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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UK retail sales had a bangish March, jumping 1.1% m/m and a whopping 6.7% y/y, according to the Office for National Statistics. Headlines had a field day, marvelling at shoppers’ ability to “ignore Brexit chaos,” “defy Brexit turmoil” and hit the shops “unfazed by Brexit.”[i] This does seem like a testament to the nation’s stiff upper lip. However, whilst we don’t share the widespread view of Brexit (particularly a no-deal Brexit) as automatic economic or equity market doom, we do wonder if March’s sales jump is really a case of shoppers defying conventional wisdom—or if it is instead another instance of Brits prepping for a no-deal Brexit that didn’t end up happening.
Take a stroll down memory lane and recall mid-March. Politicians were nowhere close to a Brexit deal, and the 29th of the month loomed as the date Britain would supposedly crash out of the EU. Headlines had warned you for months that UK residents could lose access to popular continental European products, not to mention necessities like medicine. In the face of such warnings, stocking up likely seemed wise and logical! It wouldn’t surprise us if many shoppers hit the high street with such a mindset.
This is just one speculative interpretation, of course, but it wouldn’t be the only instance of stockpiling. For months, IHS Markit’s Purchasing Managers’ Indexes (PMIs)—monthly surveys tracking broad business activity—for the UK showed soaring inventories. March’s manufacturing PMI release opened with this statement: “The impact of Brexit preparations remained a prominent feature at manufacturers in March. Efforts to build safety stocks led to survey-record increases in inventories of both purchases and finished products. Trends in output and employment also strengthened as stockpiling operations at clients led to improved inflows of new work.”[ii] In other words, pre-Brexit scrambling and hoarding likely deserved most of the credit for the manufacturing PMI hitting a 13-month high.
The European Central Bank (ECB) is attempting to boost the economy! Or at least that is how it—and the financial media we reviewed—are portraying ECB President Mario Draghi’s decision last week to renew the central bank’s “targeted longer-term refinancing operations” (TLTROs). Financial media we surveyed commonly described it as a “major policy reversal” and a “U-turn,” bringing back major economic stimulus. We think this gives the ECB too much credit. Thursday’s announcement largely extends the status quo—an unnecessary move, in our view. Whilst couched as stimulus, we think it was really designed to defang a false fear: maturing TLTRO loans.
First, understand: TLTROs are not quantitative easing (QE). TLTROs let banks borrow funds for a fixed period directly from the ECB at discounted rates, providing they use them to underpin loans to businesses and consumers. This lowers banks’ funding costs, in theory. By contrast, under QE the ECB bought long-term fixed interest securities to reduce longer-term interest rates, which heavily influence banks’ loan profits. By doing so whilst fixing short rates just below zero, the ECB reduced the difference between short- and long-term interest rates (it flattened the yield curve, in industry parlance). Because banks borrow short term to fund long-term loans, this reduces profits on future lending. TLTROs do no such thing.
This isn’t the first time the ECB extended cheap funding to banks. The original version was 2011’s longer-term refinancing operation (LTRO), which didn’t require banks to lend the funds. Amid a debt crisis and recession, banks scrambling for liquidity borrowed over €1 trillion in three-year LTRO funds.[i] When LTRO repayment approached in 2014, we saw many in media fearing this would squelch lending. Hence, the ECB introduced the first TLTRO with four-year maturities, allowing banks to roll over their LTRO funds, providing they used them to underpin lending. Banks took €430 billion.[ii] In 2016, the ECB launched TLTRO-II—another four-year facility—which permitted greater borrowing at lower rates for new private sector loans. Banks not only rolled over most of their TLTRO-I funding, they increased it to €739 billion.[iii] Repayments for TLTRO-II are now poised to start coming due in the next 12 – 18 months. The ECB’s announcement it will offer two-year funding should allow banks to roll over funding once again, if they choose to.
Editors’ Note: MarketMinder Europe doesn’t favour any political party or politician in any country. Worldwide, we think political bias is blinding and leads to investor error. We assess global politics solely for their potential market and economic impact.
In our view, world politics have hit a relatively quiet stretch this month so far. There haven’t been major elections. Big legislation? Little to speak of. There is, of course, talk—a constant. However, the lack of landmark action doesn’t necessarily mean there aren’t developments worth noting. Here is a quick collection of some things we are watching, featuring the UK, Canada and Spain.
Italian gross domestic product (GDP)—a government-produced estimate of national economic output—fell -0.2% q/q in Q4. The dip is the second straight quarterly contraction, meeting one popular definition of a recession.[i] In the financial press we survey, this 31 January news release came with fears the eurozone’s third-largest economy will drag down the entire bloc. Yet a deeper dive suggests that may be a hasty judgment, in our view. Whilst Italy and the eurozone share some headwinds, our research shows some unique local factors made Italy more vulnerable. With those headwinds likely to fade soon, in our view, we think economic reality should surpass dreary expectations we find widespread in the media today. Expectations beating reality typically fuels rising equity markets.
