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.

A Look at US GDP’s First-Half Dip—and Beyond

Q2 US Gross Domestic Product (GDP, a government-produced measure of domestic economic output) fell -0.9% annualised, its second consecutive quarterly decline after Q1’s -1.6% dip.[i] Because this is one traditional definition of recession (broad, extended period of economic contraction)—although not the official way America defines it—headlines we read feverishly debate whether this means one is now underway. And, with US GDP about a quarter of the world’s, they discuss what it augurs for the global economy.[ii] But in our view, that debate is too backward-looking for investors to mind it much. Months-old economic activity has little relevance for stocks, which we think have already dealt with the mild economic contraction and are looking ahead to what the next 3 to 30 months have in store relative to expectations.

Our research shows stocks move ahead of economic activity, and bear markets (typically prolonged, fundamentally driven declines exceeding -20%) often precede recessions as stocks discount the likely decline in investment and corporate earnings. We think this year’s shallow (to date) US and global bear market (when defined in US dollars) would be pretty consistent with a shallow recession.[iii] But whether or not one is underway is questionable. America’s National Bureau of Economic Research (NBER), which is the US’s official arbiter, doesn’t define a recession as two sequential GDP contractions. Rather, it defines it as a “significant decline in economic activity that is spread across the economy and lasts more than a few months.”[iv] Diving under the bonnet of Q2’s GDP report, we think there are reasons to question whether the US economy meets that threshold.

Exhibit 1 breaks out the US’s net trade (exports minus imports, light blue columns) and inventories (burgundy) by their contribution to headline growth (dark blue line). It also shows America’s government spending contribution (lavender) and three major GDP components: consumer spending (71% of GDP), business investment (15%) and residential investment (3%) in shades of green.[v]

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Are July’s Business Surveys Normal?

Has a summertime swoon arrived? July business activity contracted in major developed economies, including the US and eurozone, per the latest surveys from research firm S&P Global. We aren’t dismissive about today’s global headwinds, but we think it is critical to ask whether any of this information is surprising to markets—and in our view, the answer is no. July’s purchasing managers’ indexes (PMIs) don’t reveal much new on the economic data front, in our opinion, and we think stocks likely reflect this weakness to a large extent already.

As Exhibit 1 shows, S&P Global’s July flash (i.e., preliminary) PMIs weakened across the board from June and missed expectations.[i]

Exhibit 1: The Latest PMIs

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The EU's Natural Gas Conservation Plan Has A Couple Holes

Here are two things that seem related but—on a closer look—we don’t think are: Tuesday, the International Monetary Fund (IMF) sounded the global recession alert, citing the potential for a severe winter energy shortage in Europe.[i] Also Tuesday, the European Commission agreed a natural gas conservation plan for European Union (EU) member states.[ii]

The IMF’s latest projection may or may not prove correct about those shortages, but in our view, that is less important than the fact that it echoes the past several weeks’ worth of recession warnings from commentators we follow, which we think stocks have already moved on.[iii] Therefore, what matters from here is how reality evolves compared to baked-in forecasts, in our view. That is where we think the EU’s move comes in. If you read the finer points, we think it becomes clear the conservation plan mostly kicks the can down the road and doesn’t automatically tee up tough cuts that would take German industry offline and guarantee a eurozone recession.

The EU’s plan is not energy or electricity rationing. It isn’t even rationing. It is a loose agreement for most member states to voluntarily reduce natural gas consumption by -15% from the average amount each used over the past five years.[iv] It won’t apply to islands (Ireland, Cyprus and Malta), which are disconnected from Continental supply lines. It doesn’t have a clear enforcement mechanism, which is jargon for a clear answer to the question, or what? It doesn’t mandate how to curb consumption. It leaves loopholes for countries that have full gas reserves, “are heavily dependent on gas as a feedstock for critical industries,” or have sharply raised consumption over the past year (potentially exposing them to severe hardship if they go -15% below the prior average).[v] It also offers exemptions for countries that don’t draw much gas from Continental pipelines and feed gas into the system for their neighbors. And whilst it leaves room for the cuts to become mandatory if the European Commission declares a “Union alert,” details on what would trigger that aren’t sketched out yet (beyond a request from five member states to do so).

