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.

An End-of-Summer Sentiment Check-In

Unquestionably, 2022 has been a trying year, with headlines in financial publications we follow touting everything from inflation to energy prices, potentially looming rate hikes, the Ukraine war and more. Worldwide, stocks have been weak.[i] In US dollars, global stocks are in a bear market—a typically long decline exceeding -20% from a high.[ii] Given that backdrop, we think a fair amount of investor disappointment and frustration is understandable. But, although it can be hard to appreciate in the moment, our historical research shows bull markets (broadly rising stocks) are born on pessimism—and, as we will show, recent surveys suggest bearishness is at an extreme. This doesn’t pinpoint when an upturn will begin or whether it is already underway—nothing does—but we see widespread pessimism as a reason for optimism.

Bank of America’s (BofA) global fund manager survey, widely watched amongst commentators we follow, showed broad bearishness in September.[iii] The latest reading indicated a record share of respondents have cut equity holdings.[iv] Now, records start in 2002, so it isn’t an especially long history, in our view, but it does include 2007 – 2009’s bear market and early-2020’s brief downturn for comparison. Similarly, 62% of managers have raised cash holdings—a reading that has never been above 60% in two decades.[v] Also notable: 72% expect the global economy to weaken in the next year, with 68% seeing recession—broadly weak economic conditions—likely.[vi] Both rates are near all-time highs, exceeded by only March 2009 and April 2020.[vii] The earnings outlook is even glummer with 92% expecting declining profits.[viii]

BofA’s survey reflects professional investors’ attitudes—what large money managers are thinking and (presumably) doing. But the American Association of Individual Investors’ (AAII) polling suggests to us individual investor sentiment is similar, at least in the US.[ix] AAII surveys its members weekly about their outlook: positive (bullish), negative (bearish) or neutral. Combining them, AAII subtracts the bearish from the bullish, resulting in its net bull-bear percentage. This can be very noisy week to week, so to smooth it out a bit, Exhibit 1 shows the rolling four-week average. Although off its summer trough that coincided with the S&P 500’s 16 June year-to-date low in US dollars, it remains below nearly all points in its 35-year history.[x] Whilst it isn’t so surprising individual investors are feeling dour, we think the extent is rather remarkable.

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Despite Falling Alongside Stocks, Bonds Still Have a Purpose

UK bonds have entered a bear market (typically a prolonged fundamentally driven decline exceeding -20%) this year, whilst stocks haven’t.[i] In blended portfolios of equity and fixed-interest securities, we think bonds’ purpose generally is to provide asset-class diversification, cushioning against stock volatility for those whose goals, needs and risk tolerance make that desirable. But given this year’s environment, an investor might ask: If bonds don’t mitigate portfolio swings, why own them at all? In our view, although bonds may disappoint temporarily, they can still provide adequate cushion over investors’ required time horizons (the period investors need their money to work to reach their financial goals).

The UK’s ICE BofA Sterling Broad Market Bond Index, a gauge of investment-grade government and corporate fixed-interest securities denominated in pounds, has fallen -24.6% from its 11 December 2020 peak.[ii] Double-digit bond declines aren’t ideal, but by the same token, bonds were never riskless to begin with—like stocks, they are subject to occasional volatility. We think what matters for investors with blended allocations is that bonds are less volatile—overall and on average—than stocks.[iii]

Although it may not always feel great, a look at recent history over the last five years shows that has still been the case. When stocks fell -10.0% from 11 January 2018 through 23 March 2018, the ICE BofA Sterling Broad Market Bond Index ticked down -0.1%.[iv] (Exhibit 1) Later in 2018, stocks hit new highs 28 August, but then tumbled -15.9% to Christmas Eve.[v] The Sterling Bond Index rose 0.5% in that time.[vi] Then came pandemic lockdowns. As stocks plunged -26.1% from late-February 2020 to their mid-March low, Sterling Bonds declined -0.7%.[vii] During these times, we think bonds’ smoother path would have likely helped investors taking cash flows from their portfolios, as it makes the precise timing of security sales and distributions less impactful to overall returns, theoretically, than it would be for someone with an all-stock portfolio.

