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.
Is the UK slipping into a debt crisis of its own making? Commentators we follow have begun asking this question in the wake of a new report showing the UK has more debt with inflation-linked interest payments than any other major country.[i] With floating-rate debt constituting nearly 25% of overall outstanding Gilts, it is more in line with many Emerging Markets than developed, according to recent research.[ii] The relatively high share wasn’t historically a problem, but recent hot inflation (economy-wide price increases) has ratcheted up interest payments, leading many commentators we follow to argue public finances could be in trouble. And it is true, payments have jumped.[iii] But we see some mitigating factors we think are widely ignored, suggesting to us there is a high likelihood these warnings won’t come to fruition, which likely helps UK stocks keep climbing.
In a vacuum, we can see why the raw numbers don’t look great to many observers. Exhibit 1 shows UK central government interest payments on a rolling 12-month basis, with conventional and inflation-linked (aka index-linked) Gilt interest payments separated. Total interest payments have more than doubled since 2020, and index-linked Gilts are responsible for the vast majority of this.
Exhibit 1: Central Government Interest Payments (Trailing 12-Month Basis)
Editors’ Note: Our political commentary is non-partisan by design. We favour no party nor any politician and assess developments for their potential economic and market impact only.
Spain went to the polls in late July, five months ahead of schedule, as Prime Minister Pedro Sánchez and his centre-left Socialist Workers’ Party (PSOE) sought to limit the damage from a resurgent centre-right Popular Party (PP). Voters returned a hung Parliament giving neither side a clear path to a majority, likely raising uncertainty for the time being—but also pointing to political gridlock in the longer term, which we think is likely to benefit markets as uncertainty gradually falls.
When Sánchez called a snap election after the PSOE lost badly in May’s local elections, commentators we follow pencilled in a win for the PP and its leader, Alberto Nuñez Feijoo.[i] The PP had a comfortable polling lead at the time, and many political analysts we follow projected it would land them a coalition government with the more right-wing, populist Vox.[ii] But Sánchez took the risk anyway, seemingly hoping the PSOE and its more populist left-wing allies, Sumar (formerly known as Podemos) could hang on to enough seats to leave the right-wing bloc shy of a majority—giving him a chance to reform a government with support from small regional parties.[iii]
After making new highs in February, UK stocks hit an air pocket after persistent inflation (economy-wide price increases) drove commentators we follow to warn far more rate hikes would spur a deep economic downturn.[i] In price terms, the MSCI UK Investable Market Index (IMI) slipped briefly below -10%, hitting correction territory (a correction is a sharp, sentiment-driven decline of -10% to -20%).[ii] More volatility could come, and it seems clear the UK economy isn’t firing on all cylinders, as we will discuss. Yet we think the latest data lend little support to calls for a nasty recession (prolonged economic contraction), as inflation decelerated in June with prices rising only a smidge from the prior month—much less than expected.[iii] Meanwhile, June’s inflation-adjusted retail sales jumped and July’s flash composite purchasing managers’ index (PMI) showed ongoing growth.[iv] Who knows how the Bank of England will interpret this, but to us, the data show the UK economy continues defying rock-bottom expectations.
Most coverage we read focussed on the Consumer Price Index (CPI), which rose just 0.1% m/m in June, below consensus estimates for 0.3% and decelerating rapidly from May’s 0.7%.[v] Month-over-month figures aren’t seasonally adjusted, so we wouldn’t draw big conclusions about the trends, but we think it is a noteworthy slowdown all the same. Core CPI (excluding food, energy, tobacco & alcohol) rose 0.2% m/m—half expectations—after a 0.8% increase previously.[vi] This brought the year-over-year inflation rate down sharply. CPI fell to 7.9% y/y from May’s 8.7%—and a peak of 11.1% in October.[vii]
Whilst these figures grabbed headlines we followed, CPI isn’t the Office for National Statistics’ (ONS) headline measure. That honour goes to another measure called CPIH—which includes owner occupiers’ housing costs. This metric follows CPI directionally but has been lower during this inflationary stretch, and it also dropped quickly to 7.3% y/y from 7.9% (and 9.6% in October).[viii] Meanwhile, core CPIH decelerated more moderately to 6.4% y/y from May’s 6.5% peak.[ix]
The latest batch of sentiment surveys provide some evidence the dire pessimism prevalent last year is easing. In our view, these polls aren’t perfect, but they do offer one way to see nascent warming. Some pessimism remains and scepticism abounds, according to our observations, but it seems thawing is starting to happen—as we think typifies a young bull market (prolonged period of broadly rising stocks).[i]
We will start in America, where the University of Michigan’s (U-Mich) widely watched Index of Consumer Sentiment registered 72.6 in July from June’s 64.4—its second-straight monthly climb and well ahead of consensus estimates of 65.5.[ii] July’s was the highest reading since September 2021—a year and a half after early-2020’s bear market ended—and the largest monthly advance since 2006.[iii] (A bear market is a long downturn of -20% or worse with a fundamental cause.) All underlying components improved, led by a jump in long-term business conditions, as the survey credited the rise to the ongoing slowdown in inflation (broadly rising prices across the economy) and a resilient labour market.[iv]
Now, we don’t think this means US consumers are feeling super chipper. July’s preliminary estimate is still well off February 2020’s prepandemic level, and moods remain down relative to the past 20 years. (Exhibit 1)
It is back! Chinese debt alarm, that is, with commentators we follow focussing on local government debts ... which many think are large—and could trigger a deep economic downturn. We think this has likely added to near-term uncertainty for Chinese stocks. But in our view and from a global perspective, the issue appears isolated, a widely known extension of China’s real-estate issues, and the economic effects are likely much smaller than most allege—particularly because the central government has plenty of firepower to step in with fiscal aid if needed, as we will explain. This doesn’t seem like a global risk to us.
