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.


Brexit Grinds on, but the UK Economy Grinds Higher

Whilst many people see the summer as the “doldrums”—an idle period featuring beaches, heat waves, umbrella drinks and air conditioning—this summer is off to quite a newsy start. Last week was no exception, and we aren’t just talking about the Three Lions’ heartbreak against Croatia or Serena Williams’ astounding run at the All England Lawn Tennis and Croquet Club. Here is our attempt to round up some biggies—the cabinet resignations, Brexit back-and-forth and some cheery economic data.

Checking in on Chequers

After 6 July’s all-hands cabinet meeting at Chequers yielded an agreement on an alleged “soft Brexit,” the following week brought lots more political news. Foreign Minister Boris Johnson and Brexit Minister David Davis (along with a handful of junior ministers) can now add the word “former” to their titles, as both resigned in protest. The now-former ministers favoured a sharper break with the EU, with Johnson colourfully calling the plan, “a polished turd.” We think this highlights the continued and persistent divide among May’s Conservative Party on the issue, which likely adds to Britain’s extremely gridlocked government.

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North Korea Is Probably a Long Way From ‘Land of Opportunity’

US President Donald Trump and North Korean Supreme Leader Kim Jong-un apparently had a modestly successful discussion at last week’s summit, pledging “joint efforts to build a lasting and stable peace regime on the Korean peninsula” and making symbolic gestures to denuclearization and pressing pause on US/South Korean “war games.” Whilst foreign policy wonks, Twitter and body language experts immediately dissected the proceedings and statement, some media commentary began salivating over the prospect of a newly open North Korean economy, full of natural resources and development opportunities to exploit. Some investors have apparently already based trades on this thesis, sending some South Korean Industrials firms’ share prices sky-high this year in anticipation of their winning North Korean contracts.[i] However, we would implore readers to cool their jets: Investing isn’t a get-rich-quick scheme. North Korea may eventually open up and yield actual investing opportunities, but this is probably a long, long, long way off.

Media enthusiasm seems concentrated in two main areas: infrastructure development and North Korea’s vast reserves of rare earths (metals such as scandium and yttrium, which are widely used in computer and smartphone manufacturing, among other commercial and industrial applications) and other natural resources. But we believe there are numerous obstacles standing in the way of these. Not least of all: North Korea is still communist. Most workers don’t earn money, getting by instead on bartering. As The Telegraph explained in a recent article: “For the most part workers do not receive wages. Instead, payment in kind is made - if there is any payment at all. It is therefore, by in-large, a barter economy with huge levels of bonded labour. Put another way: swathes of the population are thought to be enslaved in addition to being generally oppressed and are likely to have to trade foods, fabric or coal, in order to get by.”[ii] Meanwhile, the country has nothing resembling modern capital markets—no modern monetary system (which would include a central bank that sets interest rates in a free market as well as robust currency exchange facilities), no national banking network to serve households and very few foreign capital links. In short, we think North Korea is short on the main ingredients of economic growth: human capital, technology, capital and productivity. They appear to have a lot of catching up to do.

As you might imagine, North Korea also lacks an equity market. The only way for retail investors to “invest” there would be to own shares of listed foreign companies that win contracts there—which we believe explains the big run-up in all those South Korean firms. We suspect this run-up is a strong indication that these seemingly breaking developments in the North are already reflected in current share prices. Moreover, these are all speculative bets, in our view—investors today are seemingly just guessing which firms might eventually win contracts if Trump and Kim strike a bigger deal someday. These are uncharted waters, making it impossible to assess actual probabilities. We think probabilities are a much sounder basis for investment decisions than distant possibilities.

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A Springtime Thaw?


Did winter showers start bringing some springtime flowers for the UK economy? (Photo by aleroy4/iStock by Getty Images.)

What is this about a wedding we hear? Possibly boosted by preparations for the Duke and Duchess of Sussex’s nuptials, UK April retail sales snapped back after the dreary winter, helping improve economic cheer. Adding to the good news, inflation fell to its lowest rate in 13 months in April. Both figures are backward-looking and not predictive for shares, but we think better than expected results—and lots of flowers—might help ease some of the recent economic uncertainty, perhaps helping lift investors’ spirits.