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Italy’s Debt Likely Remains Affordable

Editors’ note: MarketMinder is nonpartisan, preferring no party nor any politician. Our analysis aims solely to assess political developments’ potential market impact.

According to many commentators we follow, it was supposedly a double whammy for Italian bond markets last Thursday after (now caretaker) Prime Minister Mario Draghi resigned and the European Central Bank (ECB) hiked its benchmark interest rate by half a percentage point (ppt). Italy’s 10-year yield rose 0.22 ppt on the day to 3.58%—its highest since bond markets threw a tantrum during 2020’s initial COVID lockdowns.[i] Commentators now say a financial crisis is brewing, but we don’t think one looks any more likely than last month.

One popular measure of default risk is the credit spread—the difference between the country’s yields and the yields of a country with minimal risk. The wider the spread, the higher the perceived risk of default, as it shows investors require extra compensation to take the excess risk. Exhibit 1 shows Italy’s credit spread versus US Treasurys, which has widened lately. Yet that move alone doesn’t guarantee trouble, in our view. Whilst widening credit spreads can point to possible financial stress, our historical research shows they don’t automatically signal imminent default. Based on our observations, Italy is familiar with this. In April 2020, Italy’s 10-year yield spread against global benchmark US Treasurys widened to 1.54 ppts.[ii] During the eurozone’s debt crisis, it hit 5.65 ppts.[iii] In neither case did Italy default.[iv] (Note: We use US Treasurys as the benchmark—rather than, say, German bunds—because of America’s perceived global financial safe-haven status. In an existential euro crisis, we think capital probably wouldn’t flee to another eurozone member.)

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No, Copper Doesn’t Diagnose Economic Health

The doctor is in—Doctor Copper, that is. The metaphorical Economics PhD with an allegedly uncanny forecasting ability is back in headlines this month, as many commentators we follow argue copper prices’ recent slide signals a nasty recession looms. Yet in our experience, copper’s record as a leading indicator is pretty spotty. We don’t recommend relying on it to determine what the economy is up to.

The case for copper’s prescience might seem intuitive. Proponents of copper’s prescience argue that a humming economy will have widespread construction of homes, offices, factories, warehouses and stores—driving demand for copper, which is a key construction component. Therefore, if copper prices drop, it allegedly signals falling demand, which means construction is down, which means the economy is sagging.

In our view, this logic doesn’t really hold up in developed-world economies, where services are much more important to growth than construction and physical goods.[i] Many decades ago, when heavy industry and infrastructure had larger economic roles, we think it made sense to view copper as a leading indicator.[ii] When pioneering the Leading Economic Index (LEI) in 1938, economists Wesley C. Mitchell (founder of the National Bureau of Economic Research, which dates US business cycles) and Arthur Burns included copper on their initial list of the most telling components.[iii] But by the time LEI was reconfigured in 1950, copper was out.[iv] The more growth came from services and intellectual property, the less of a role copper appeared to play.

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Beyond the Data: China's Q2 GDP

China released Q2 gross domestic product (GDP, a government-produced measure of economic output) data Friday, and—please stay with us—we think the data were arguably the least interesting thing about it. No, we aren’t dismissing the sharp slowdown to 0.4% y/y, which missed economists’ consensus forecasts and reflected the economic damage from this spring’s COVID restrictions.[i] Nor are we glossing over continued real estate weakness, which remains a challenge. But, in our view, the press release itself was a tour de force in political messaging that, when you understand the context, appears to augur well for economic policy—and growth—over the rest of this year. We also think that, in turn, argues for economic fundamentals likely continuing to support Chinese stocks’ rebound off March’s lows.[ii] Let us discuss.

