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.

About the ECB’s Apparent About Face

Whilst the European Central Bank (ECB) didn’t announce policy changes at last Thursday’s meeting, ECB President Christine Lagarde’s accompanying talk seemed to reverse course from her prior statements about inflation (economy-wide price increases). Before Thursday, Lagarde argued fast-rising prices were temporary and passing.[i] Now she says inflation is “tilted to the upside” and could stick around for “longer than expected.”[ii] This rhetorical shift sparked speculation the ECB will soon start raising its benchmark interest rate, when it signalled previously it would stand pat this year.[iii] Yet—oddly, in our view—the data that likely helped motivate the switch also argue against it. We think this highlights, once again, that the ECB’s guidance isn’t actually that reliable. We also think it illustrates the folly of trying to predict what monetary policy institutions will do, no matter how data dependent they claim to be.

We think unexpectedly higher inflation likely contributed to the ECB’s changing its tune. Headline eurozone inflation hit 5.1% y/y in January—up from December’s 5.0%, above consensus expectations for a retreat and a record high.[iv] This comes against the backdrop of persistently high inflation rates globally and monetary policy institutions’ increasingly taking action—and mounting pressure from some eurozone officials to follow suit.[v] But in our view, there is a big, big caveat to that high headline figure: Energy prices, which accelerated to 28.6% y/y, remain the big driver.[vi] Core inflation, which excludes food, energy, alcohol and tobacco, slowed to 2.3% y/y, moderating from December’s 2.6%.[vii]

Now, the ECB targets headline inflation, not core.[viii] But in our many years of observing them, we have seen monetary policy institutions fairly regularly look through rising prices when the drivers are volatile and narrow. Actually, the ECB appears to us to have been doing that since last July, when headline inflation breached the bank’s 2.0% target.[ix] In our view, it isn’t clear why this latest data dump prompted the shift. The ECB could easily change its mind again, whether or not the data shift as well. Monday, Lagarde was back to downplaying inflation, saying: “There are no signals that inflation will be persistently and significantly above our target over the medium term, which would require measurable tightening.”[x] What to make of the latest ECB-speak? We can’t tell—nor do we think anyone else can.

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Britain’s ‘Black Thursday’ Wasn’t About Anything Falling

Editors’ Note: MarketMinder Europe favours no politician nor any political party, and our commentary is intentionally non-partisan. We assess political developments for their potential economic and market impact only.

We think one of the financial world’s stranger quirks is its tendency to name its very, very bad days. 1929’s stock market crash was “Black Tuesday”.[i] 1987’s was “Black Monday”.[ii] When the British pound crashed in 1992 as the country left the European Exchange Rate Mechanism, it was “Black Wednesday”.[iii] So you might think that, given financial commentators we follow have already named 3 February 2022 “Black Thursday”, UK stocks or the pound crashed.[iv] Yet Thursday, British stocks ticked down just -0.6% in sterling—hardly a move worth naming.[v] The pound strengthened slightly against the dollar.[vi] No, Thursday earned its auspicious moniker not because of market reaction, but because of energy regulator Ofgem’s announcement that the energy price cap will rise 54% in April, the Bank of England’s (BoE’s) 0.25 percentage-point (ppt) rate hike, and the monetary policy institution’s forecast for the inflation rate to top 7% this spring.[vii] Based on all the data available right now, this, plus forthcoming tax increases, looks set to take a bite out of households’ real disposable incomes this year. In our view, this likely creates political problems for embattled Prime Minister Boris Johnson and his potential rival, Chancellor of the Exchequer Rishi Sunak—and leads to what we think are some rather strange policy responses. Let us parse the day’s events and explore the potential market implications.

Our view on Thursday’s rate move as a macroeconomic and stock market risk hasn’t changed since last Tuesday’s commentary. We think markets have largely factored the widely expected move into share prices already. Furthermore, the UK’s yield curve—a graphical representation of one issuer’s interest rates across a range of maturities, from short to long—doesn’t appear to be at risk of imminently inverting.[viii] That is a plus, as many economic researchers we follow argue inverted yield curves—when short rates top long—often precede recessions. But we think rate hikes do have some secondary effects, and those could add to some households’ woes.