In our daily readings of UK media the past few months, middling economic data and equity market volatility have seemingly caused investor sentiment toward Britain to darken. Q1 GDP probably didn’t help as growth slowed to its weakest since 2012. Even though the “Beast from the East” bore much of the initial blame, many investors worried there was more at work than weather. IHS Markit/CIPS’ Purchasing managers’ indexes (PMIs) for April—surveys estimating the share of firms experiencing growth in services, manufacturing and construction—showed more than half of firms grew. The surveys’ subindex of new orders—a look at future production—suggested further expansion ahead. That said, the PMI readings weren’t as strong as analysts expected. Manufacturing PMI slowed, whilst services sped only modestly.[i]

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Quick Hit: Italy’s Sovereign Debt Auction Adds Valuable Perspective

Yesterday, the Italian Treasury sold €5.6 billion in 5-, 7- and 10-year sovereign debt (BTPs) at auction. You might think this sale ill-timed—coming on the heels of Tuesday’s sovereign debt market volatility, which saw rates across Italy’s yield curve jump. We have seen lots of media coverage fearing recently rising yields combined with Italy’s debt load risk the country’s finances, leading them to wonder whether fixed-interest investors would be willing to step into the breach when refinancing was needed. Yet when the dust settled Wednesday, the Italian auctions were oversubscribed. Actually, the 10-year auction had its highest bid-to-cover ratio (1.48 bids per BTP sold) this year, suggesting higher yields attracted demand. Imagine that. The resulting yields (3.00% on the 10-year) are higher than a month ago for sure, but they are a far cry from the 7.56% yield Italy auctioned 10-year debt at in November 2011, near the eurozone sovereign debt crisis’s height. The 5-year debt sold Wednesday partly refinanced a May 2013 issue at a lower rate! (2.32% versus 3.01%). Similarly, a decade ago, Italy was issuing 10-year debt at yields north of 5%. We’d do a comparison for 7-year debt, but Italy didn’t issue that maturity until 2013. Though if you’re curious, the inaugural auction yielded 3.76%—nearly double yesterday’s 2% yield.

Consider the debt fears dominating headlines this week in light of these results: If Italy didn’t default or require a bailout when it was financing itself at higher rates—nearly double in the case of 10-year debt—is there a valid reason to think today’s rates risk imminent default? 

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Why Slower Factory Growth Likely Isn’t Cause for Alarm

Fresh off the Q1 GDP release—which many seemed to view as subpar—IHS Markit’s April manufacturing purchasing managers’ index (PMI) fell to 53.9 from March’s 54.9, missing consensus expectations for 55.0.[i] The gauge, a survey of manufacturing firms’ business activity conducted by economic research firm IHS Markit, hasn’t accelerated since last November.[ii] In our observation of the media’s reaction, dour takes appeared to dominate, labelling the report “thoroughly disappointing”—evidence the UK economy has “fundamentally slowed this year.” IHS Markit’s director commented that “while adverse weather was partly to blame in February and March, there are no excuses for April’s disappointing performance.” Whilst it is possible (though not automatic) that one weak monthly survey of UK manufacturers could presage a factory slowdown, we don’t believe this means the economy (or shares) are automatically headed for a rough patch.

We don’t mean to sugar-coat this report. New orders—the gauge’s most forward-looking component—decelerated in April, with export orders notching a 10-month low. Moreover, as IHS Markit’s official manufacturing PMI release noted, “Falling backlogs of work, supply-chain constraints and rising stocks of finished goods also signalled that output growth will remain subdued in the coming months.”[iii]

But we don’t think this, on its own, proves the UK economy is on the ropes. PMI readings over 50 still signal expansion, according to the survey’s methodology, and historical data indicate final output figures frequently diverge from what surveys suggest. PMIs, after all, measure the breadth of growth, not the magnitude. They estimate the percentage of firms growing but don’t attempt to quantify how much their activity expanded (or contracted, for the minority of companies reporting pullbacks). Moreover, manufacturing is only about 10% of UK output, and an occasional softer (but still expansionary) monthly reading has historically been consistent with continued economic growth.[iv] Conversely, the UK Services PMI—representing about 80% of the UK economy—lifted slightly in April to 52.8 from March’s 20-month low of 51.7, suggesting the sector’s long-running expansion likely continues for now.

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Across the Great (Sentiment) Divide

A recent spate of seemingly soft data releases suggests February and March weren’t kind to the UK and German economies. We don’t think this is noteworthy in and of itself—not every month can be a winner—and given we are midway through April, it may seem like old news to some. But deeper digging reveals a useful nugget for investors, in our view. Although both countries fared about the same, we saw many headlines amplifying Germany’s struggles—dubbing them a downturn in the making. Meanwhile, our observation of media coverage indicates many downplayed the UK’s, waving off what they perceived as a “blip.” In our view, these divergent receptions suggest sentiment towards the eurozone has room to improve—a factor we think could prove bullish for shares there.

