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.

To Size Up the Tax Hike and ‘Triple Lock’ Change, Tune Out Political Rhetoric

Editors’ Note: MarketMinder favours neither any politician nor any political party, focusing instead on the potential economic and market impact of developments.

This week, UK Prime Minister Boris Johnson triggered a flood of angst-laden headlines in financial publications we follow when he unveiled the government’s plan to hike various taxes, chiefly to support the NHS. The government also revealed plans to revise the state pension’s triple lock cost of living adjustment—a plan the government passed Wednesday evening. This move met withering criticism amongst financial headlines we reviewed—from both sides of the political aisle: Some pointed out the moves violated promises from the Tories’ 2019 election manifesto, whilst others alleged the scope of tax hikes is too small to provide the funding needed. Maybe there is truth to these points. Maybe not. Either way, for investors, we think those politicised narratives are a distraction. There are personal finance developments here to note, but overall, we think these changes are quite small relative to the rhetoric.


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Why We Don’t Think High Valuations Signal a Dim Future

Globally, headlines we follow tout historically high valuations, measures comparing share prices to fundamental metrics like earnings or sales, as a negative allegedly frothy markets are overlooking. This is particularly true in America, where price-to-earnings (P/E) ratios show markets are at their most expensive since 2000’s dot-com bubble, supposedly foretelling poor returns.[i] Some claim this is about returns immediately ahead—and that a bear market (a typically long, fundamentally driven decline exceeding -20%) may lurk around the corner.[ii] We see others arguing it refers to lower-than-average returns over the long-run future. But to us, this implies valuations are predictive. We think history shows you otherwise, a lesson worth taking note of now.

P/Es come in various flavours depending chiefly on the earnings denominator. Some use the past 12 months’ earnings. Others include those hinging on analysts’ 12-month forward earnings estimates or the, bizarrely distorted in our view, cyclically adjusted P/E (CAPE), which employs a 10-year average of inflation-adjusted earnings. But lately, it is the first—the so-called trailing P/E—fearful headlines we read seem to tout.[iii] Using America’s S&P 500 equity index for its long history, according to data from Global Financial Data, Inc., its trailing 12-month P/E is presently hovering around 35—in the top 3% of readings since 1926.[iv] Whilst UK P/Es are far lower at 18.8, this is still high for British markets, which are value-orientated and tend to trade at lower valuations as a result.[v] Sound alarming? We don’t think so. Here is why.

For one, last year’s lockdown-skewed quarterly results are still influencing the calculation.[vi] According to our analysis, the destruction of firms’ profits last year plus the steep rally in equities—which anticipated better corporate results ahead tied to reopening—inflated P/Es massively. We think this also explains why the current level (35.3) is actually down from June’s peak (45.7)—Q2’s blockbuster earnings helped.[vii] The same holds in Britain, where P/Es touched 35.9 at 2020’s close but have retreated since, tied to earnings’ recovery.[viii] But the current trailing 12-month P/E valuation still includes depressed earnings in Q3 and Q4.[ix] Against this backdrop, we don’t think it is abnormal for valuations to seem elevated.

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The Dividend Divide

With long-term fixed interest yields down modestly from their early-2021’s not-so-high highs, chatter amongst financial commentators we follow has inevitably returned to high-dividend shares as an alternative income generator. Whilst 10-year UK gilts pay a paltry 0.63%, the MSCI World High-Dividend Yield Index boasts a 3.44% yield, spurring an avalanche of headlines like “5 High-Yield Dividend Stocks for Healthy Income” and “6 Dividend Stocks With Big Payouts and Less Risk.”[i] What better time, in our view, to explain why high-dividend shares generally aren’t the magic solution to all your investing dilemmas?

Dividends have long had the reputation as steady workhorses that churn out reliable payments whilst avoiding the brunt of the equity market’s occasional declines. If we were to hazard a guess, we would posit that this stems from days gone by, when dividend cheques came in the mail, there was no CNBC or Internet, and tracking share prices generally required a daily perusal of your newspaper’s Business section. That took deliberate effort, whereas the cheques just showed up, perhaps giving the perception of stability.