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The Well-Known Lesson From Q4 Eurozone GDPs

Q4 gross domestic product (GDP, a government-produced measure of economic output) for several eurozone nations have come out over the past week. Amongst the financial commentators we follow, some noted the bloc’s return to pre-pandemic levels of output, but most focused on the slowdown due to Omicron. IHS Markit’s January’s purchasing managers’ indexes (PMIs, which are widely followed monthly business surveys) added more evidence of COVID measures’ impact, with some analysts (correctly, in our view) noting growth will likely pick up as restrictions ease.[i] To us, the broad discussion of restrictions’ economic impact shows how familiar society is with the script today. We think surprises move markets most, and at this point, restrictions lack shock power.

Eurozone GDP grew 0.3% q/q in Q4, missing expectations of 0.4% but enough to bring output above pre-pandemic levels.[ii] (Exhibit 1) The bloc’s second-biggest economy, France, grew 0.7% q/q, whilst Spain (2.0%) and Italy (0.6%) also reported growth.[iii] However, Germany, which many observers we follow view as Europe’s economic engine, contracted -0.7% q/q.[iv]

Exhibit 1: The Big Four Eurozone Economies’ Post-Pandemic GDP Climb

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Our Perspective on Those $100 Oil Forecasts

Is oil going to $100 per barrel? The consensus amongst financial commentators we follow increasingly appears to be yes, with forecasts now calling for West Texas Intermediate (WTI, the US benchmark) and Brent (global) crude oil prices to pass $100 or even $120 later this year—up from WTI’s current $90.27 and Brent’s $91.12.[i] If those forecasts prove true, it would complete oil’s round trip to prices from before America’s shale boom vastly increased supply—making it no coincidence that supply concerns underpin those projections.[ii] Virtually no financial commentators we follow, as far as we have seen, forecast oil production coming anywhere near pre-pandemic levels, which we think is a case of recency bias—in which people extrapolate what just happened far into the future. It seems to us these analysts are missing some underappreciated supply drivers, yet even if we are wrong and oil jumps high from here and stays there, we don’t think there is likely to be much economic (or market) impact. Stocks and the economy did fine with oil above $100 in most of 2011 – 2014, and they can probably do so again.[iii]

The case for high oil rests on forecasters anticipating production will continue to crawl in North America and OPEC+ nations. The latter made headlines Wednesday for agreeing to proceed with a planned 400,000 barrel-per-day (bpd) production increase in March.[iv] Yet as many financial commentators we follow have noted, the cartel and its partners have struggled to reach higher production targets in recent months.[v] African producers are struggling, too.[vi] Nigeria continues to contend with terrorist attacks on its oil infrastructure, whilst conflict and a political void in Libya leave the country with Africa’s biggest proven reserves idling.[vii] Elsewhere, Russia is developing some new fields more slowly than expected, and Saudi Arabia—which has ample spare capacity—has declined to make up the shortfall.[viii] Hence, according to a Wall Street Journal analysis of an internal OPEC report, the cartel missed its December target by 824,000 bpd.[ix] Add in warnings of Russia potentially cutting oil exports to the EU—whether because of sanctions or sabre-rattling—and you get the spectre of a possible big shortage.

Thing is, our research finds these headwinds aren’t really new. OPEC+ participants have long struggled to meet quotas.[x] Yes, the future of Russian exports to Europe is unpredictable, but the oil market is fully global. If Russia does stop supplying Europe, we think the market will simply shift. Perhaps that supply will go elsewhere—maybe China—whilst the US, North Sea, Middle East and North Africa, Canada and Brazil fill Europe’s shortfall. Oil, like water, always finds a way, and rising prices would be a strong incentive to ensure it does, in our view. Moreover, for all the attention OPEC+ receives, the cartel’s relevance has long been on the wane, largely because the US has become the world’s swing producer.[xi] High prices encouraged booming US production a decade ago.[xii] We think they can easily encourage producers to boost output again.

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In Our View, British Rate Hikes Aren’t Bearish, Either

The Bank of England (BoE) meets Thursday, and if the financial commentators we follow are any indication, it seems the whole financial world expects policymakers to set the Bank Rate at 0.5%. In the past, this was generally considered low—indeed, when former BoE chief Mervyn King set the Bank Rate there at the end of 2007 – 2009’s financial crisis, it was an all-time low.[i] But then his successor, Mark Carney, tested the lower bound further with a 25-basis point rate cut after the Brexit vote.[ii] A couple of rate hikes and one pandemic later, Carney’s successor, Andrew Bailey, dropped the rate down to 0.1% in March 2020.[iii] Now, if the BoE acts as analysts we follow expect, the move to 0.5% will be the second-straight rate hike—a first since 2004.[iv] Many financial commentators we follow are pencilling in several more rate hikes in the coming months, and many of them warn rate hikes will send long-term bond yields skyward and stocks spiraling lower.[v] Yet, we think history disagrees.

