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.
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Two widely watched economic indicators—retail sales and industrial production for America and China—hit newswires last week. Unsurprisingly, they prompted plenty of chatter in financial publications we follow (e.g., is American consumer spending slowing? Is the Chinese economy stabilising?). Whilst we think these data provide more evidence economic conditions have been holding up better than many economists we follow anticipated in the world’s largest economies, we caution against drawing large conclusions from them.[i] Let us explain.
In America, August retail sales rose 0.6% m/m, accelerating from July’s 0.5%.[ii] Petrol station sales (5.2% m/m) led, but growth was broad-based—of the 13 major types of businesses, 9 grew, 3 contracted and 1 was flat.[iii] August US industrial production (IP) expanded for a second straight month (0.4% m/m) and its manufacturing subsector ticked 0.1% higher.[iv] In China, August retail sales rose 4.6% y/y, noticeably better than estimates of 3.1%, whilst industrial production’s 4.5% y/y beat expectations of 3.8% growth.[v] The reaction to these reports we observed in financial headlines featured some tempered optimism, though commentators continued raising plenty of doubts. In America, we found some arguments that treated growing retail sales as a sign of ongoing consumer resilience, allowing the economy to avoid recession (a period of contracting output)—though we noticed some arguments that headwinds remain. The views we read regarding the Middle Kingdom also warmed, as some analysts we follow pondered whether peak pessimism has passed thanks to Chinese policymakers’ recent economic support measures.
In our view, the latest figures suggest economic activity held up in August, but we wouldn’t read much more into the numbers. For example, seasonal effects likely coloured US August retail sales and industrial production to an extent. (Seasonal adjustments, which are economic modelling approaches that aim to smooth out repeat, calendar-related impacts on a data series, usually account for this, but statisticians warn they have been imperfect since the pandemic lockdowns skewed typical trends.) Back-to-school shopping likely boosted personal electronics and clothing sales whilst high demand for air conditioning during the hot summer months drove IP subsector utilities’ second-straight monthly rise.[vi]
Is the long-awaited recession (a period of contracting economic output) finally here? Several economists say so after the Office for National Statistics (ONS) revealed the UK’s monthly gross domestic product (GDP, a government-produced measure of economic output) dropped either -0.5% or -0.6% m/m in July, depending on which data series one uses, with all three main components (heavy industry, construction and services) falling simultaneously for the first time in over a year.[i] This is possible, in our view, and with UK stocks still off February’s highs and enduring a weak August, we think it is hard to argue stocks are pricing in a robust economy.[ii] However, we think it is also hard to argue the latest GDP is out of sync with the recent choppy sideways trend, so we suggest not leaping to recessionary conclusions.
Exhibit 1 shows monthly GDP growth rates since 2022 began. We go back that far because, as you will see, there is a lot of bounciness, much of which the ONS reported was tied to skew from one-off events including the late Queen’s Platinum Jubilee, her passing, the World Cup, the King’s coronation and various industrial actions. We think that last bit is crucial because, according to the ONS, healthcare and education strikes were major factors in July’s services output dip.[iii] Moreover, though, the net result of all these choppy months was that quarterly UK GDP grew three straight quarters through Q2 2023 after a small decline tied to the late Queen’s funeral in Q3 2022.[iv] So if previous occasional declines similar to July’s didn’t correspond with a recession, we think it seems quite premature to say one is now for sure underway.
Exhibit 1: Choppy Monthly UK GDP Is the Norm
A spate of eurozone data ranging from industrial production to retail sales came out last week and the results weren’t pretty, in our view. It all suggests to us the eurozone’s recent flattish growth and Germany’s mild contraction may persist or even worsen somewhat.[i] But we think markets have long anticipated eurozone economic weakness—especially in Germany. Our research shows stocks look forward, so this isn’t coming as much of a shock to them—and, counterintuitively, it could help investors move on from talk of an economic downturn.