It is a quaint, comforting image—and in our view, wrong. We like dividends! But they aren’t special. They don’t add to returns. They aren’t even a return on your investment—they are a return of your investment. Every time a company pays a dividend, the exact amount in pounds is removed from the share price. The company is basically slicing off a small piece of its total value and sending it to shareholders. It can be hard to see due to market volatility, but by rule, every time a company pays a £1 dividend, the share price falls by £1.

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A Handy Primer on Growth and Value Shares

What categories of equities are doing best lately? That is a question with multiple answers, some easier to understand than others, in our experience. Saying US shares are beating Europe and Asia seems intuitive. So is saying Tech and Communication Services are amongst the best sectors. But, based on our interactions with investors over the years, when the conversation shifts to growth beating value, many investors’ brows furrow. We are here to help with that, as we think the value and growth distinction is especially important to returns in 2021. Understanding what makes a share growth versus value can help investors understand why certain categories have led since lockdowns—and will probably keep doing so for the rest of this bull market, in our view.

Through Wednesday’s close, global shares have more than doubled since last year’s 16 March bear market low.[i] (A bear market is a typically long, fundamentally driven, broad market decline exceeding -20%.) But doing that well—or better—required emphasising the right kind of companies. Since this young bull market began, global value shares have risen 52.1%, whilst global growth is leading the charge at 85.2%.[ii] Lest you think owning only growth shares and ignoring value would have been an easy path to big returns, however, there have been several countertrends along the way where value led—testing investors’ mettle. In our experience, many investors are tempted to chase whatever category is doing best in the recent past, which could have lured many to swap a growth emphasis for value. The most notable countertrend occurred late last year and early this year, tied to enthusiasm over COVID vaccines and widespread expectations of swift reopenings launching a new Roaring Twenties-style boom of lasting, fast economic growth. By Q1’s end, we saw many commentators globally claiming value would lead for a long while, which could have led many investors to follow their forecast. Yet from mid-May onward, growth crushed value 19.9% to 4.2%, and we think it is likely to stay in the driver’s seat for the rest of this bull market.[iii] (A bull market is a long period of overall rising equity prices.)

To understand why, it helps to understand what growth and value entail and when each category usually does best, according to our research. Value shares, as the name implies, are generally valued more cheaply relative to their underlying assets and earnings potential than growth shares (which we will get to shortly). In our experience, they typically have lower valuations, which are metrics comparing prices to various fundamental measures like price-to-earnings ratios, price-to-book, price-to-sales, etc., that many investors use to gauge whether share prices are expensive or cheap. Value shares often return more of their earnings to shareholders via dividends and share buybacks, investing less in long-term endeavours, according to our findings, and their profits tend to be highly sensitive to economic trends.

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Value at Work: Britain’s Much Maligned Private Equity Push

What is going on with all these private equity deals? That is a question we have seen repeatedly this summer, as financial commentators we follow grapple with the increasing number of UK-listed shares bought out by large investors that have made a business out of taking companies private. As we write, a group of investors is making a widely discussed bid for Morrison’s, and industry researchers report several dozen other deals have been proposed or completed this year. With the number of UK-listed companies shrinking accordingly, several commentators we follow have concluded UK markets are in ill health and will likely struggle to compete with other nations for new listings unless something changes. Some have lauded the government’s proposals to reform listing rules in hopes of enticing more Technology companies to list in London, and perhaps that will indeed prove beneficial. Yet we think there is a much simpler explanation for the buyout spree, one that doesn’t reflect poorly on UK markets.

That explanation: UK markets are heavy on value-orientated companies, and private equity investors are the ultimate value investors. Value-orientated companies tend to carry relatively lower price-to-earnings ratios and more debt, making them more sensitive to economic conditions. They tend to return more money to shareholders via dividends and share buybacks and invest less in growth-orientated endeavours. By contrast, growth-orientated companies generally have higher valuation metrics like price-to-earnings ratios and focus on re-investing profits into the core business to expand over time and capitalise on long-term technological trends, making their profits relatively less sensitive to economic ups and downs, according to our research.