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Transatlantic Trends in Retail Sales

August retail sales might not be the top thing on everyone’s mind as this sombre week winds down, but the data stole headlines all the same Friday as the Office for National Statistics (ONS) reported sales volumes fell -1.6% m/m in August—the largest drop in a year.[i] Even as petrol prices fell, rising prices in other categories—as well as high household energy costs—hit demand at all subsectors of non-food stores (e.g., department stores, clothing stores, household goods stores and other non-food stores).[ii] The pound fell to a fresh low, and commentators we follow warned the negative report is another indication that the UK economy is in recession (a broad economic contraction). That may well be, and it seems likely even if new Prime Minister Liz Truss passes her plan to freeze household energy prices this winter and next, households will still feel a pinch. Yet at times like this, we think investors benefit from stepping back and considering that markets are global—and if their portfolios are diversified amongst international stocks in proportion with each country’s weighting in a broad index like the MSCI World, the UK probably isn’t a huge chunk of their portfolio. That makes economic trends outside the UK worth a close look, particularly in America, which is about two-thirds of developed-world stock market value.[iii] There, we currently observe a phenomenon we call the pessimism of disbelief: investors’ tendency to emphasise bad news and hunt for negatives in news that would otherwise be good. We have long observed this mentality to reign around stock market lows, suggesting that investor sentiment in America is primed for a stock market rebound that would benefit globally positioned British and European investors. The coverage of Thursday’s US retail sales report is a prime example, in our view.

American retail sales resumed growing in August, following July’s (downwardly revised) -0.4% month-over-month slide with a 0.3% rise.[iv] That rise was subject to big positive skew from autos and big negative skew from petrol stations—both influenced mainly by price movements, as America’s Census Bureau doesn’t adjust retail sales figures for inflation. But those categories seemingly cancelled each other out, as retail sales excluding autos and petrol stations also rose 0.3% m/m.[v] Headline retail sales also rose 9.1% y/y, which—as many noted—outpaced August’s year-over-year inflation rate, implying sales continue to eke out some growth on an inflation-adjusted basis.[vi] Mind you, we think that is overly simplistic considering properly deflating retail sales would require squaring up the month-over-month sales growth and inflation rates in dozens of small categories, but we found the observation interesting all the same.

Not because it was a cheerful observation—rather, in typical pessimism-of-disbelief fashion, most of Thursday’s commentary didn’t offer positive reasons why inflation wouldn’t be eroding spending on goods and food service. Articles we read didn’t tout strong demand, nor did they express relief that falling petrol prices are freeing up more of people’s money for discretionary spending. Rather, much of the coverage centered on timing: Not only is August back-to-school month, which boosts sales of clothing and school supplies, but it is also typically when stores will slash prices in order to make room for holiday-season inventory. Accordingly, many commentators we follow credited deep discounting for sales’ seeming resilience, implying that the only reason consumers are buying more is that they are raiding clearance sales in order to pinch pennies.

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Four Timely Timeless Lessons for a Volatile Market Environment

Global stocks are down slightly year to date, and the path has been quite volatile.[i] Stocks slumped from early January – early March before rebounding sharply by the end of Q1.[ii] From there global stocks churned lower—down as much as -13.9% after hitting their year-to-date low on 16 June—before rallying over the next two months.[iii] Then from mid-August through Wednesday, the MSCI World Index fell -3.8%.[iv] In our experience, sharp bouts of volatility can cause investors to focus on short-term developments, which can drive reactive investment decision-making—a mistake, in our view. To counter that thinking, here are several timeless lessons we think are particularly useful during a challenging year for investors.

Lesson One: Fathom the Power of Compounding

Many financial publications we follow discuss the concept of compound growth—i.e., earning a return on returns. In our view, understanding this concept is critical for investors, as those who take advantage of compounding’s power position themselves well for the long-term. To illustrate compounding in practice, consider the following hypothetical: A UK investor contributes £20,000 to an Investment ISA and earns a return of 8% after one year (£1600). For illustrative purposes only, presume this investor invests £20,000 at the beginning of each year for the next 29 years, makes no withdrawals and earns a constant 8% annual rate of return. Thanks to compounding, that cumulative contribution of £600,000 over 30 years turns into over £2.4 million. (Exhibit 1)

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American Jobs Data and the Pessimism of Disbelief

Coming into Friday’s widely watched US employment situation report, alarms abounded from commentators we follow. But, perhaps counterintuitively, their warnings weren’t that the data would support widespread recession (widespread economic contraction) narratives. No, most warned the opposite: that data would show a big payroll gain, suggesting labour markets remain tight—in turn, fostering more US Federal Reserve (Fed) hikes. There are myriad presumptions that underlie this good-data-are-bad-news theory, but above all, we think the inconsolable mood illustrates the Pessimism of Disbelief in action—a sign sentiment is too low relative to reality. Whilst American labour markets may mean little to British investors, the Pessimism of Disbelief is a key driver globally, in our view, and the jobs report provides a keen look at it.

