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 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.


Steep Selloff Sign of Correction—Not Bear

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.

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Datapocrypha

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.

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Bad Things That Didn't Happen in 2017

2017 was the year that:

President Trump didn’t torpedo the US economy, trade, bull market or democracy.

Protectionism didn’t strangle the global expansion or snowball into a trade war.

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The ECB ’s Tapering is Not New

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.

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The Global Economy Keeps Growing

Halfway through Q4, countries are releasing Q3 GDP numbers and many research outlets happily note economies are finally growing in sync. Huzzah! Granted, broad-based global growth isn’t necessary for equities to rise higher—this bull market has run eight years despite weak spots and regional contractions—but it shows how far the expansion has come. Whilst backward-looking, these GDP reports show the global economy was in solid shape entering Q4. More investors are realising this reality could contribute to warming investor sentiment—a bullish development.

North America Is Dealing With Some Natural Disasters

US Q3 GDP rose 3.0% annualised, a smidge below Q2’s 3.1%—the first back-to-back quarters of 3% growth in three years. Whilst headlines called this “impressive growth despite hurricanes,” key areas experienced slowdowns. For example, personal consumption expenditures slowed to 2.4% from Q2’s 3.3%, and trade was also weaker: Exports rose 2.3% and imports contracted -0.8% (compared to Q2’s respective 3.5% and 1.5% rates). This import contraction actually contributes to a higher headline GDP number—a statistical quirk as GDP calculates trade as net exports (exports – imports)—which misses the fact imports represent domestic demand.   

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Breaking the Brexit Blues

Based on recent headlines, the UK might not seem ok. Brexit talks are plodding along, leaving business leaders antsy. Conservative Prime Minister Theresa May is facing a rebellion from her own ministers. Projections are bleak on the economic front. Sounds bad! However, in our view, many investors fail to appreciate the UK economy’s strength—a sign of sentiment’s disconnect from reality—which sets up bullish upside surprise.

Brexit and its alleged negative consequences continue influencing just about every major economic and political UK narrative. Talks between UK and EU negotiators seem constantly stalled, frustrating both pols and businesses alike. Domestically, controversy has embroiled UK politics. Two ministers resigned from May’s government recently, prompting speculation that the prime minister has lost control—and rumblings of a leadership challenge have started. 20 Tory MPs have also threatened to revolt against a bill enshrining 29 March 2019 in UK law as the official EU exit date.

Beyond these developments, policymakers and experts bemoan the state of the UK economy. BoE Governor and metaphorical “unreliable boyfriend” Mark Carney said the economy would be “booming” if it wasn’t for Brexit. Analysts worry inflation’s 3.0% y/y rise in October—a repeat of September’s rate, which was the highest in five years—could choke consumer spending, especially since wages rose only 2.2% y/y in the same month (implying they fell in real terms). UK retail sales rose 0.3% m/m in October, beating expectations, but headlines dwelled on the first year-over-year contraction in four years.[i] UK industries have also expressed concern future trade deals could hurt them significantly in the long term. The underlying theme: Things are bad now, and they will only get worse when the UK actually exits.

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The Eurozone Outside of Catalonia

With so much media coverage recently over Catalonia and the well-telegraphed non-event that was the 26 October ECB meeting, some other noteworthy political developments in the eurozone seemingly fell on deaf ears. France passed sizeable tax cuts and Italy passed long-rumored electoral reforms. Whilst neither fundamentally changes our bright outlook for eurozone equities, they represent more falling uncertainty and—especially in France—show how sentiment in the eurozone is still playing catch-up.

France

President Emmanuel Macron took advantage of his En Marche! Party’s 61% majority in the National Assembly, passing a budget including some tax cuts and reductions in public spending. The purpose of this budget—in conjunction with previously announced hiring and small business reforms—is to encourage businesses and entrepreneurs to move back to France by removing some laws that local and international business long complained about. In aggregate, the administration projects the budget changes will reduce France’s budget deficit below the eurozone’s 3% (of GDP) limit.