In our experience, in countries with strong institutions and independent statistical agencies, economic releases are usually pretty dry. Based on the scores of releases we have read over the years, most won’t even reference government officials, never mind sing their praises. But China is different. So the official release for Q2’s economic data begins not with a dry summary of the results, but with what we think is a rather poetic statement: “Faced with extreme complexities and difficulties, under the strong leadership of the Central Committee of the Communist Party of China (CPC) with Comrade Xi Jinping at its core, all regions and departments deeply implemented the decisions and arrangements made by the CPC Central Committee and the State Council, responded to COVID-19 and pursued economic and social development in a well-coordinated manner, stepped up macro policy adjustments, and fully implemented a package of pro-stability policies and measures. As a result, the resurgence of the pandemic was effectively contained, the national economy registered a stable recovery, production and demands saw improving margins, market prices were generally stable, people’s livelihood was protected sufficiently with robust steps, the momentum of high-quality development was sustained and the overall social stability was maintained.”[iii]

It is entirely unsurprising to us to see such a statement now, as this autumn’s National Party Congress approaches. Xi, reportedly, is seeking an unprecedented third term as party leader, which many observers argue would effectively cement him as president for life. We think simple logic suggests this is easier said than done when the government’s zero-COVID policy and its many social and commercial disruptions complicate everyday life.[iv] Logically, we think the situation therefore creates two urgent tasks for Xi: easing COVID frustration and helping the economy rebound as quickly as possible without storing up debt problems later. We read this press release as a preliminary declaration of success. The official message seems to be that lockdowns, whilst difficult, were successful and therefore worth it, and the payoff of a swift economic rebound is here—aided by fiscal stimulus, under Xi’s watchful eye and careful guidance.

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What to Glean From the UK’s May Monthly GDP Release

A curious thing happened on the way to the UK’s allegedly surefire recession Wednesday: Some of the data that many commentators we follow previously argued confirmed its existence were revised away.[i] Not only did monthly gross domestic product (GDP, a measure of economic output) grow in May, but April’s contraction was milder than initially reported, and March’s slide flipped to a slight gain.[ii] Now, analysing the numbers here probably won’t give you much insight into whether a recession is or isn’t underway, in our view—that much is still rather muddy, as we find it often is when pockets of weakness and relative strength abound. But we think the revised wobbles show why getting bogged down in headline data isn’t too productive for long-term investors. In our view, stocks look forward, not at backward-looking numbers that won’t be final until long after the fact.

Exhibit 1 shows how this year’s results evolved between April and May’s estimates. Overall, we don’t find the changes terribly significant, but they did shift some analysts’ GDP growth projections pretty radically. Until Wednesday, most commentators we follow had seemingly pencilled in a Q2 decline. Now, with April falling less than expected and May up, some commentators we follow argue that will be enough to offset the impact the extra bank holiday during the Platinum Jubilee will have on June’s data, perhaps making Q2 GDP flat or even slightly positive. Moreover, the data no longer show GDP falling two straight months after a flat February, which had caused financial commentators we follow to extrapolate declines forward.[iii] In our view, a Q2 GDP contraction was always more if than inevitable, and we guess the data now just make that a bit clearer to some (notwithstanding the potential for further revisions, of course).

Exhibit 1: The Ever-Changing UK GDP Data

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Another Multi-Decade Inflation High

Editors’ Note: Inflation has become a hot political topic, and we aren’t commenting on it from that standpoint. We are looking at the investment-related implications only.

9.1%. That is the latest multi-decade high the US’s Consumer Price Index (CPI, a broad measure of goods and services prices) year-over-year inflation rate hit in June.[i] Globally, commentators we follow focussed predominantly on what the acceleration from May’s 8.6% means for Federal Reserve policy, warning that continued aggressive interest rate rises could ripple worldwide, with the UK economy not spared from the dislocations.[ii] We suggest looking at inflation from a different standpoint. One of the most basic investing principles, according to our research, is that stocks move on the gap between sentiment and reality. Based on this, we don’t think stocks need prices to ease or interest rates to stay static. By our count, inflation is just one of seven or eight (at least) items weighing on sentiment globally right now. Therefore, we think the key to recovery isn’t fundamental improvement, but gradually easing uncertainty on a multitude of fronts.