We found the data similarities striking. UK February manufacturing output fell whilst overall industrial production managed a 0.1% m/m rise—but only because utility output increased, likely thanks to nasty weather.[i] Both measures declined for Germany.[ii] UK and German February construction activity contracted.[iii] So did February trade in both countries—exports as well as imports, which represent domestic demand.[iv] German retail sales fell in February.[v] UK retail sales rose, but the sample cut off at February 24, before what many described as one of the worst winter storms in generations struck late in the month.[vi] That delayed retail gloom until March, where preliminary data from the British Retail Consortium show sales turning south.[vii] Lastly, Germany’s March composite Purchasing Managers’ Index (PMI) remained in expansionary territory but slipped from February.[viii] The UK’s March services PMI did the same, whilst the manufacturing PMI inched up.[ix] 

Although the UK and German growth pictures look largely the same to us, media interpretations appeared to differ wildly. Coverage in the UK generally noted broad weakness for February and March, but the analysis and interpretation seemed relatively sanguine. Instead of projecting weakness ahead, most observers largely blamed the weather and wrote it off as skewed. For example, in response to the underwhelming industrial production, manufacturing and construction figures, an economist for a manufacturing trade group said the report “looks more like a temporary wobble than a turn for the worse.”

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How to Make Sense of the Latest Wage and Savings Data

With full-year savings and spending data for 2017 now in the books, thanks to the Office for National Statistics’ latest report, it seems fair to say the results are mixed. Consumer spending rose, but only 1.7% from 2016, its slowest rise since 2011.[i] The household savings rate eased to 4.9%, the lowest on record.[ii] Meanwhile, the BoE reported a £1.6 billion rise in consumer credit in February, causing the year-over-year growth rate to inch up to 9.4% from January’s 9.3%.[iii] Yet the week prior, ONS data showed inflation slowing to 2.7% y/y in February and January wage growth improving to 2.6% y/y—2.8% including bonuses.[iv] That revelation was enough to keep media reactions to the falling savings rate fairly calm, with coverage portraying January and February as a potential inflection point for household finances. Whilst this improvement in sentiment is noteworthy, we have long believed investors were too pessimistic about the macroeconomic impact of last year’s higher inflation. With media coverage still broadly portraying last year’s consumer spending rise as a product of rising debt and plunging savings, we think there is considerable room for sentiment to catch up to reality—a force we believe should benefit UK shares over the period ahead.

We don’t mean to diminish the hardship some families might have faced over the past year. For those whose incomes didn’t keep up with faster inflation, higher prices probably did pinch. Similarly, as more employers start factoring higher prices into their pay increases, many households are likely feeling some relief. As an economic risk, however, we don’t think negative real wages were ever as dangerous as headlines frequently made them out to be. Falling real wages can squeeze consumers, but we don’t believe this means they automatically prevent consumer spending from growing.

To see this, consider longer-term trends. Average weekly total earnings of UK employees before tax and other deductions, adjusted for inflation—what people frequently shorthand as “real wages”—remain 6.5% below their March 2008 peak.[v] Yet quarterly consumer spending, also adjusted for inflation, has risen 9.1% over the same period.[vi] Exhibit 1 shows real wages (both including and excluding bonus pay) and consumer spending over this entire stretch. Even as real wages fell for a long spell during this economic expansion’s first five years, consumer spending grew. Whilst it bounced around during the first couple years, consumer spending growth turned consistently positive in late 2011—over two years before real wages started their recovery.

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About That Brexit Breakthrough

The UK and EU sort of reached an actual Brexit breakthrough Monday, agreeing on the length and terms of the post-Brexit transition period. According to negotiators, through December 2020, the UK will mostly still act like an EU member, following all relevant rules and participating in the single market. Between the official Brexit date and the transition period’s end, Britain won’t have a say on EU rulemaking, but it will get the green light to start signing its own trade deals. Both sides are hailing this as a big achievement, and we agree, progress is progress. So, huzzah! At the same time, what we have long observed investors to seem most concerned with is what happens after 30 December 2020, and progress on that front remains glacial. Yet thanks to the transition period, we believe it looks increasingly likely that whatever the final arrangement, investors and businesses should be able to begin planning for it well before it takes effect, helping markets gradually price in its potential plusses and minuses.