No question to us eurozone economic data for Q3 have gotten off to a poor start. July German industrial output fell -0.8% m/m, its third straight monthly contraction, and Spain’s dropped -4.0%.[ii] This brought year-on-year declines to -2.2% and -1.8%, respectively.[iii] Meanwhile, eurozone retail sales fell -0.2% m/m in July, leaving them down -1.0% y/y.[iv] Then, too, as we discussed recently, August purchasing managers’ index readings seemingly confirmed contraction continued last month. Moreover, leading credit indicators have signalled stalling growth for months. Private sector lending slowed to 1.6% y/y in July and has trailed inflation (economy-wide price increase) for two years, suggesting real credit (adjusted for inflation) to the economy has been contractionary.[v] M3 money supply is also falling now.[vi]
But for stocks, we think the data are only part of the story. The other part, in our view: How do these results align with expectations? On that basis, we don’t think there is much of a surprise here. After the IMF projected German recession (prolonged economic contraction) last October, gross domestic product (GDP) contracted for two quarters in Q4 2022 and Q1 this year (with growth flat in Q2), prompting pervasive talk amongst commentators we follow about its earning the sick man of Europe moniker.[vii] This was as Germany’s widely followed IFO Business Climate Survey hit an October 2022 low of 85.2—which August’s reading recently retested at 85.7.[viii] (Exhibit 1, blue line) Headlines now describe Germany’s “economic rut” getting deeper, with demand “feeble” and the outlook “bleak.”[ix] Attitudes toward the eurozone as a whole mirror those toward its largest economy in commentary we read. After falling for four straight months, the European Commission’s Economic Sentiment Indicator breached its October low in August (maroon).[x]
Are oil prices headed back to triple digits? Some commentators in financial publications we follow say so after two major producers, Saudi Arabia and Russia, extended supply cuts last week. But in our view, overlooked drivers imply oil prices will be range-bound—so the presumption the recent rise in crude means much higher levels and fuel prices ahead is likely off base.
Oil prices climbed throughout the summer, from $74.51 per barrel at June’s end to $90.67 a barrel on 11 September, an increase of more than 21%.[i] That has led to higher fuel costs, including for petrol and diesel—and the latter has been getting attention in financial commentary we monitor due to its myriad uses, including commercial transport and manufacturing.[ii] Now, with Saudi Arabia and Russia extending their voluntary production cuts of a combined 1.3 million barrels per day (bpd) from June levels through yearend, we have observed many questioning the implications.[iii] Will oil’s rise hurt consumption? Does more costly crude spell trouble for already flagging demand and economic activity in China? Will it reignite inflation (broadly rising prices across the economy)? Is this a sign to buy Energy stocks, since we find their earnings are price-sensitive?
But our review of recent history suggests the moves of Saudi Arabia, Russia and its partners within and outside the Organization of the Petroleum Exporting Countries (a group collectively known as OPEC+) aren’t major swing factors for oil markets. Last October, OPEC+ announced voluntary cuts to reduce production targets by 2 million bpd (from August 2022 levels)—to about 41.9 million bpd—starting in November and lasting through 2023.[iv] The cartel followed that with another “voluntary production adjustment” in April this year amounting to 1.66 million bpd.[v] Despite all the speculation, we doubted OPEC+’s decisions would send oil prices soaring. Based on our observations, OPEC+ members have struggled to meet their production quotas for myriad reasons, including disruptions (e.g., worker strikes in Nigeria) and underinvestment.[vi] Given most of the cartel’s members are already undershooting their production quotas, Saudi Arabia and Russia have seemingly taken it upon themselves to support oil prices with additional voluntary summertime production cuts.[vii]
The Office for National Statistics (ONS) admitted what many commentators we follow portrayed as a rather big error last week, revealing revised data showed that, instead of being over a full percent below its prepandemic high, UK gross domestic product (GDP, a government-produced measure of economic output) actually passed that milestone two years ago.[i] Far from being the worst economy in the G7, a dubious distinction we have seen in publications we follow these past couple years, the UK was cruising right alongside France and decidedly not the metaphorical sick man of Europe. In the week-plus since this revelation, commentators we follow have spilled rather a lot of pixels griping over economic data’s allegedly worsening inaccuracy and the supposedly dire implications for investors. We take issue on two fronts. One, big belated revisions aren’t new. Two, we see no evidence initially inaccurate data beguiled stocks.
Economic data are always subject to revision, sometimes long after the fact. In 2012, the US Bureau of Economic Analysis adjusted its methodology to count intellectual property products as business investment and then recomputed data decades prior.[ii] Amongst the less extreme examples, US data initially showed GDP rose in early 2008, and it wasn’t until late in the year that revisions showed recession had actually begun with the New Year.[iii] Later, August 2011’s US unemployment data initially showed zero jobs created, which had commentators we follow discussing the possibility of a double-dip recession (two economic contractions in rapid succession)—and looking rather silly when the reading was revised up markedly that autumn.[iv]
But stocks are well aware of this, in our view, largely because they are forward-looking. Our research suggests they price corporate earnings 3 – 30 months out, and they don’t wait for economic data to put numbers on what they live through. We have found they are extraordinarily good at sussing out the environment around them.
