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 Eurozone Follows the Path America Charted: Economic Update

The eurozone and several member-states released Q3 gross domestic product (GDP) Friday—and tossed in October inflation as a bonus. (GDP is a government-produced measure of economic output, and inflation is a rise in prices across the broad economy.) In our view, all largely follow the course the US charted when it reopened from COVID lockdowns earlier this year, and none of the results likely surprised stocks for good or ill. As we will show shortly, the results suggest reopening drove swift growth, whilst energy prices fuelled faster inflation. Both developments were widely expected amongst financial commentators, and both appear likely—to prove short-lived, which we think should prove fine for markets. Let us take each in turn.

Behold, the Reopening Boom!

Q3 GDP results for the eurozone and three of its four biggest member-states all accelerated from Q2, with the outlier—Italy—still notching double-digit annualised growth. (The annualised growth rate is the full-year growth rate that would result if the quarter-on-quarter growth rate repeated sequentially over a full year.)

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UK Budget 2021: Schrödinger’s Tax Hikes

Editors’ Note: MarketMinder Europe is politically agnostic. We favour no politician nor any political party and assess policies’ potential impact on the economy, markets and personal finance only.

Are UK taxes going up or down? When Chancellor of the Exchequer Rishi Sunak unveiled the 2021 Budget Wednesday, he said, “My goal is to reduce taxes. By the end of this Parliament, I want taxes to be going down, not up.”[i] That mission statement capped a speech in which he presented a smattering of targeted tax cuts, including reduced beer and air travel duties; expanded business rates relief for retail; leisure and hospitality businesses; a small reduction in bank taxes; expanded research & development tax credits for corporations; and a reduced taper rate for the universal credit, which gives modest relief to low-income beneficiaries.[ii] He did not announce broad new tax increases—rather, he froze fuel duties and cancelled a previously announced increase on some alcoholic beverages. Yet the Office for Budget Responsibility (OBR), a nonpartisan government watchdog, estimates the UK’s tax burden will hit 33.5% of gross domestic product (GDP, a government-produced measure of economic output) by fiscal 2026 – 2027, the highest since 1951.[iii] (It sees public spending reaching 41.6% of GDP by then, the highest over a sustained period since the late 1970s.[iv]) So … who is right? We would argue the correct answer is both and neither of them, which we also think illustrates why UK stocks have seemingly dealt fine with the prospect of a higher tax burden.[v]

Yes, the ideas in Sunak’s speech technically cut taxes, perhaps scoring some political points—which is what the public Budget spectacle has probably always been about, in our view. But these small measures follow personal and corporation tax increases passed over the summer and a previously announced increase to the National Insurance Contribution. The OBR estimates these increases will add £49.7 billion to the UK’s total annual tax burden by 2026, whilst the cuts announced today total a paltry £1.6 billion.[vi] So, score a fact-check point for the OBR’s bean counters.[vii]

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Why We Don’t Think Market Volatility Is a Call to Action

The past several weeks have seen some volatility return, with global stocks falling -3.9% from 6 September to 4 October’s low, then rebounding almost to breakeven by last Friday’s close.[i] Still, some financial commentators we follow have suggested now is the time to reduce equity exposure and raise cash, arguing the likelihood of more negativity is high. Holding more cash in anticipation of rocky market stretches may sound sensible, but we think doing so could cost you dearly if you need long-term growth to reach your investment goals. Let us review.

There are myriad reasons for holding cash, though some are more beneficial than others, in our view. For example, cash is a near-necessity in an emergency fund (savings earmarked for unexpected expenses) or for a known or planned expenditure—two scenarios where subjecting capital to any volatility, which may lead to short-term losses, can pose a huge problem. Cash also can make sense as part of a defensive strategy during a bear market (typically a lasting market downturn of -20% or more due to an identifiable fundamental cause), perhaps alongside bonds and other securities, depending on market conditions. However, we think it makes sense to go this route only if you see a bear market forming and have based your assessment on careful fundamental analysis, not merely recent returns. In our view, the reasons we have seen in financial headlines for raising cash now seem less beneficial. A common rationale we have observed: Recent volatility is a call to pare back share holdings to protect capital whilst also building up some opportunistic cash reserves to invest after a decline.

Whilst that reasoning may sound nice in theory, it falls apart in practice, based on our experience. Our research shows volatility doesn’t announce its arrival or departure, and a short negative spell doesn’t automatically beget more market bounciness. As we wrote last month, markets had been relatively calm in 2021—until September.[ii] But last month’s dip doesn’t say anything about future market movement, in our view. Yes, more negative volatility is always possible, and if equities fall anew, the calls we have seen to hold cash for future buying opportunities could look prescient. But volatility goes both ways. If markets go through a stretch of positive volatility, that better buying opportunity you are waiting for may be in the rearview already.

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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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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.