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.

The Bank of England’s So-Called Double-Tightening Is Anything But

Thanks to recent comments from Bank of England (BoE) Governor Andrew Bailey and his colleagues on the Monetary Policy Committee (MPC), it seems to us some market-based indicators suggest investors preparing for the BoE to raise its benchmark interest rate, the Bank Rate, within the next few months. Some financial commentators we follow deem this necessary to contain inflation (broadly rising prices across the economy), which has accelerated this autumn.[i] Others take a more dour view, warning the move could choke the recovery since the BoE has also signalled that as it raises the Bank Rate it will begin unwinding its Asset Purchase Programme (APP)—allegedly a form of double-tightening of monetary policy. In our view, however, the BoE’s guidance regarding the APP outlines a beneficial approach that reduces the risk of choking the recovery as the Bank Rate rises. Let us explain.

Through the APP, the BoE purchased UK gilts and corporate bonds from banks, leaving it with approximately £875 billion worth of gilts and £20 billion worth of corporate bonds on its balance sheet.[ii] Like similar programmes globally—known collectively as “quantitative easing” or QE—it aimed to reduce consumers’ and businesses’ borrowing costs, on the theory that this would stimulate the economy. When the BoE purchased long-term gilts, it helped reduce long-term government interest rates since—all else equal—it increased demand for gilts, which raised their prices, and gilt yields fall as prices rise. When banks set lending rates, they generally base them on gilt yields, so when gilt yields fall, so do the public’s borrowing costs, overall and on average.

The BoE is no longer adding to its gilt holdings. But it is still reinvesting the proceeds from maturing gilts to keep its total holdings steady. Hence, it is still making some purchases, which we think extends the dampening effect on long-term interest rates. However, at August’s meeting, Bailey stated that “the MPC intends to begin to reduce the stock of purchased assets, by ceasing to reinvest maturing UK government bonds, when the Bank Rate has risen to 0.5% and if appropriate given the economic circumstances.” He further stated: “The MPC envisages beginning the process of actively selling assets later, and will consider it only once the Bank Rate has risen to at least 1%, depending on the economic circumstances at the time.”[iii] Presently, the Bank Rate is at 0.1%.[iv] Monetary policy institutions often set interest rates in quarter-point increments, so many analysts we follow posit the Bank Rate could reach 0.5% at the BoE’s first or second rate rise, depending on whether the MPC chooses to first set rates at 0.25%. In either case, those warning of double-tightening presume the combination of raising the Bank Rate to 0.5% and ceasing all asset purchases would be a severe economic headwind, if not the death knell for the economic recovery.

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An Update on Chinese Property Developers

Editors’ note: MarketMinder Europe doesn’t make any individual security recommendations. Companies mentioned here are only for illustrative purposes to highlight a broader theme.

Evergrande’s missed bond payment a few weeks ago raised alarm amongst many of the financial commentators we follow. Since then it has missed a couple more and given few indications it plans on paying international bondholders.[i] A few other Chinese property developers—mostly small, distressed ones—have followed suit, to varying degrees.[ii] Yet the spreading chaos commentators we follow expected and warned could spill globally seems absent, in our view. This doesn’t shock us—as we wrote recently, our analysis shows China’s financial system is largely still isolated from the world’s. But also, the latest reports suggest to us China’s government is acting to mitigate the local effect, and the process appears to be playing out in an orderly fashion. This underscores why we didn’t and don’t think Evergrande is a financial crisis catalyst—neither locally in China nor globally.

Evergrande has now missed a combined $279 million (£202 million) in offshore coupon payments since late September, which will officially constitute a default if they remain unpaid after a 30-day grace period expires on Saturday.[iii] Meanwhile, more credit events are popping up. To date, seven small, distressed developers including Fantasia Holdings, China Properties Group and Xinyuan Real Estate have either missed payments to offshore creditors or compromised with them, replacing existing debt with new bonds.[iv] Yet all these transactions are in the millions of pounds—far too small to cause fundamental troubles in China’s economy, much less the world’s, in our view.[v]

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No Surprises in China’s Slowdown

Chinese gross domestic product growth slowed to 4.9% y/y in Q3, with most financial commentators we follow surmising that the problems at property developer China Evergrande and associated real estate woes, combined with September’s electricity shortage, took a big bite out of the economy. (Gross domestic product, or GDP, is a government-produced measure of economic output.) Whilst we agree those issues likely did have some negative effects, we think most of today’s coverage overstated them and ignored a simple but important point: Q3’s growth rate is right in line with the long-running trend, as we will show. In our view, that makes these results a return to pre-pandemic normal, not a sign of sudden big problems in the world’s second-largest economy—a fine backdrop for equity markets.[i]