According to the official Brexit timeline, UK and EU officials aim to wrap up Brexit talks late this year in order to give member-states sufficient time to ratify the deal by the UK’s official March 2019 departure date. So although the transition period is a bit shorter than UK Prime Minister Theresa May initially sought, simply having an agreement is positive, in our view—it lets the two sides move on and focus on the “end state” agreement that will govern the UK and EU’s relationship from 2021 onward. Haggling over the transition agreement for a few months would have delayed this more crucial process. We think having more time may lower the likelihood of their rushing into a half-baked end state agreement.

Having the transition in place should also enable businesses and investors to start dealing with Brexit long before it becomes a reality. If the negotiation timetable sticks, there should be a roughly two-year gap between the unveiling of the end state agreement and when it takes effect. Whilst markets often dislike sudden sweeping change, in our observation, they have historically been more sanguine about seemingly big changes that take effect at a long delay. America’s Dodd-Frank financial reforms passed in 2010, but most of their provisions took effect over the next few years. US health insurance reform (The Affordable Care Act) passed that same year but didn’t take effect until 2013. These twin overhauls didn’t cause a bear market. They perhaps created winners and losers, but investors had time to assess the situation. Now, these are anecdotal examples, but one could ask: What is Brexit if not a regulatory overhaul?

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Italy’s Election: Let the Games Begin!

Italy voted on Sunday, and as of Monday afternoon, here is what the results have revealed: The anti-establishment populists won the most votes, the second-place finisher is considered a failure (based on media coverage we have seen), the third-place finisher thinks it should govern the country, and the man who would be kingmaker is now seemingly an afterthought. We don’t know—and probably won’t know for a while—which parties will end up in government. Officials are still figuring out how many seats each party gets, and it will likely be a few weeks before President Sergio Mattarella decides which party leader should get the first attempt to form a government. So uncertainty hasn’t vanished from Italian politics. However, now that investors know the basic results, we think markets can start weighing potential outcomes—including the very high likelihood that whoever forms Italy’s next government, diverse coalitions are usually a recipe for gridlock, reducing the chances of major change. Considering media coverage shows investors broadly fear major change in Italy, we think gridlock throwing sand in the gears should bring relief. In our view, this should be positive for Italy and eurozone shares.

Exhibit 1 shows the vote tally as of Monday afternoon.

Exhibit 1: Estimated Election Results

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Brexit’s Flurry of Headline Fears

According to the latest headlines, this week Jeremy Corbyn lured “Bremainer” Tory MPs away from Theresa May, the EU all but tried to annex Northern Ireland, and John Major potentially upended the entire Brexit process. At least, that is our attempt to reduce the media coverage of these major, complex news items into a simple and absurd soundbite for humourous purposes. All kidding aside, you would be forgiven for thinking these were watershed events with potentially huge implications for Brexit and its eventual impact on the UK economy and equity markets. Yet upon closer analysis, we believe none of these events represents a material shift from the status quo: Politicians are still creating noise, the big Brexit questions remain unsettled and the negotiation process remains slow and public, with plenty of daylight between both sides. In our view, this week’s developments shouldn’t prompt long-term investors to alter their opinion of UK equity markets.

Of the three events, we think Corbyn’s machinations may prove most significant in the end, but for now, we believe any forecast based on them would be speculative at best. When he announced Labour supported staying in the EU’s Single Market, some pro-EU Conservative MPs reportedly said they would cross party lines and vote with Labour against May’s plans to leave the customs union. Whilst the number of potential rebels is unclear, political analysts believe just 12 Tory MPs siding with Labour could result in a Commons defeat for May. This raised several questions about her ability to pass legislation (Brexit-related or otherwise) and the long-term viability of her minority government.

Yet political observers and investors have asked these same questions for months. It is well-known that May’s government is gridlocked. We think it has also long been apparent that political divisions would likely result in a watered-down Brexit resulting in little practical change from the extant relationship. As for the prospect of May’s government falling, this has been the subject of political and investor chatter for months. For all the headlines, Monday’s drama seems like more of the same.

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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 Headquarters: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom. Fisher Investments Europe Limited’s parent company, Fisher Asset Management, LLC, trading under the name Fisher Investments, is established in the USA and regulated by the US Securities and Exchange Commission. Investment management services are provided by Fisher Investments.