“As is often the case, we are navigating by the stars under cloudy skies. … We will keep at it until the job is done.”[i] No, we aren’t quoting the protagonist of a summertime blockbuster film or a legendary crooner—that was the US Federal Reserve (Fed) Chair Jerome Powell waxing poetic to conclude his keynote address about inflation at the big monetary policymaker shindig in America’s Jackson Hole, Wyoming, a two-day event covered by many financial publications we follow. Unsurprisingly, we have seen many analysts dissect what Powell’s speech means for monetary policy. But in our view, Powell’s words aren’t a big revelation—nor a roadmap of the Fed’s future actions—which is worth remembering for globally minded investors.
In a speech titled “Inflation: Progress and the Path Ahead,” Powell acknowledged some improvement in prices as pandemic-related distortions eased, though he also reiterated his view that “restrictive monetary policy” is necessary to further cool inflation.[ii] In his words: “Based on this assessment, we will proceed carefully as we decide to tighten further or, instead, to hold the policy rate constant and await further data.”[iii] The Fed chair’s widely awaited words didn’t surprise many observers based on our coverage of financial headlines. As one analyst described it, Powell “hit it more down the middle, with no major future changes in future hikes a welcome sign,” a stark contrast to when he allegedly “took out the bazooka” and alluded to more restrictive monetary policy.[iv] We noticed other commentators call the Jackson Hole speech evidence of a “fully data-dependent Federal Reserve,” even though it seems to regurgitate what we have seen the Fed say for fully two years under the guise of analysis.[v]
Though we noticed many economic observers applaud the Fed’s seemingly measured approach, we have some questions. Is this an admission Fed policy wasn’t cautious before? We wondered as much going back to March 2020 when the Fed announced a barrage of measures, including a seemingly reactionary round of quantitative easing (QE) asset purchases. At the time, the Fed argued extraordinary actions were necessary to calm markets.[vi] Perhaps—although we could envisage a case in which their unexpected moves weren’t hugely beneficial for the economy. Moreover, the economic logic behind massively increasing money supply when lockdowns severely constrained said supply was never clear, in our view. But hey, kudos to Powell for his newfound caution. Overall, we haven’t seen many financial commentators question the wisdom or logic behind Powell’s speech—highlighting the non-event Jackson Hole was this year—and regularly is, in our view.
Here we go again. Over the weekend, a former member of the Bank of England’s (BoE’s) Monetary Policy Committee—and now the head of an international economic think tank—made waves with an op-ed arguing the UK is poised to diverge from the rest of the world’s disinflationary trend.[i] This aligns with sentiment we have seen toward the UK these days, and in our experience, it comes with chatter around higher-for-longer interest rates hitting the economy and public finances—and, by extension, stocks. Yet we think it misses the mark, rendering this a brick in UK stocks’ proverbial wall of worry, in our view.
The op-ed, which featured in The Observer, claims three factors unique to Britain make it unlikely to enjoy a return to more normal price conditions.[ii] Those factors? One, wage gains have accrued to high-income workers, teeing up industrial actions and big pay hikes for industries with wage shortfalls (e.g., public health, safety and transport)—both of which it deems inflationary.[iii] Two, more Brexit growing pains as certain grace periods for EU standards and products run out, raising costs and reducing imports. Three, uniquely erratic boom-and-bust fiscal policy where short-lived positivity from tax cuts and spending alternates with austerity, bringing low productivity and weak gross domestic product (GDP, a government-produced measure of economic output) growth even before inflation is factored in. Cue the stagflationary malaise.[iv]
We could probably spend 1,500 words on any one of these in turn, exploring the merits as well as what we think are the fallacies before arriving at the conclusion that most of the argument amounts to speculation, and that a lot of underlying assumptions would have to prove correct for the forecast to pan out. But we think there is a larger philosophical error here: It is the same Keynesian-style argument we have seen monetary policymakers and economists globally make for more than three years now (referring to the economic school of thought pioneered by economist John Maynard Keynes in the early/mid-20th century). This school of thought views demand and governments as the drivers of all activity, including prices. The inherent assumptions are the same that led monetary policymakers to presume their 2020 COVID interventions wouldn’t prove inflationary.[v] And the same that inspired economists and policymakers to deem it near certain 2022’s steep rate hikes would induce painful recessions (periods of contracting economic output)—necessary medicine to cure inflation.[vi] And now these are the same assumptions that make many economists we follow question how inflation has slowed markedly without spiking unemployment and broad economic problems.[vii] Broken clocks aside, if this logic has been so wrong for so long, we think the likelihood it is suddenly right seems low.