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Terrorism Is Tragic But Markets Are Resilient

Last month, 13 people were killed and more than 100 injured as terrorists struck in Barcelona and Cambrils, Spain. Terrorists also struck in Turku, Finland, in a stabbing attack claiming two lives and injuring several more. In the grand scheme of things, the loss of life overshadows anything investment-related. Now is the time for the living to pay respects to the deceased, count their blessings and remain vigilant against future attacks. For investors, though, remember that terrorism’s historical impact on capital markets is small—terrorists are unlikely to deter markets for long.

We are sure you are as tired of reading these types of articles as we are of writing them. Unfortunately, the list of recent terrorist-related incidents runs long.

  • 2016 ended with a truck killing a dozen people at a German Christmas market.
  • The new year started with a horrendous attack at a Turkish nightclub.
  • The UK suffered three attacks before the first week of June ended.
  • France has been hit by numerous acts of terrorist violence over the past couple years—this year, there was a knife attack at the Louvre and a shooting before the presidential election.
  • In August a neo-Nazi domestic terrorist sped into a crowd of people, killing one and injuring many others in Charlottesville, Virginia.
  • Thirty-seven people died in a casino attack in the Philippines in June.
  • Not to mention scores of violent attacks in more volatile regions like the Middle East.

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The Unbearable Lightness of ECBeing

European Central Bank (ECB) President Mario Draghi is feeling positively chipper about the eurozone economy. GDP has grown for 15 consecutive quarters and inflation is nearing the ECB’s just-under-2% target. Mandate accomplished! Many people now anticipate an end to the ECB’s “non-standard monetary policy measures”—quantitative easing (QE) to most—and, perhaps after that, hiking rates back above zero. This has some observers speculating about the impact of tapering QE and worrying it will hurt continental equities. But extant evidence suggests these fears are overdone. Tapering QE is much more likely to help eurozone equities than hurt.

QE is commonly misperceived as stimulus—including by the ECB—but in practice it hinders economic growth. When the ECB buys long-term bonds in large quantities—so much so they’ve struggled to find enough—it raises their prices. Since bond yields move inversely to prices, rising prices mean falling yields. Central bankers think lower long-term rates stimulate growth by making borrowing cheaper for individuals and businesses, driving loan growth. The problem is, this ignores the supply side. By reducing long-term interest rates while short rates are fixed, QE also narrows the spread between the two—flattening the yield curve. Because banks’ lending profit margins depend on this spread—they borrow short, lend long and pocket the difference—flattening the yield curve lowers their incentive to lend, stifling businesses’ credit access and dragging on economic activity.

QE didn’t create the eurozone’s economic expansion. QE began in early 2015,[i] but eurozone GDP had already been growing for two years by that time. (Exhibit 1) The economy surpassed its Q1 2008 peak—officially progressing from recovery to expansion—one quarter later. Before the ECB’s “expanded asset purchase program” (EAPP) was announced in January 2015, the eurozone’s 2011 – 2012 sovereign debt crisis was over. ECB emergency lending undertaken during that time was no longer needed. As credit markets normalised, the ECB’s balance sheet shrank.

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The Sorry Truth About Buy-to-Let

With gilt yields near historic lows and bank accounts paying next to nothing, income-focused investors have increasingly gravitated toward buy-to-let in recent years. The concept seems simple: Find the right property, fund a deposit with your savings or pension pot, find tenants to cover your mortgage and then some, and reap regular cash flows and big returns when you eventually sell. Some buy-to-let investors even boast of annual yield as high as 20%i! In reality, though, buy-to-let has many drawbacks, and for many investors, the benefits don’t outweigh the costs.

Tax Changes Trigger Troubles

For one, several recent and forthcoming tax and regulatory changes have made buy-to-let significantly costlier for investors. In April 2016, stamp duty on second homesii rose three percentage points, and property was excluded from capital gains tax reformsiii, forcing landlords to pay relatively higher capital gains taxes. The Bank of England is toughening buy-to-let mortgage requirementsiv, which likely drives borrowing costs higher once the rules take effect in 2017. But the real killer comes in April 2017, when the government begins phasing out buy-to-let tax relief, replacing the mortgage interest cost deduction with a 20% tax credit (the change will be in full effect in 2020). This is not an even swap: It can transform profits into losses, and further add to landlords’ tax bills by bumping them to a higher tax bracket. A recent Spectator article by Merryn Somerset Webb shows the math:

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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.

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.