Also lost in most coverage we encountered: Chinese GDP thus far appears to be on track to meet the government’s full-year target of at least 6%, as it is up 9.8% year to date from 2020’s first three quarters.[ii] There is some COVID skew in this figure, stemming from last year’s lockdowns and the related contraction in economic activity. Yet according to a press release from China’s National Bureau of Statistics’ (NBS), the compound growth rate over the past two years is 5.2%.[iii] That is very much in line with pre-pandemic growth rates. So is Q3’s 4.9% growth, as Exhibit 1 shows—it largely extends the decade-long slowdown from the double-digit growth rates of old.

Exhibit 1: Slowing Growth Is the Norm in China

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British Austerity: A Solution Seeking a Problem

Austerity is coming back. That is the warning we have seen from several financial commentators we follow in the wake of Chancellor Rishi Sunak’s speech at the Conservative Party Conference earlier this month. Sunak’s address warned of the need to put public finances “back on a sustainable footing” and stressed the importance of “fiscal responsibility” as UK national debt closes in on 100% of annual economic output (as measured by gross domestic product, or GDP). As he warned against “stacking up bills for future generations to pay,” he seemingly set expectations for tax rises beyond the national insurance contribution increase announced earlier this year—raising the spectre of tougher austerity than Britain experienced in the 2010s. Then, austerity (a general term for measures to reduce the deficit) largely amounted to former Prime Minister David Cameron’s government increasing public spending slower than projected under his predecessor, Gordon Brown.[i] This time, the mere mention of tax rises appears to have inspired warnings of much tougher austerity now and in the future, what with pension and other age-related spending forecast to rise over the long term according to the Office for Budget Responsibility’s projections. Whilst we don’t think it is possible to predict government policy precisely, we do think investors likely benefit from having a clear understanding of the UK’s debt load and its sustainability over the foreseeable future, so let us review.

Whenever financial commentators we follow discuss national debt—whether in the UK, US or elsewhere—they typically focus on the absolute amount outstanding as a percentage of GDP. We can understand the impulse, as large numbers like debt tend to be meaningless without context. Intuitively, the larger a country’s economy is, the more debt it can likely handle. But we don’t think debt-to-GDP sheds much light on whether debt is becoming problematic. For one, it compares two variables with little in common. GDP is what economists call a flow—the amount of activity that occurs in a year, whether measured by spending or production volumes. Debt is what economists call a stock—an amount that accumulates over time. So comparing debt to GDP doesn’t measure like against like.

Then too, the Treasury doesn’t have to repay the national debt every year. Rather, they must pay interest due to investors who own UK debt securities (known as gilts), and they must repay principal on maturing gilts. In years when the government runs budget deficits (i.e., public spending exceeds public receipts), it will generally issue new gilts to replace maturing ones, a process known as refinancing the debt. Therefore, we think the main concern is interest payments and whether the Treasury can afford them. In our view, the most helpful way to do this is to compare interest payments to government receipts.

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Brexit Alarm’s Return Looks Unlikely to Unsettle Equities

Editors’ Note: MarketMinder Europe is politically agnostic. We favour no politician nor any political party and aren’t inherently for or against political developments like Brexit. We assess events for their potential economic and market impact only.

Just in time for Halloween, the Brexit monster appears reanimated, as illustrated by financial commentators we follow warning of trade wars and economic calamity haunting both sides of the English Channel. At issue: the Northern Ireland Protocol aspect of the Brexit agreement, which established customs checks on goods travelling from Great Britain to Northern Ireland in order to prevent a hard border between it and the Republic of Ireland, an EU member.[i] Neither side has argued the present system is working well, with the recent so-called sausage war over the protocol’s ban on British meat entering Northern Ireland but one high-profile example.[ii] UK Brexit Minister David Frost officially announced his intent to renegotiate the agreement on Tuesday, and EU Vice President Maros Sefcovic outlined the EU’s position Wednesday.[iii] We won’t hazard a guess at how this plays out, but we still don’t think this is likely to be a wallop in waiting for the UK, European or global markets.

Two years ago, when UK and EU officials were racing against time to strike a Brexit deal before the deadline, Northern Ireland was amongst the biggest sticking points. UK leaders wanted trade across the Irish Sea to remain unfettered, but the Good Friday Accords, which cemented the peace agreement between paramilitary groups in Ireland and Northern Ireland, required an open border between the two with no checkpoints.[iv] To preserve that, the UK and EU agreed Northern Ireland would remain in the EU’s customs union, also known as the single market. Hence, goods crossing the Irish Sea were subject to checks.