Ahead of the release, we saw many headlines say signs of strong economic growth entail further Fed tightening. Commentators we follow argue those Fed hikes will pummel stocks even more. As the thinking goes, ongoing labour shortages and supply constraints mean any growth in payrolls is inflationary. To fight inflation, they say the Fed has to crush job growth and induce recession if need be to bring prices to heel. Under these conditions, commentators we follow argue the outlook for corporate earnings isn’t great. Hence, good news gets portrayed as really bad news.

Based on our observations, that was the general zeitgeist entering the release. Never mind that our research shows the link between jobs and inflation is tenuous at best. Never mind that rate hikes aren’t automatically negative for the economy or stock markets, in our experience, and that markets are very well aware the Fed is trying to tighten policy, which likely limits their surprise power. Never mind that we have found the Fed isn’t as powerful as commentators we follow suggest.

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The Fearful, Snap Reaction to the New Prime Minister

Editors’ Note: MarketMinder Europe’s political commentary is intentionally nonpartisan, favoring no party nor any politician, assessing developments solely for their potential market and economic effects.

The UK has a new prime minister, and commentators we follow around the globe are predictably focussing on a top politician’s personality and all manner of sociological issues. We will leave that to them, as we think stocks focus much more on actual policy. And on that front, we see plenty of room for the reality of new Prime Minister Liz Truss’s administration to deliver positive surprise. Several commentators we follow have argued that Truss’s economic policies amount to even faster inflation, potentially followed by a debt crisis, which a politicised Bank of England will be unable to fix.[i] We mostly see a new prime minister with a big agenda that is about to run into political gridlock. In other words, the status quo, which we think is likely to bring falling uncertainty and a positive surprise for stock markets.

At first blush, Truss seems to be making a break with the policies of her predecessor, Boris Johnson, and Rishi Sunak—Johnson’s Chancellor of the Exchequer and Truss’s leadership rival. After all, Johnson and Sunak raised the National Insurance Contribution, an unusual stroke for Conservative Party leaders—as was their decision to schedule a corporate tax increase for 2023.[ii] Truss has pledged to undo both and hewed rather closely to traditional Conservative policies on the campaign trail.[iii] But look beyond the past two years, and we think the picture changes. To us, Truss mostly channels Johnson’s economic policy rhetoric pre-COVID, when he and Sunak talked of boosting economic competitiveness and tackling the alleged regulatory and administrative bloat that arose from decades of EU membership. Johnson and Sunak don’t seem to have acted on this much, which many commentators we follow portrayed as a break with the Conservative Party’s 2019 election manifesto. Between her policy brief and cabinet appointments, Truss seems to be posturing her premiership as a return to those election commitments, which we reckon is hardly a radical or unprecedented move from markets’ perspective.

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On Britain's Rising Rates and Debt Service

Editors’ Note: MarketMinder Europe doesn’t make individual security recommendations. The below merely represent a broader theme we wish to highlight.

Whenever long-term interest rates rise, we find it isn’t long before financial commentators’ focus turns to debt—national debt. It already seemingly has in Britain, with 10-year Gilt yields closing August at their highest since early 2014—2.8%.[i] Our research shows that level isn’t high by global or historical standards. Nor do we think it ties to concerns about the UK’s creditworthiness, as we will explain—rather, we think it is part of a global, sentiment-fuelled wiggle as investors continue overthinking monetary policy institutions’ interest rate hikes. We doubt it sticks for long. Yet it is raising some eyebrows amongst financial commentators we follow because a relatively sizable portion of the UK’s outstanding debt has inflation-linked interest rates, making Britain’s debt service costs more sensitive to consumer price levels than America’s.[ii] Even with this factored in, however, we don’t think UK debt is a ticking time bomb likely to hit the economy or markets in the foreseeable future.

The raw numbers here might seem alarming. UK net debt (which excludes intra-government holdings, or those that the government owns itself) outstanding tops £2 trillion and finished fiscal 2021/2022 at 98.2% of gross domestic product (GDP).[iii] According to the official figures, 30% of the total Gilt pile is inflation-linked, and like rail fares, that linkage is to the antiquated Retail Price Index (RPI), which hit 12.3% y/y in July, creating the spectre of a rapidly rising interest rate bill.[iv]

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An Economic Data Check-In

Lately, we have seen economic data coming out a bit better than expected. Whilst a backward-looking glance won’t dictate where markets are headed, we think it helps lay down the baseline reality from which to gauge sentiment. Have a look at some of the higher-profile recent reports.