The current concern centres on local government financing vehicles (LGFVs), which are off-balance sheet obligations China’s local governments use to skirt the central government’s restrictions on debt issuance and fund infrastructure and real estate projects.[i] Because LGFVs are off-balance sheet, they aren’t officially accounted for, so their size is opaque.[ii] Public estimates vary from £7 trillion to £10 trillion, which would be around half China’s 2022 gross domestic product (GDP, a government-produced measure of economic output).[iii]
Ballooning LGFVs are an outgrowth of real estate weakness.[iv] Before real estate’s downturn, when China’s local governments were short of tax revenue—like they were after 2020’s lockdowns crushed economic activity—they turned to selling long-term leases for land to property developers, seemingly buoyed by insatiable appetite for housing (and investment homes).[v] But after 2021’s Chinese property developers’ travails, not so much.[vi] In their place, LGFVs—which traditionally sold debt to fund public infrastructure projects—stepped in last year, going on a land (lease) buying spree.[vii] China’s government then sought to crack down, which caused net issuance to dry up.[viii] Many commentators we follow say this potentially hurts local governments’ ability to roll over existing debt, leading to current calls for a reckoning. A record level of LGFVs are coming due just as China’s ailing property markets and rolling lockdowns have drained local government coffers the last couple years.[ix] This has them warning they may not be able to meet their LGFV obligations and spurred calls for financial assistance from Beijing.
Here is a question we have been mulling since UK May monthly GDP (gross domestic product, a government-produced measure of economic output) came out Thursday morning: When is more information not necessarily helpful for investors? When the Office for National Statistics (ONS) announced it would start publishing a monthly GDP series five years ago, we were keen. We thought a more timely look at broad output would add more detail and insight into developing trends. Over the last year, however, we have started wondering if the added frequency merely shines a spotlight on monthly variability, obscuring long-term trends. In our view, May’s results are a case in point: GDP fell -0.1% m/m, partly reversing April’s 0.2% growth and bringing the rolling 3-month tally to 0.1%.[i] But ONS’s data release explained the drop stemmed primarily from one-off events, including the extra bank holiday for King Charles’s coronation and an uptick in industrial action, which disrupted several industries.[ii] Rather than get hung up on the latest wiggles, we suggest zooming out, viewing the broader trend and comparing that with expectations—the way we have found stocks do.
Exhibit 1 shows monthly GDP since mid-2018, giving a look at the present and how it compares with pre-pandemic trends. As you will see, monthly output has been more or less flat for the past year. But it was also pretty flat in the half-year leading up to COVID lockdowns, so we think it seems hard to argue the present malaise is new or surprising to stocks.
Exhibit 1: UK Monthly GDP’s Long Sideways Crawl
Editors’ Note: MarketMinder Europe is politically agnostic. We prefer no party nor any politician and assess developments for their potential economic and market impact only.
It is the end of an era. Mark Rutte, the Netherlands’ longest-serving prime minister (PM), is stepping down as leader of the centre-right People’s Party for Freedom and Democracy (VVD)—the largest party in the Dutch parliament—and has announced he will not run for another term at the next election following his government’s collapse. He is still in office as caretaker PM for now, but with the vote due by November, the Dutch will have a new premier for the first time in 13 years. We don’t know who that will be, let alone how the next election will shake out—especially since the ascension of the conservative upstart Farmer-Citizen Movement (BBB) party presents a new wildcard. For now, though, we think a look back at Rutte’s premiership illustrates a few useful lessons for global investors.
It Doesn’t Seem to Us Markets Sweat Ideology Much
Last autumn, 10-year gilt yields spiked over 4.5%, triggering a fallout amongst some pensions and contributing to the downfall of former Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng, as commentators we follow blamed the duo’s pro-growth agenda of modest tax cuts for gilts’ jump.[i] Yields fell, we saw replacement Prime Minister Rishi Sunak and Chancellor Jeremy Hunt receive wide praise in financial coverage we follow for trying to rein in the deficit, and everyone seemingly moved on.[ii] So much so that now, with 10-year gilt yields now back above their October 2022 high, publications we follow haven’t reported on it much at all—nor have they called for the government’s ouster.[iii] We see a couple of timeless investment lessons here.