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No Shortage of Souring Sentiment

Hear the one about supply chain bottlenecks knocking global growth, threatening the economic recovery from lockdowns? The International Monetary Fund (IMF) did—and ratcheted down its projection for developed-world growth this year from 5.6% to 5.2%.[i] So did the people surveyed by Germany’s ZEW Institute, whose measure of German investor confidence slipped to its lowest level since COVID panic set in last year.[ii] And the US small business owners surveyed by the National Federation of Independent Business, whose sentiment measure fell again in September.[iii] And US CEOs surveyed by The Conference Board—their confidence level slipped almost -20% in Q3 on, you guessed it, supply issues.[iv] This all comes on the heels of The Conference Board’s broad US consumer confidence measure sinking to a seven-month low in August.[v] Many financial commentators we follow are treating these increasingly dour sentiment readings as portending to weak economic activity ahead in a self-fulfilling economic prophecy. We think that is a stretch. To us, these surveys and projections show the state of sentiment—and what equity markets have likely priced in—extending the proverbial wall of worry for equities to climb in the process.

We do think it is fair to say all those who cite supply shortages as an economic headwind are on to something. Whilst strong demand and overflowing order books are great, at the end of the day, output and spending are what show up in flagship economic statistics. If businesses can’t get the supplies they need, they can’t make their widgets, and output drops. If they can’t get finished widgets to customers in a timely fashion, then sales likely drop. Both can weigh on industrial production, retail sales, gross domestic product (GDP, a government-produced measure of economic output) and other hard data.

Thing is, our research shows equities don’t have a one-to-one relationship with any economic statistic. In our view, they don’t need growth to be fast or even particularly good. Just ok and not so bad are quite fine outcomes, based on our research, if investors’ general expectations are low enough. We think this is because equity markets move not on absolute reality, but the gap between reality and expectations. The lower expectations become, the easier it theoretically becomes for reality to beat them, even if reality is not so wonderful.

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Last Week in US Debt and Global Taxes

Editors’ note: MarketMinder is nonpartisan, preferring no party nor any politician. Our analysis serves solely to ascertain government actions’ potential market impact—or lack thereof.

Last Thursday, two political measures commentators we follow have been closely watching took steps forward: In America, Congress advanced a measure to raise the debt limit, whilst Ireland signed on to the US-backed global minimum corporate tax deal. Here we will bring you up to speed on these matters—and put them in broader perspective.

US Congress’s teensy debt-ceiling increase: Last Wednesday, the Republican Party’s leader in the Senate helped clear the way for Democrats to pass a standalone debt limit extension, which commentators we follow had been warning for weeks would trigger calamity. As his statement noted, he would “allow Democrats to use normal procedures to pass an emergency debt limit extension at a fixed dollar amount to cover current spending levels into December.”[i] In other words, he wouldn’t use the minority party’s statutory powers to delay a vote on a bill to raise the debt ceiling a smidge.

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Inside the Global Energy Price Spike

In the energy crunch heard ’round the world, households and businesses reliant on oil and gas are scrambling, driving financial commentators we follow to warn of impending calamity from the UK to China as oil hits a seven-year high.[i] Coverage we read warns shortages and price spikes will hurt households, raise businesses’ costs and compound global supply-chain dysfunction as factories slash output. We don’t doubt many will feel a pinch, yet we also think a little perspective is in order. Whilst it may take time to iron out production wrinkles and shortages, in the 3 to 30 month timeframe we think forward-looking markets evaluate, the winter fuel chaos commentators hype doesn’t appear likely to tank global growth—or markets.

What is behind the global energy crunch? Regional factors, based on our analysis. China appears to have banned Australian coal imports over a geopolitical spat, whilst it has also been trying to cut its coal dependence generally.[ii] Last year, China became the world’s largest liquid natural gas (LNG) importer.[iii] But switching to gas-fired electrical generation hasn’t been smooth. China’s government caps electricity prices, so utilities couldn’t pass rising costs to consumers.[iv] Spiking wholesale power prices force them to operate at a loss, so many cut output, sparking blackouts.