America’s July personal consumption expenditures (PCE) release last Friday showed inflation-adjusted consumption rising at Q3’s start and inflation (economy-wide price increases) moderating. Real PCE—aka consumer spending—rose 0.2% m/m.[i] (Exhibit 1) In our estimation, that isn’t gangbusters, but it is right on its monthly average rate since 2002.[ii] To us, that indicates underlying demand is holding up despite inflation.

Exhibit 1: American Consumer Spending Growth Slow, but Still Upward

Source: US Federal Reserve Bank of St. Louis, as of 1/9/2022. US real PCE and its goods and services components, January 2002 – July 2022. Recession shading uses US National Bureau of Economic Research (NBER) business cycle dates. NBER defines recession as a significant decline in economic activity that is spread across the economy and that lasts more than a few months.

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Will a ‘Housing Recession’ Spur Wider Economic Contraction?

With commentators we follow warning a UK property downturn looms, we think a look across the pond—where similar concerns have sprouted—may be instructive for investors. Last week, America’s National Association of Home Builders’ August survey suggested its members’ sales conditions are starting to deteriorate as US mortgage rates have doubled from last year, leading it to declare a “housing recession” is underway.[i] Besides ongoing supply chain problems lifting construction costs, builders noted cancellations are spiking. With American home inventories rising, housing starts slowing and reports of sellers slashing prices to attract baulking buyers, headline chatter over a potential residential real estate collapse is growing. Many of them warn such a downturn could hit the US economy hard—and send stocks slumping anew. But although the housing market may be weakening, we don’t think stocks are likely to mind much.

The American housing market has indeed hit a rough patch. US home sales have dropped sharply.

Exhibit 1: America’s Home Sales Sinking

Source: FactSet, as of 26/8/2022. US Census Bureau new privately owned houses sold and National Association of Realtors existing homes sold, January 2000 – July 2022.

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The UK's Commodity Supply Chain Adapts

Seemingly every couple weeks, we see more news breaking that yet another global energy producer is ramping up oil and natural gas exports to Europe. Israel is the latest example, with its energy ministry announcing natural gas production is up bigtime year to date amidst plans to increase exports to the EU.[i] We have seen many such anecdotes involving non-Russian suppliers, including Azerbaijan, Qatar, the US and others, but data on how all of this is panning out has been a bit thin, in our view.[ii] Germany publishes monthly crude oil imports by country but not natural gas. The Netherlands publishes both, but the data are values (in euros), not volumes (in barrels or tonnes or the like), subjecting them to big skew from commodity price swings. So you can imagine our excitement on Wednesday, when the UK’s Office for National Statistics (ONS) posted a report detailing how the country has adapted to Russian sanctions. It is but one example, but we think knowing how the UK has replaced Russian commodity imports may help investors get a better sense of how supply chains are readjusting, perhaps easing uncertainty as we head into the winter.

The UK’s main commodity sanctions included a pledge to phase out all Russian crude oil imports by yearend, cease natural gas imports as soon after that as possible, and ban all iron and steel products.[iii] As the ONS notes, Russia accounted for 24.1% of the UK’s refined oil imports in 2021, 5.9% of its crude oil imports and 4.9% of its natural gas imports.[iv] Now, the UK also produces its own crude oil, refined petroleum and natural gas, so these percentages don’t represent Russia’s share of UK consumption, which was more like 8% of total oil and oil products, according to Business Secretary Kwasi Kwarteng’s March estimates.[v] Much of its natural gas imports are also re-exported to Continental Europe.[vi] But refined petroleum imports in particular play a key role in the UK, making Russia’s impending absence an important hole to fill.[vii] Unsurprisingly, UK businesses haven’t waited for the bans to take effect: Russian fuel imports fell to zero in June.[viii] Meanwhile, the UK imported more refined oil from the UAE, Saudi Arabia, Belgium, the Netherlands and India.[ix]

That last one is perhaps most of interest, in our view, given India hasn’t ceased buying Russian crude—actually, it has ramped up Russian imports bigtime and is reportedly refining Russian oil into petrol and diesel shipped globally.[x] We think it is entirely possible that the UK is now simply buying Russian crude that was refined in India, underscoring an important point about energy markets, in our view: They are fully global, and total global production is what ultimately matters most. Even if Russian petroleum products are taking a more circuitous route than usual, they are still contributing to global supply, which we think goes a long way toward explaining oil prices’ fall from their March peak.[xi]

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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.