Italy’s Q4 GDP contraction follows Q3’s -0.1% q/q dip.[ii] Although GDP details remain scarce, commentary from Italy’s national statistics office and companies surveyed by economic research firm IHS Markit hinted at weakness being concentrated in fixed investment, manufacturing and exports. Weak fixed investment likely resulted from Italian interest rates spiking higher during autumn’s budget standoff with the EU. The budget spat drove 10-year Italian government debt yields up to 3.6% in October from 2.8% in September.[iii] Whilst 3.6% isn’t historically high, we suspect the sharp spike may have temporarily deterred borrowing, with downstream impacts on business investment. This is doubly the case here, in our view, as the jump looked fear-driven and likely fleeting. According to our analysis, temporary rate spikes often cause businesses to delay funding planned investments as they wait for rates to subside before locking in years’ worth of interest expenses. It is sound financial management to take a wait-and-see approach before making a long-term decision. With Italy’s budget standoff now over and rates lower, firms are better able to pursue business plans, borrowing and investment they may have hesitated to undertake last autumn. In our view, this probably pushed some economic activity from late 2018 into early 2019.
We think new EU emissions standards also likely pinched Italy in the autumn. These seemed to hit Italian industrial production, which fell in all three months during Q4, dropping -0.8% m/m in December.[iv] They also apparently drove deteriorating manufacturing purchasing managers’ indexes (PMIs)—surveys estimating the percentage of businesses that grew in a given month. The new standards took effect in September, creating production problems automakers needed to solve, according to industry reports. For example, Volkswagen estimated higher standards would interrupt production of 200,000 – 250,000 vehicles in 2018’s second half.[v] Whilst Germany is more known for auto production and felt a related GDP hit in Q3 (as did Sweden), Italy is also vulnerable because many Italian manufacturers supply German carmakers. Auto sales figures hint at consumers buying ahead of the new regulations, with sales jumping before the rules took effect and falling through yearend. (Exhibit 1) This is normal when changes like this take effect, in our view, and we think it usually proves short-lived as everyone adapts to the new regime.
MPs voted 29 January on several amendments to Prime Minister Theresa May’s “Plan B” for the terms of Britain’s exit from and future relationship with the EU, following Parliament’s earlier rejection of her deal with the EU. Plan B looked a lot like the initial deal—including the controversial “Irish backstop,” which would leave the UK in the EU’s customs union and Northern Ireland in its single market if negotiators didn’t reach a permanent trade agreement—plus a few small concessions aimed at rallying support from eurosceptic Tories and even some Labour MPs. Of the seven amendments selected by Commons Speaker John Bercow for a vote, only two passed. One was a non-binding rejection of a so-called “no-deal” Brexit, whilst the other instructed May and EU leaders to replace the Irish Backstop with “alternative arrangements.” Their passage prompted rampant discussion throughout financial media, with many observers speculating about the potential impact on financial markets. In our view, they don’t appear to much alter Brexit’s course. They might render a Brexit delay or second referendum less likely than they perhaps appeared before last week, but the endgame still appears unclear. Investors still await clarity, and only time will tell if the next vote—the much-anticipated “meaningful vote”—set for 14 February, delivers it.
Exhibit 1, whilst a tad oversimplified, aims to summarise the many ways Brexit could have gone before last week’s votes. The starting point is May’s Plan B—her original deal, plus provisions giving MPs more input into a potential free trade deal with the EU, pledging to renegotiate the Irish backstop and increase protections for workers. The second row is a simplified aggregation of the proposed amendments, which combines overlapping amendments into general categories (e.g., combining four different extend the Brexit deadline amendments into one box). The third row specifies whether each would have been legally binding. The fourth, at last, attempts to show how all led, in different ways, to one of four general outcomes: a Brexit deal, a delay, a no-deal Brexit and a second referendum.
Exhibit 1: Simplified Rendering of Brexit Amendment Proposals
Nowadays, the words “European politics” seemingly mean “the latest in Brexit talks.” But other things are happening! In Greece, Italy and Sweden, recent developments again show widely feared European populism isn’t threatening. Whilst financial media often discuss the risk radicals upending the status quo, in our view, these developments show political gridlock reigns.
Greece’s Lesson in Moderation
Whilst Greek government theatrics perked recently, they resolved just as fast—and to little fanfare—likely ensuring Prime Minister Alexis Tsipras (a leftist firebrand turned economic liberaliser) and his Syriza Party’s government stay in power at least a few more months. Last June, Tsipras negotiated an agreement with Macedonia—Greece’s northern neighbour—to change its name to North Macedonia, but his government splintered over 25 January’s parliamentary vote. Since Yugoslavia broke up, Greece has called Macedonia the Former Yugoslav Republic of Macedonia, or FYROM, and the naming dispute has prevented it from joining NATO and the EU. Part of Greece’s objection rests on historical grounds, but Greek leaders have also long pointed out that using “Macedonia” implies a claim on northern Greek territory that was also part of ancient Macedonia and retains the name. Perhaps supporting this claim, (now-North) Macedonian leaders once gave a presentation with a map of their country in the background—with the southern border enveloping Greek territory. Greece, for obvious reasons, didn’t enjoy the symbolism. But both sides accepted renaming Macedonia/FYROM as North Macedonia, which implicitly recognises there is a southern portion of ancient Macedonia outside of its control. However, Syriza’s coalition partner, the nationalist Independent Greeks party, quit the government 13 January in protest. Tsipras survived the ensuing no-confidence vote 16 January, but if Parliament didn’t approve the deal, most political observers thought it likely would have triggered snap elections. In the end, Parliament approved it with a margin of 153 – 146 with 1 abstention, avoiding a snap election before October’s regularly scheduled contest.
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.
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.
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]
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.
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