In the UK and much of Europe, weak wind power generation has also driven up demand for gas, which smaller utilities struggled to manage, leading to outages.[v] Adding to the crunch: low reserves, as Russian gas export curbs have depleted inventories to decade-low levels.[vi] Dutch near-term gas futures, the European benchmark, quintupled to a record-high €100 per megawatt hour last Thursday from €20 in April.[vii] This appears to be having knock-on effects globally. In the US, natural gas prices more than doubled from $2.43 (£1.79) per million British thermal units in April to $6.31 (£4.65).[viii] Except for intermittent spikes associated with brief supply disruptions, like a February cold snap that literally froze natural gas production amidst surging demand, prices are at their highest in more than a decade.[ix]

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Why Rising Interest Rates Needn’t Stall Big Tech

Are US Treasury markets hinting at trouble ahead for the large Tech and Tech-like shares that have led this extended period of generally rising equities (i.e., a bull market)?[i] Some market commentators we follow on both sides of the Atlantic have suggested they are, based on the observation that rising long-term US sovereign debt yields have coincided with short-term pullbacks in Tech shares at various points this year, including points in recent weeks.[ii] With the US Federal Reserve signalling asset purchases made through its quantitative easing (QE) programme will wind down soon, we have seen some analysts posit that a continued rise in long rates means tough times for Tech and Tech-like firms from here. But our study of market history shows rising rates aren’t automatically negative for Tech shares, as we will detail below. Whilst we don’t think rising rates are likely to persist, we still think investors would likely benefit from keeping that perspective in mind.

According to those warning rising interest rates will weigh on Tech and Tech-like firms’ returns, when yields are low, investors are more willing to buy growth-orientated companies—firms that generally reinvest most profits in their business instead of paying high dividends and seek to capitalise on innovation and long-term technological trends—on the expectation of big future profits. But when long-term yields are rising, we have seen some observers say investors then become more optimistic about upcoming economic and market conditions, so they supposedly prefer companies poised to benefit most from stronger economic activity in the present—ordinarily, value firms, whose profits tend to be highly sensitive to economic trends, based on our research. To support this claim, we have seen analysts cite a mix of recent data as interest rates have ticked higher, including the first weekly outflow from Tech mutual and exchange-traded funds in the week ending 22 September—a finding we have seen some observers we follow call indicative of potential Tech sector weakness.[iii]

But looking beyond what just happened shows a more complicated picture, in our view, as recent history proves Tech shares can do just fine alongside rising rates. From 25 July, 2012 to 2013’s end, the 10-year US Treasury yield rose from 1.43% to 3.04%.[iv] Tech rose 27.9% over that stretch—a bit behind global markets’ 33.0%, but still up nicely.[v] Or consider when the US Treasury yield climbed from 1.37% to 3.24% between 8 July, 2016 and 8 November, 2018.[vi] Tech’s 67.5% return over that timeframe more than doubled global equities’ 29.2%.[vii]

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China’s PMI Dip: Another Brick in the Wall of Worry

Thursday brought the first look at how China’s electricity shortage is affecting the economy, and the results weren’t exactly pretty: The government’s official manufacturing purchasing managers’ index (PMI) sank to 49.6 in September, implying contraction.[i] Caixin’s PMI, which includes a host of smaller private firms, technically broke even at 50.0, but its production subcomponent remained in contractionary territory, according to commentary from Caixin and IHS Markit.[ii] In response to these survey results, many analysts we follow warned that China’s energy crisis is adding to economic pressures, jeopardising the global recovery from the pandemic and lockdowns. In our view, that is just a tad hasty, and the likelihood that global markets will have to reckon with a hard landing in the world’s second-biggest economy remains low.

When interpreting PMIs, we think it is helpful to consider both their quirks and their history. They do not measure—or even attempt to measure—how much activity increases from month to month. That responsibility lies with output measures like industrial production. PMIs, by contrast, are surveys. Businesses report on whether output, new orders, employment, supplier delivery times, sentiment and other categories rose or fell versus the prior month. Then the agency producing the PMI compiles all the results and computes them into an index. The index’s reading, roughly, is the percentage of businesses reporting increased economic activity overall. If it exceeds 50, a majority of firms reported expansion, which implies the sector grew. If it is below 50, it implies contraction. So September’s 49.6 manufacturing PMI means a slight minority of firms reported expansion.

But because the PMI doesn’t measure how much businesses grew, the relationship between PMIs and output is fuzzy at best. If only 49.6% of businesses reported growth, but they grew by more than the others contracted, then output can still rise in a given month. So whilst we think PMIs are handy, as they are generally amongst the first economic indicators released for a given month, we think it is best to take them with a grain of salt. We suggest not getting too excited by incremental moves down or up, especially when they are very close to 50, like China’s latest figures.

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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 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.