So, what can we glean from US inflation data about the likelihood of stabilising prices stabilising investors’ moods? Based on our read of sentiment, the main source of uncertainty underlying inflation right now is the chief contributor: energy prices. Those rose 34.6% y/y, which included a 48.7% rise in petrol prices.[iii] (Ugh.) That fuelled a sharp divergence between headline and so-called core inflation, which excludes food and energy prices—not because they are meaningless (they aren’t), but because they are quite volatile and can occasionally mask underlying trends. Core CPI actually ticked a wee bit slower, from 6.0% y/y in May to 5.9%.[iv] That doesn’t mean inflation is for sure slowing from here, but we think it cuts against the notion that all prices are accelerating rapidly.

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Political Update: Tragedy in Japan

Editors’ Note: MarketMinder Europe favours no politician nor any party. We assess political developments for their potential economic and market impact only.

The world continues digesting last week’s major political earthquakes, with the Conservative Party’s leadership contest kicking off and Japanese Prime Minister (PM) Fumio Kishida reportedly eyeing a cabinet reshuffle in the wake of Sunday’s upper house election and former Japanese PM Shinzo Abe’s tragic assassination. We have seen a ton of speculation from commentators we follow as to how these events will potentially affect economic policy in the months to come, particularly in Japan, given Abe’s history as the architect of his Liberal Democratic Party’s (LDP’s) economic policy. Whilst it might feel trivial to focus on this aspect rather than the gravity of the tragedy, we have long found markets to be pretty laser focussed on policy, not the social and human angles. So let us look at the latest political developments through that lens.

In the wake of the tragic assassination—and, as widely expected—the LDP and its coalition partner, Komeito, took the vast majority of seats up for election on Sunday.[i] That gives them a super majority in both houses of Japan’s legislature and, following Abe’s death, most commentators we read are focussed on what this means for the revision of Japan’s constitution. Article 9 of the constitution, which American officials drafted with the country’s consent following World War II, renounced the right to sovereign warfare and a standing military. Abe, whose grandfather served in Japan’s wartime government, pushed for an amendment of this article throughout both of his stints as PM (first in 2006 – 2007, then from 2012 – 2020). That endeavour was something of a lifelong ambition, based on his many interviews and even old school papers on the topic, and he frequently argued rewriting the article to enshrine Japan’s Self Defense Force into law was necessary to strengthen and protect his country as China’s navy grew more active in the region.

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Supply Chains in the Spotlight

With all that is going on in the world this week, it might seem trivial to zero in on one cog in the global economy. Yet even little nuggets of falling uncertainty can matter, and there is one that we don’t think investors should overlook: Even as recession (broad extended economic contraction) chatter mounts, we find global supply chain pressures are easing. Whilst they aren’t fast inflation’s only cause, they have been a contributing factor, in our view, due primarily to dislocations from lockdowns and reopening. But in recent weeks, things appear to us to have started settling down a bit, albeit to little fanfare from financial outlets we follow, which we think likely helps gradually ease one of the key uncertainties in this year’s plethora of alleged risks.

Consider Exhibit 1. Since we featured the New York Fed’s Global Supply Chain Pressure Index (GSCPI) last month, it has fallen further. The GSCPI mashes together various global shipping and transportation costs plus other supply chain indicators including delivery times, backlogs and inventory levels. June’s reading was still elevated relative to the index’s history, but it was noticeably down from December’s peak. This doesn’t mean disruptions won’t flare again—see 2021 after 2020’s spike—but absent further severe lockdowns (like China’s) affecting global supply chains, we think companies appear to be working through bottlenecks.

Exhibit 1: Global Supply Chain Pressures Elevated, but Easing

Source: Federal Reserve Bank of New York, as of 7/7/2022. Global Supply Chain Pressure Index, January 1998 – June 2022.

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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.