Technology and e-commerce companies are classic growth-orientated shares, whilst Energy, Materials, Financials, Utilities and Consumer Staples sit primarily in the value category. The MSCI UK Investible Markets Index (IMI), a broad index covering 99% of UK-listed firms by market capitalisation, devotes over half its market capitalisation to those five value sectors, versus just 2.7% for Information Technology.[i] (Market capitalisation refers to the value, in pounds, of all outstanding shares.) Many of the private equity firms’ buyout targets mentioned in this summer’s coverage are in these old-line industries as well as the MSCI UK IMI Value Index. That isn’t an airtight categorisation, as many of the criteria separating growth and value are qualitative rather than quantitative, but we do think it illustrates the broader point.

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Has Japan’s Revolving Door Returned?

Editors’ Note: MarketMinder is politically agnostic globally, favouring no party nor any politician. We assess political developments solely for their potential impact on markets and personal finance.

Last Friday, Japanese Prime Minister Yoshihide Suga surprised many financial commentators we follow, announcing he won’t seek re-election as Liberal Democratic Party (LDP) chief almost a year after taking office. Hence, the country will get a new prime minister shortly after 29 September’s party vote—with the victor likely leading the LDP into the general election, due by 28 November. Japanese equities jumped, with many observers we read suggesting a more charismatic leader who champions additional fiscal stimulus could help reduce Japanese shares’ huge lag versus the world. But we think that oversells it. This shift is likely to prove little more than a personality change, and it could signal the return of Japan’s revolving door—a reference to frequent leadership change in Japan in which eight prime ministers led the country between 2006 and 2012. The ouster of an unpopular leader could perk sentiment some short term, but we doubt this does anything material for Japan’s longer-term fundamentals.

In explaining his decision, Suga cited the country’s struggles with the Delta variant, claiming he couldn’t simultaneously campaign for the leadership post and do his job running a country facing a crisis.[i] That is a sensible-sounding rationale, but most observers we follow think the actual explanation is simpler: Suga’s approval rating is … bad. When he took office following long-tenured Shinzo Abe’s resignation on health grounds last September, Suga’s cabinet was actually quite popular. According to broadcaster NHK, its approval was 62% immediately after appointment.[ii] We observed other polls put it even higher, hovering near 70%. Suga is the son of a strawberry farmer and hails from the rural north, not Tokyo. He put himself through college by working at a factory before entering politics, giving him a particular man of the people appeal.

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The Equity Market’s Rational Rise

In recent days, a new presumption has quietly gained steam amongst financial commentators we follow: Rising equity markets, they warn, are increasingly detached from a faltering economic recovery in America and Europe. Sure, most flagship economic indicators are still doing well, but slowing real-time data (e.g., American restaurant bookings), supply shortages and the Delta variant have forecasters on edge. The implication: Euphoric markets are ignoring bad news and in for a rocky road once they become wise to reality. In our view, this misunderstands how markets work, and even if the recovery does take a breather for whatever reason, it doesn’t automatically render rising markets irrational.

For one, to presume equities should do X if near-term indicators do Y misunderstands how markets work, in our view. Economic data, no matter how timely, are backward-looking. Any given indicator reflects what happened last week, month or quarter, depending on the statistic. Markets, however, are forward-looking. Our research indicates they generally look about 3 – 30 months out. Their focus within that span isn’t the precise economic trajectory, according to our findings, but whether the economic and political landscape in general look likely to keep corporate profits generally better or worse than the broad universe of investors expected. If economic data in the here and now wobble a bit, that could very well rein in expectations, making it easier for reality to beat—and fueling equity returns.

We do think it is generally true that bear markets often begin when euphoric investors overlook deteriorating economic conditions. But we think that is generally about forward-looking economic indicators, not coincident and lagging data. For instance, if equities were notching new highs whilst the US, UK and other major nations’ yield curves were inverted, that could mean trouble ahead. The yield curve is a graphical representation of a single issuer’s interest rates, ranging from short to long. If it is inverted, that means short rates exceed long, which we have found often leads to tighter credit and economic contraction. Additionally, if the Conference Board’s Leading Economic Indexes were dropping and the new orders components of Purchasing Managers’ Indexes were contracting, we think that would be a strong signal that it is time for investors to take a cold, hard look around them. It wouldn’t be a call to immediate action, in our view, as getting out of the market is one of the biggest risks investors needing equity-like returns to reach their goals can take. That is why we generally think it is beneficial to wait at least three months after a peak to take action, lest you move hastily and miss more bull market if you are incorrect. But that sort of disconnect is something we would think it wise to watch very, very closely during that three month window.