Here are two things that might seem logically related: Two big UK Energy firms announced last week the government’s windfall profits tax wrecked their Q2 earnings and curtailed North Sea investment plans accordingly, and UK stocks’ bad month has put them back near correction territory.[i] Thus, here is something that might surprise you: UK Energy stocks are up month to date, albeit with some sharp volatility along the way.[ii] We think this is a pretty striking reminder of how markets deal with bad news well in advance.
The tax, introduced in May 2022, added a 25% surtax on Energy firms’ profits—on top of the headline 40% rate, bringing the total to 65%.[iii] The goal? Redistribute profits that stemmed from a factor outside businesses’ control (in this case, spiking oil and natural gas prices following Vladimir Putin’s Ukraine invasion) to the households affected by said energy prices.[iv] Knowing high taxes discourage investment, the government sought to blunt the impact by including an 80% investment allowance, which the Treasury described as “a 91p tax saving for every £1 [firms] invest.”[v] In November, the government announced the windfall tax rate would jump to 35% on January 1, 2023—bringing the total marginal rate to 75%—and sunset in 2028 rather than 2025.[vi] The investment allowance remained, though, at the same cash value.
At the time, it wasn’t clear to us what the tax hit would be and whether the allowances were enough to preserve investment despite the apparent disincentive. Some large global firms said, anecdotally, that it was impacting their plans, but in our view, it was all rather speculative.[vii] Until last week, when one of the UK’s largest domestic producers announced it booked a post-tax loss in 2023’s first half, with its effective tax rate reaching 102% once currency moves were factored in.[viii] Another producer announced it was writing down assets and cancelling planned investments due to the tax.[ix] Now commentators we follow are warning that as companies write down the value of their North Sea oil and gas leases, bank funding will dry up, causing a vicious circle of lower production and lower investment.
For the past several weeks, we have seen economic expectations inch higher—most notably in the US—as commentators we follow have started fathoming that inflation has eased without monetary policy institutions’ inducing recessions, a so-called soft landing.[i] Economists we follow started erasing recession forecasts instead of delaying them.[ii] But it seems all it took to reverse the positivity was a rocky August for stocks, coupled with some not-so-great Purchasing Managers’ Indexes (PMIs, monthly surveys that track the breadth of economic activity; readings above 50 indicate growth, below 50, contraction).[iii] With these surveys putting Europe in contraction, the US close to flat and only Japan in firm expansion, headlines we read are once again arguing recession is a foregone conclusion.[iv] We think that is a bit hasty. Yet even with that said, in our view, sentiment still seems dreary enough toward the weakest spots (Europe and the UK) that an actual economic downturn—if one struck—should have limited surprise power for stocks, which we find is key to their direction over meaningful timeframes.
Now, we don’t think August’s flash (preliminary) PMIs were great by any stretch. Yet this isn’t unprecedented: As Exhibit 1 shows, composite readings (which combine services and manufacturing output) spent much of 2022’s second half (and in some cases beyond) under 50, suggesting more firms contracted than grew. Outside Germany, however, this didn’t translate to a recession.[v] Gross domestic product (GDP, a government-produced measure of economic output) wobbled a tad in Japan, the eurozone and some member states, but it kept growing in the US and to a lesser extent the UK.[vi] Therefore, we think it is premature to declare recession is a sure thing now. It may be. It may not be.
Exhibit 1: A Composite PMI Double Dip
What do you do when two indicators seemingly measuring the same thing point in different directions? Those closely watching UK manufacturing lately may have encountered this very conundrum, with purchasing managers’ indexes (PMIs) diverging from the ONS’s official industrial production measure. Whilst the former suggests contracting activity, the latter—though not strong—has trundled along. The apparent conflict can be confusing, but understanding how each works could help clarify the situation, allowing investors to better see the underlying reality and how well expectations match it.
From last August through its latest July reading, S&P Global’s manufacturing PMI has been below 50, the dividing line between expansion and contraction.[i] In other words, over the last 12 months, less than half of firms the S&P Global surveys have reported growth in their business. Whilst a timely read—PMIs are generally the month’s first economic report—they don’t tell you how much businesses grew or contracted in aggregate, only whether a majority saw output grow or contract.[ii] So even if a majority of firms reported declining activity, if the minority grew more than the rest shrank, actual output may still be net positive. This appears to have occurred as summer kicked off.
Looking at just the manufacturing component of industrial production (stripping out mining & quarrying, oil & gas extraction and utilities), Exhibit 1 shows output grew in June (the latest reading) and is up since August 2022—when the PMI first fell sub-50.
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.
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