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 stock 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.
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.”
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.
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?
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
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.
One of media’s chief pastimes in recent years—and particularly in recent weeks, given the hyper-focus on inflation—seems to be speculating about what central banks will do in light of economic data releases. So it was with joy that we relished the massive confusion in the press as it attempted to discern exactly what Britain’s latest Labour Force Survey meant for future BoE actions. Would the slight unemployment rate uptick delay hikes? Or would the higher-than-anticipated wage growth speed them? At times like this, it is worth remembering central banks’ actions cannot be forecast—they are people’s decisions, often biased and opinionated. Bankers decide which data to emphasise and which to downplay; which theories to operate on and which to ignore. In our opinion, the media fixation on what data mean for rate hikes is a sideshow for equity investors—one we hope you tune out.
First, the data. Britain’s unemployment rate ticked up 0.1 percentage point to 4.4% in Q4 2017—an unexpected increase, as economists forecast no change.[i] This is still a very low unemployment rate by historical standards, close to the early 1970s’ record lows. Nevertheless, some economists said this uptick should delay BoE rate hikes, noting it moves Britain’s economy away from the 4.25% unemployment rate the BoE says will spur wage-driven inflation. (More on that concept to come.)
Yet here is the thing: The unemployment rate isn’t simply the percentage of the population out of work. Rather, it is the percentage of unemployed people who sought a job in the previous four weeks. If they didn’t seek work, they aren’t included—these discouraged people fall out of the labour force. In Q4, the unemployment rise wasn’t driven by increasing slack in the labour market. It wasn’t due to firings, layoffs or anything of the sort. Actually, 88,000 more people finished Q4 2017 employed than at its outset.[ii] It’s just that 109,000 people rejoined the labour force. How, then, will the BoE see this uptick?
UK shares capped their worst week since January 2016 on Friday, with the MSCI UK Index’s -4.6% weekly decline bringing its total drop to -8.8% since its 12 January peak.[i] Global markets also took it on the chin, with US shares officially entering correction territory on Thursday when denominated in USD. Scary stuff, until you remember bull markets usually die with a whimper, not a bang. We believe this looks like a classic bull market correction, and likely not the start of a bear market—and not just because American markets bounced on Friday. The selloff could very well resume on Monday, and short-term volatility is always impossible to predict. But given corrections tend to end as suddenly as they begin, we think the wisest move for long-term growth investors now is to sit tight, lest you sell after a drop and get whipsawed by the recovery.
As a refresher, corrections are sharp, quick, sentiment-driven declines of -10% to -20% or so. They start suddenly and usually end equally quickly, with further gains on the other side. Bear markets, by contrast, are deeper (-20% or worse), longer and have identifiable fundamental causes. Corrections are fleeting and a normal part of any bull market. They help keep sentiment in check, preventing equity markets from overheating and helping extend the bull’s lifespan. They aren’t possible to predict or time repeatedly, so in our view, enduring them is the toll we all pay for bull markets’ stellar longer-term returns. However, we believe it is possible to navigate bear markets and cut out a chunk of the downside if you can spot one early enough.
Big down days like last Monday and Tuesday morning do happen during bear markets, but usually not at the beginning. Bear markets usually roll over gradually, lulling investors into complacency with a gentle decline. The average monthly decline of a bear market is around -2% to -3%, with declines escalating at the end due to negative compounding. Those tame early declines suck people in, throwing more and more money at what they see as buying opportunities—they focus only on price movement, without looking at forward-looking fundamental indicators. They don’t announce themselves with steep early drops—if they did, they wouldn’t lure people back. Yet big down days during bull markets aren’t uncommon, either. For example, when America’s S&P 500 fell -4.1% on Monday, it was the index’s largest drop since mid-2011 but also the 10th daily decline of -3.5% or worse during this bull market.[ii] Not so rare.
From the Office of National Statistics and Bank of England to private professional bodies and business surveys, data abound. Sizing up these data is a core aspect of understanding recent economic and market trends. But wading through it all is a daunting task, further complicated by the fact not all data carry an equal market impact. Hence, as an investor, time is precious and knowing where to allocate that time is a critical skill. Proper filtering not only saves you from a time-sucking chore, but it may also improve investment decisions—win-win! So in the spirit of helping you win back some valuable time, here are some widely covered datasets we believe aren’t as crucial as many think.
First a quick note: None of what follows is to argue you should ignore these factors in forming an assessment of the economy. Rather, we would suggest making note of them, but only allocating them significant time if there is something very unusual—a random spike or fall out of step with the recent trend. Also, if you are analysing individual securities or sectors, some of these may be more (or even less!) important.
Producer Price Inflation: Input prices (for materials and fuels) and output prices (for goods leaving the factory gate) supposedly track how businesses pass costs from one stage of production to the next, giving an early glimpse into corporate profit margins and consumer price inflation. But inflation is always and everywhere a monetary phenomenon—prices increasing broadly across the economy. Raw material and intermediate wholesale prices are likely to manifest in higher consumer prices only in areas where producers have pricing power. Therefore, so-called cost-push inflation is a misnomer. How much money chases goods and services drives inflation, not what upstream vendors charge each other. For this reason, if inflation is what you are trying to monitor, we believe you are better served watching money supply measures, like the BoE’s M4 excluding “intermediate other financial corporations”—broad money supplied to the private non-financial sector—or perhaps M4 lending (ex. IOFCs). Now, there may be some influence on profit margins from producers’ costs rising, but using PPI as a proxy isn’t going to yield much insight.
If you buy the major media narrative , ECB head Mario Draghi made a huge announcement on 26 October. The bank announced it would reduce—taper!—monthly bond purchases from its present €60 billion pace to €30 billion beginning in January 2018. But they also said they would extend the program’s life from its previously scheduled January end to September 2018. Media further fixated on some fuzzy , hedgy language [i] in Draghi’s statement that suggested future policy would be (in the US Federal Reserve’s terms) data dependent.[ii] Equities rose , which media interpreted as markets celebrating the “accommodative” beginning of the ECB’s taper. To us, that's a bit perplexing. We never thought ECB tapering was a negative—in our view, that got the impact of quantitative easing (QE) backwards. Moreover, here is some breaking news from 11 months ago: This isn’t new. The ECB did the same thing last December—they just denied it was a taper then, when they didn’t now.
The reason why tapering didn’t—and shouldn’t—sink equities is effectively two-fold : One, the ECB telegraphed this move months ago. Markets don’t wait around for policy announcements to start acting on them—markets anticipate. The fact the ECB did what it hinted at made this largely a bore . Second, in our view, QE never supported equities and the economy the way many presumed. Whilst central bankers talked up this “stimulus ,” it really discouraged lending . Banks borrow short term and lend long , profiting off the difference (or spread) between them. QE’s long-term bond buying depressed yields. With short-term rates super low already, their buying narrowed the gap between the two. Less profitable lending meant less plentiful lending. People respond to incentives.
By now, you’d think most would have caught on to the notion that taper fears are misplaced. We’ve already seen the US not only taper QE (meaning they reduced the rate of bond purchases), but begin unwinding it slowly.[iii] No calamity ensued; lending sped ; the economy grew; equities rose. Same deal for the UK. Japan’s asset purchases have also (quietly) slowed of late, although BoJ Governor Haruhiko Kuroda hasn’t called it a taper.
Investing in equity 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 equity 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.