Exhibit 1 shows UK stock returns before and after the first rate hike in every completed tightening cycle since the MSCI UK Index’s 1969 inception. As it demonstrates, returns after rate hikes are positive much more often than not, with only two rate hikes occurring within a year of a global bear market (a prolonged, fundamentally driven, broad equity market decline of -20% or worse) beginning.[vi] Our historical analysis shows the BoE wasn’t the bear market’s proximate cause on either occasion. In the early 1970s, we think it was the fallout from transatlantic price controls and the oil shock. In 2000, our research shows it was the Tech bubble’s implosion, which rippled globally after starting in the US that March. The only other time when returns after a rate hike were negative over the next two years was following November 2017’s increase. Then, UK stocks got caught up in global stocks’ twin corrections in 2018 (sentiment-driven declines of around -10% to -20%), which stemmed first from trade war fears and then, at yearend, from the wave of hedge fund selling we discussed a few weeks back.[vii] The BoE’s rate hike preceded the first correction by nearly three months.[viii]

Exhibit 1: BoE Rate Hikes and UK Stocks

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Data Deep Dive: Q4 2021 US GDP

Q4 US gross domestic product (GDP, a government-produced measure of economic output) jumped 6.9% annualised (the rate at which GDP would grow over a full year if the quarterly growth rate repeated in all four quarters), beating expectations, but the report didn’t spark much cheer amongst commentators we follow upon its release last Thursday.[i] Many of them explained that much of the growth stemmed from a big bump in inventories—and they warned it won’t last, meaning headline growth will likely weaken soon. Whilst that may be, we don’t think it would be a sign of economic weakness or a problem for stock markets. Looking under the surface at GDP’s pure private sector demand components, growth looked fine to us.

Exhibit 1 breaks out headline GDP growth (blue line) into two categories: the one commentators questioned last week, inventories (red column), and what we consider pure private sector domestic demand (pink column)—broadly, consumer spending and business investment outside inventories. (Note: We exclude government and trade here, which were negligible in Q4.[ii])

Exhibit 1: Steady Underlying Core Demand Growth Post-Reopening

Source: FactSet, as of 27/1/2022. US real GDP and components, Q1 2019 – Q4 2021. Pure private domestic demand aggregates consumer spending and fixed investment (excluding inventories) categories.

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A Busy Week for European Politicians

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

When it comes to European politics right now, if headlines in the financial publications we follow are any indication, most of investors’ attention is focussed on Ukraine and the prospect of a Russian invasion. Yet there are also some fresh developments on the traditional political front, which we think are contributing to elevated early-2022 stock market uncertainty. Italian lawmakers have now gone through four rounds of presidential voting and are no closer to selecting a (somewhat ceremonial) head of state. Portugal holds a snap election Sunday. France’s late-April presidential contest is heating up. All three, in our view—along with Australia’s upcoming general election—could very well contribute to stock market jitters in the near term, but we think they probably also create opportunities for falling uncertainty to be a tailwind for markets in much of the developed world later this year. Let us explore further.

Inside Italy’s Stalemate

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On the Bump in German Bund Yields

Hear ye, hear ye—a momentous event occurred Wednesday: Germany’s 10-year bond yield turned positive! Just barely, and not for long—it ticked back down to -0.013% a short while later.[i] But the brief blip above zero was enough to spur warnings from several financial commentators we follow that rising German yields would suck money out of US Treasurys, sending American long-term interest rates higher—and hurting stocks globally in the process. However logical that chain of events might seem, we think it has little grounding in reality.

For one, we think arguing a German bond (known in Germany as a bund) yielding a whisker more than nothing will pull capital away from a US Treasury note paying 1.83% focuses too much on yields’ direction.[ii] All else equal, our research shows money flows toward higher-yielding assets, which amongst the largest and most creditworthy nations, remains US Treasurys. The gap is wide enough that even if bund yields are positive, European investors can likely still buy US Treasurys, hedge for currency risk and come out ahead. If you were managing a European pension fund and trying to balance long- and short-term obligations, which would you choose? We suspect many, if not most, would likely pick the higher-paying option.