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Enjoy the Calm, but Don’t Forget Volatility

Markets have been relatively calm in 2021, despite a steady stream of fearful headlines from financial publications we follow. Now, we don’t think that long quiet period means equities’ smooth stretch is about to be shattered. Volatility can strike or vanish at any time for any or no reason. But we do think getting acquainted with this year’s lack of volatility relative to the norm can help you mentally prepare for whenever markets do hit turbulence.

So far in 2021, the MSCI World Index has had no pullbacks—declines from a prior high—exceeding -5%.[i] Although there is great variance amongst bull markets (extended periods of generally rising equities), as Exhibit 1 shows, the five bull markets since daily data begin in 1980 (excluding the current one) have averaged around nine declines exceeding -5%. By magnitude, there are typically about seven -5% to -10% pullbacks and a couple of corrections—short, sharp and sentiment-driven -10% to -20% declines. There are always outliers, but as the current bull market wears on, we think it would be unusual not to see more volatility and pullbacks.

Exhibit 1: Frequency of Pullbacks Exceeding -5%

Source: FactSet, as of 2/9/2021. MSCI World price index, 12/8/1982 – 1/9/2021. *Not including the current bull market.

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Your Tuesday Data Delight

August—that interminable slow financial news month—is finally ending, and economic record keepers globally went out with a bang. Tuesday brought an avalanche of data, running the gamut from Chilean unemployment (improving to 8.9% in July) to Slovenian gross domestic product (accelerating from 1.7% y/y to 16.3% in Q2).[i] (Gross domestic product, or GDP, is a government-produced measure of economic output.) There were also some interesting nuggets from nations that play large roles in global developed equity markets, so let us bring you the two we found most interesting.

Is Germany causing a eurozone inflation headache?

The eurozone released preliminary August inflation today, and several financial commentators we follow described the acceleration from 2.2% y/y to 3.0% (versus expectations for 2.7%) as a “shock.”[ii] Shouldering much of the blame was Germany, which announced yesterday that inflation hit 3.4% y/y when using the standard EU calculation and 3.9% using the Federal Statistics Office’s standard approach.[iii] Many analysts we follow pointed to the country’s well-documented supply chain issues, which are starting to hamper factory output in some industries—driving prices higher as customers compete for a limited supply of goods. With no end to these issues in sight, they argue, it is no longer fair to call higher inflation “transitory,” which is the word monetary policy institutions like the European Central Bank (ECB) use frequently to describe economic developments they don’t think are likely to last.

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The Overlooked Lessons at Jackson Hole

US Federal Reserve (Fed) Chair Jerome Powell virtually delivered his much-anticipated speech at the Kansas City Fed’s annual Jackson Hole monetary policy party last Friday. As many observers we follow expected, he pretty overtly hinted the Fed is heading towards slowing quantitative easing (QE) asset purchases—i.e., tapering—this year. Loads of financial commentators we follow see QE as crucial fuel for equities and the economy, and many have hyped this proclamation as a watershed moment. But, no shock to us, the news didn’t seem to faze markets one bit. In our view, this further demonstrates the near-constant coverage of the Fed and other monetary policy institutions common in financial publications we cover is overdone. In our view, the Fed, Bank of England (BoE) and other monetary policy institutions simply aren’t as powerful as many believe—worth remembering amidst calls to give them even more responsibilities.

In past communications, the Fed has tied changes to monetary policy to the state of the US economic recovery. Powell often referred to the need for “substantial further progress” in things like lowering the unemployment rate before even considering any adjustments.[i] His Friday speech implies that hazy distinction has been hit, with most coverage we read focusing on this particular section:

My view is that the ‘substantial further progress’ test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.[ii]

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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.