Italy and Spain) with less-sound finances and larger COVID outbreaks than many northern European countries. The apparent goal is that, by easing perceived fiscal pressure, they would bolster and encourage national coronavirus response efforts.

The purportedly groundbreaking part is the financing. Funding for the EU’s budget currently comes from member-states’ required contributions, import duties and a portion of each member’s value-added tax. Initially, funding for this far more expansive budget would come from €750 billion in debt issued by EU member-states as a collective entity, which has never happened before. To pay off this debt down the road, the EU would also levy a raft of new taxes. These include a tax on companies the EU classifies as significant beneficiaries of access to the EU single market—most likely multinational companies based outside the EU; a digital transactions tax on companies with a “significant digital presence,” in the event ongoing OECD efforts to develop a global digital tax fall short; and a “carbon border adjustment tax” on imports from countries with less strict emissions controls than the EU.[i]

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Did the EU Just Agree to Collectivised Debt?

For several weeks, France and several southern European nations have argued the only way to fund the EU’s fiscal response to COVID-19 without sending Italy and others into a debt crisis is to issue so-called coronabonds—joint debt issued by all 27 EU member-states as a singular entity. Germany, Austria, the Netherlands and most of northern Europe have long opposed this concept, frequently portraying it as a wealth transfer from fiscally responsible to spendthrift nations. But on Monday, German Chancellor Angela Merkel and French President Emmanuel Macron announced their joint support for a €500 billion coronabond issuance, which European markets appeared to welcome by rallying almost 5%.[i] But the enthusiasm seemed short-lived, as the deal’s many caveats and a raft of opposition emerged on Tuesday. The debate probably won’t resolve soon, and even if the deal goes through, the proceeds won’t be an immediate benefit, in our view. Regardless of the outcome, however, we think an EU economic recovery likely doesn’t hinge on coronabonds.

Though the name “coronabonds” is new, the concept of pooled EU or eurozone debt isn’t. Member-states considered the concept but rejected it when the euro was born, preferring to have a monetary union without a fiscal transfer union—a unique arrangement. Most areas that share a currency and monetary policy also share fiscal policy (e.g., government spending, taxation and federal debt issuance), including transfers from wealthier regional governments to weaker ones. That is how it works in the UK, which redistributes revenue from England to Wales, Scotland and Northern Ireland. Similarly, the US redistributes tax revenue and government debt proceeds across all 50 states. The EU, by contrast, has always had a limited budget funded by pre-set contributions from member-states, and that budget is mostly for operational and development purposes, not transferring funds to national budgets. Some eurozone member-states sought to change that during the 2011 – 2013 sovereign debt crisis, but opposition from several northern European nations prevented it from moving forward. Asking their voters to underwrite what many constituents viewed as irresponsible spending on the periphery didn’t appear politically viable.

When COVID-19 hit Italy and Spain hard both medically and economically, that heightened calls amongst financial commentators and national leaders for a fast, huge fiscal response. But with Italy’s debt finishing 2019 at 135% of gross domestic product (GDP, a government-produced measure of economic output) and Spain’s at 96%, many financial commentators we follow presume neither has the bandwidth to borrow a few hundred billion extra euros this year without causing a new debt crisis that could risk splintering the eurozone.[ii] It seems the tragedy of COVID was enough to convince Merkel she could present this to voters as a sacrifice necessitated by events out of everyone’s control, rather than a bailout of profligate spenders.

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Rounding Up Major Global GDP Figures for Q1

Japan reported Q1 gross domestic product (GDP, a government-produced estimate of economic output) on Monday, rounding out the preliminary results of COVID-19’s impact on major developed economies. As most financial commentators we follow anticipated, the Land of the Rising Sun joined Germany, France and Italy in recession (defined commonly as two consecutive quarters of falling GDP). At this juncture, investors might rationally seek to compare different nations’ results in search of insight, but national statistics agencies’ various reporting preferences may make doing so difficult. Hence, we have done the math to bring everything in line and show our analysis of what the results do—and don’t—mean for equities.

Under more typical circumstances, based on our long-running observation of economic reporting, the variance amongst countries’ GDP growth rates wouldn’t get a ton of scrutiny—just a quick Country A is growing faster than Country B. But in the COVID-19 era, financial commentators seem extremely motivated to calculate how the virus and the related stay-at-home orders are affecting the global economy, particularly with countries’ lockdowns (and re-openings) on differing timetables. Just looking at news coverage or national statistics bulletins probably won’t give you sufficient information, however, because countries use different reporting methods. The UK, eurozone and most of its member-states focus on year-over-year or quarter-over-quarter results. The former is the percentage change between GDP in a given quarter versus the same quarter in the prior year. The latter is the percentage between GDP in a given quarter and the preceding, usually with seasonal adjustments (meaning, extra calculations to account for holidays, weather and other recurring seasonal variables). The US and Japan report GDP growth at seasonally adjusted annualised rates, which is what you get if you extend the quarterly growth rate over a full year. So to enable a comparison, we made Exhibit 1, which displays seven major nations’ (plus the eurozone’s) annualised GDP growth rates over the past three quarters.

Exhibit 1: Annualised GDP Growth Rates

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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.