Then again, yields aren’t static. Suppose Germany’s barely positive yield did attract a flood of buyers, who sold their US Treasury bonds. If markets are at all efficient—which we think they are—it stands to reason that German yields would swiftly fall back below zero as buyers bid prices higher (bond yields and prices move in opposite directions). Our research shows bonds move on supply and demand, after all, and German bond supply is extremely tight, so we think it wouldn’t take much of a demand increase to tug yields lower. Meanwhile, we think the world would likely see a chance to buy Treasurys on the cheap, quickly bidding prices up and yields down and leaving everyone wondering what all the fuss was about.

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Don’t Extrapolate Slow Chinese Q4 Economic Growth

Stocks’ choppy January continued Tuesday, with several indexes globally in the red.[i] The potential for a US interest rate hike once again got most of the blame from financial commentators we follow, but headlines also dwelled on another bit of news: Chinese gross domestic product’s sharp Q4 slowdown. (Gross domestic product, or GDP, is a government-produced measure of economic output.) Though 4.0% year-over-year growth modestly beat expectations, it was the weakest expansion since lockdowns induced an economic contraction in early 2020, and many commentators we follow warn new regional lockdowns could cause further damage from here.[ii] That is possible, and it won’t shock us if weak Chinese data weigh on sentiment for a while, contributing to the grinding returns we think are likely in the first half (or so) of this year. Yet we also think China is likelier than not to continue contributing to global growth, eventually rendering fears false.

Under the hood, economic trends remained largely unchanged from prior quarters. Exports and manufacturing continued driving growth, with the former up a whopping 20.9% y/y in December.[iii] But personal consumption remained lacklustre, with retail sales crawling just 1.7% y/y higher in December and property investment contracting for the first time since early 2020’s lockdowns.[iv] In our view, it is important to consider that this weakness appears largely self-inflicted, stemming from the government’s zero-tolerance COVID approach and efforts to reduce leverage in the property sector. This is key because, new lockdowns aside, we see some evidence of these policies softening at the margins. The government is already reportedly going easier on less-distressed property developers, and monetary policy officials cut interest rates on Monday, which we think is likely to help cushion them further.

Lockdowns and the zero-COVID policies are wild cards, especially with the Beijing Olympics looming. However, political considerations suggest to us that a hardline policy stance is unlikely to last indefinitely. Based on all of the political reporting we have monitored, President Xi Jinping still appears to be intent on securing an unprecedented third term at this autumn’s National Party Congress. According to our analysis, this makes ensuring social stability paramount, so ensuring economic stability seems vital to us. If policies impact growth materially from here, we think officials will likely do whatever they can within reason to shift course and stoke the economy.

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Bad Breadth Likely Won’t Stop This Bull Market

Amongst financial commentators we follow, a common theme has begun emerging: Fewer and fewer stocks are performing well—so-called narrowing market breadth—which they argue means this bull market is fragile. Don’t buy it—in our view, this is faulty logic. Our research shows narrowing breadth is normal as bull markets (long periods of generally rising equity markets) mature, and there is no preset level indicating the bull market’s end is near. To us, it is just another sign this less-than-two-year-old bull market is acting late stage.[i] However, we think widespread alarm over typical bull market behaviour is yet another indication stocks likely have more room to run.

There are several different ways to measure market breadth. Some observers look at the number of stocks hitting new 52-week lows, which are currently far outpacing new highs.[ii] Others track the “advance-decline line”—the ratio of rising stocks to declining ones. Last week in America, some commentators we follow touted the fact daily decliners on the New York Stock Exchange and Nasdaq outnumbered advancers by about four to one.[iii] Our preferred measure is the percentage of stocks outperforming the index average. Using the S&P 500 for its long history, Exhibit 1 shows this jumped to 61% in early 2021 amidst optimism over mass vaccine rollouts and global economic reopening. But it has steadily declined since last May, with only 44% now beating the index on a rolling 12-month basis.

Exhibit 1: Narrowing Market Breadth Doesn’t Always Spell Doom

Source: Clarifi, as of 13/1/2022. Percent of S&P 500 stocks beating the trailing 12-month S&P 500 total return, 12/1/1976 – 12/1/2022. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.

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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.