First, in our view, high interest rates alone didn’t cause last autumn’s pension earthquake. Back then, when long-term rates rose, it created a problem for pension funds using a tactic called liability driven investments (LDI). We have a more detailed synopsis here for those who would like a full refresh, but this is a tool funds use to (ideally) match long-term returns to long-term liabilities, and it involves using leverage. When long rates rose and gilt prices fell, several funds got hit with margin calls, i.e., demands to pay down loans or add collateral. To meet them, they turned to the easiest, most liquid source of cash: selling gilts. These forced sales further hit bond prices, which forced more sales until the Bank of England stepped in with emergency pension funding and bond-buying programmes.[iv] These helped bridge the gap until markets calmed, leaving a national debate about LDI and pension regulations in their wake. This culminated in new guidance, issued this April, mandating stress tests and higher liquidity buffers.[v]
Those buffers may be one reason 10-year yields’ trip back north of 4.5% hasn’t triggered a fresh crisis—if not because of the new guidance, then because several funds reportedly built larger cushions proactively once last autumn’s events died down. We suspect gilt yields’ slower rise this time also plays a role. Exhibit 1 shows the 10-year yield’s movement over the past five years. Where last autumn’s jump was a twin spike, the latest ascent has been more gradual, likely giving funds time to adjust their portfolios as needed to prevent margin calls. Usually, we find it is markets’ rate of change, rather than their direction or cumulative move, that catches traders and fund managers off guard. This is likely one reason why our research finds there is no set level of interest rates (or any other market) that is inherently problematic. Time is a friend, in our view.
Halfway through the year, how is the world’s largest economy faring? [i] The latest numbers, including widely watched personal consumption expenditures (PCE), suggest growth continues to muddle along. Yet the reaction in financial publications we follow, which includes the emergence of new concerns about US economy, indicates to us that pessimism remains prevalent. In our view, that is a bullish combination, suggesting stocks have plenty of the proverbial wall of worry bull markets (extended periods of generally rising equity prices) climb entering 2023’s second half.
Per America’s Bureau of Economic Analysis, real (i.e., inflation-adjusted) PCE—the country’s broadest measure of consumer spending—was flat month-over-month in May, a tad below economists consensus expectations for 0.1% growth.[ii] On inflation—broadly rising prices across the economy—the PCE price index decelerated to 3.8% y/y in May from April’s 4.3%, whilst core prices (which exclude food and energy) hit 4.6% y/y, down -0.1 percentage point from April.[iii] The headline deceleration met expectations whilst core prices slowed a bit (-0.1 percentage point) less than expected.[iv] Also last week, the Census Bureau announced manufacturers’ orders for durable goods (meaning goods designed to last three years or more)—which aren’t adjusted for inflation—rose 1.7% m/m, well ahead of expectations of a -0.9% contraction.[v] Nondefense capital goods orders excluding aircraft (commonly known as core capital goods orders) ticked up 0.7%.[vi]
Based on financial commentators we follow, the broad reaction to May’s figures was mixed. We saw some optimism about the stronger-than-expected core capital goods orders—which many economists treat as a proxy for business investment—along with concerns of lost momentum in consumer spending. Similarly, though we noticed a few commentators cheer the deceleration in prices (the PCE price index’s slowest year-over-year pace since April 2021), we also read many concerns about how American monetary policy officials may act on the news since prices remain well above their 2% annual inflation target.[vii]
What do Taylor Swift and Beyoncé have in common? Aside from being world-famous pop stars, both are reportedly responsible for surging prices—i.e., Swiftflation and Beyflation.[i] This isn’t just nosebleed prices for nosebleed seats, but sky-high hotel prices during the big event.[ii] With people shelling out instead of cutting back amidst monetary policy institutions’ hikes, economists warn a summer of “funflation” threatens to keep inflation elevated—and credit conditions tight, supposedly kryptonite for the economy.[iii] On the surface, we think this is just another extension of rate hike alarm, but in our view, the broader discussion is most telling about sentiment. Headlines we read imply today’s consumer behaviour is somehow new and dangerous, as if major sporting and entertainment events haven’t skyrocketed nearby restaurant and hotel prices for decades. To us, this is a striking example of the pessimism of disbelief (PoD)—focussing excessively on negative developments whilst ignoring or dismissing positive ones—which we find normally accompanies young bull markets (periods of broadly rising equity markets).
Although decelerating goods prices have led inflation lower since it peaked last autumn in the UK and last summer in the US, warnings from commentators we follow have turned to stubbornly high services prices, like shelter or medical care.[iv] The alleged funflation threat looks to us like an outgrowth of this. Rather than take the good (overall inflation is trending lower, albeit slowly, and consumer demand appears to be holding up) with the bad (some prices aren’t stabilising yet), we see economists fixating on the bad parts, like celebrity performances, drawing headline attention.[v]
As the Office for National Statistics (ONS) reported recently, “Prices for recreational and cultural goods and services rose, overall, by 6.8% in the year to May 2023, up from 6.4% in April, and the highest rate since August 1991. ... The largest [increase] came from cultural services (particularly admission fees to live music events).”[vi] Because of performers’ celebrity stature, it stands to reason from our perspective that given the prices they (and venues they perform at) can command—and the halo effect on local lodging and dining establishments—the cost of admission is higher.
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.
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