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.

Much Ado About UK GDP

Midway through November, a month and a half after September’s end, Q3 economic data are rather backward looking. Yet the UK’s Q3 GDP (gross domestic product, a government-produced measure of economic output), released late last week, let commentators we follow make comparisons, and the verdict amongst some seems to be that Britain is falling behind.[i] You see, on a quarterly basis, UK GDP remains -2.1% below its Q4 2019 pre-pandemic peak, lagging other major developed world economies.[ii] Fair enough, to an extent. For markets though, we think this is trivia. Whilst we think economic growth supports stocks, it isn’t a race, and our research shows stocks don’t move in lockstep with GDP.

Most coverage we read pointed to the UK’s slowing growth, which decelerated to 1.3% q/q in Q3 from Q2’s 5.5%, saying this means Britain’s recovery is faltering under the weight of post-Brexit supply disruptions and labour shortages.[iii] Whilst those issues may be crimping growth on the margin, they aren’t unique to the UK, in our view. We don’t think Brexit is the primary, or even a major, cause. For example, exports fell -1.9% q/q led by a -5.8% drop in goods exports.[iv] But the quarterly decline was driven by non-EU exports.[v] Meanwhile, services exports rose, driven by financial services.[vi] Imports rose 2.5% q/q, mostly from non-EU fuel imports.[vii] Not everything is about Brexit. Also notable: Services imports rose, too, as easing travel restrictions allowed more Britons to vacation abroad.[viii]

Beyond trade, manufacturing and construction fell -0.3% q/q and -1.5%, respectively, due mainly to ongoing chip shortages for cars and building supply delivery delays.[ix] But services, by far the UK’s biggest economic driver at close to 80% of GDP, rose 1.6% q/q, with accommodation and food services jumping 30.0% and recreation services up 19.6% in Q3.[x] Services output overall still slowed from Q2’s 6.5% q/q growth, but it is now just -0.7% below its Q4 2019 level.[xi] In our view, growth was always likely to slow as output approached pre-pandemic highs and the burst from easing restrictions faded.

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‘Too Few Goods’—the Simple Explanation for October’s Elevated US Inflation Rates

The US Consumer Price Index (CPI) inflation rate hit a 30-year high, 6.2% y/y, in October.[i] Many financial commentators we follow argue this is a big warning sign for the UK and Europe, implying dogged, persistent inflation will take hold on both sides of the Atlantic Ocean. Whilst we agree inflation rates are likely to remain elevated in the short term, we still think it is premature to say high inflation will last indefinitely. In our view, America’s high inflation rate is a symptom of a reality we have all lived through the past 20 months: It is far, far easier for a government to suddenly stop economic activity via lockdown than for businesses to restart it once regulations permit. We think stocks have long understood this, even if it is only just starting to dawn on the world at large.

We do think it is useful to look to the US as a preview for the UK and Europe, given America reopened from lockdowns sooner, making several US economic indicators’ recovery run a few months ahead of those in the UK and Europe.[ii] And in America, the sudden halt and choppy restart of the global economy explains much of consumer prices’ trajectory since early 2020, in our view. First lockdowns shattered production and demand, sending prices tumbling.[iii] That created a low year-over-year comparison point this spring, when vaccines’ rollout enabled broader reopening, juicing consumer demand. We think that added skew to the year-over-year inflation rate, making the month-over-month rate a better place to look when assessing inflation’s drivers. As Exhibit 1 shows, the biggest contributors to month-over-month rates this spring and summer were categories tied most to reopening, including hotels, airlines and used cars—which were in short supply after rental car companies rebuilt their fleets in a hurry.

But as summer rolled into autumn, some reopening-related pressures faded, as Exhibit 1 also demonstrates, and new pressures appeared in their wake. Many stemmed from supply shortages, which in turn stemmed from labour shortages and global shipping delays. These are perhaps most visible in accelerating food and vehicle prices. Owners’ equivalent rent is another recent driver—an imaginary cost that no one pays, as it is the hypothetical amount a homeowner would pay to rent their own house. The other recent big contributor is energy prices—namely oil and petrol prices—which jumped when global demand surged as coal and natural gas prices spiked and utilities throughout Europe and Asia needed an alternate power source in a hurry.[iv] In October, energy alone accounted for over one-third of CPI’s 0.9% m/m rise.[v]

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About That Vaccine-Driven Value Rally…

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

One year ago Tuesday, Pfizer and BioNTech announced that their COVID vaccine candidate had shown promising results in advanced American clinical trials, and commentators who had long championed value-orientated stocks got a proverbial shot in the arm. Our research shows value stocks normally lead early in a bull market (a long period of generally rising equity prices), but growth-orientated shares had led since stocks bottomed the prior March.[i] The vaccine announcement led many commentators we follow to argue they weren’t wrong when they argued value would lead, just early. According to their logic, value had lagged because lingering lockdowns were disproportionately harming these firms, they claimed, and vaccinations would get the party started for real. A year later, that hasn’t exactly worked out as they anticipated, as we will show.

To set the stage, growth-orientated stocks generally have higher valuation metrics like price-to-earnings ratios and focus on re-investing profits into the core business to expand over time, making their profits relatively less sensitive to economic ups and downs. Their earnings often come more from long-term technological trends than near-term economic conditions. Value-orientated shares, by contrast, tend to carry relatively lower price-to-earnings ratios and more debt, making them more sensitive to economic conditions, and they tend to return more money to shareholders via dividends and share buybacks and invest less in growth-orientated endeavours. Their economic sensitivity is at the root of forecasts for them to lead once vaccines rolled out.

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What Q3 Earnings Results Say About Stocks and Inflation

Q3 earnings season is drawing to a close for US corporations, which still have mandatory quarterly reporting requirements—making them a handy snapshot of profit and sales results for globally diversified investors. With over 91% of companies in the S&P 500 Index reporting results through Monday, profits are up 39.2% from Q3 2020, shattering analysts’ consensus expectations for a 23.5% y/y rise.[i] We don’t find strong growth shocking, considering earnings fell -5.8% y/y a year ago, meaning today’s figures look back to a depressed base.[ii] But we do think the big divergence from expectations is noteworthy, particularly for what it reveals about how companies are adapting to the supply chain crunch, labour shortage and rising costs that many financial commentators we follow warn are hobbling global commerce.

All US sectors enjoyed growing earnings in Q3, with growth rates ranging from 3.7% y/y (Utilities) to irrational (Energy, whose net income rose from a -$1.5 billion loss in Q3 2020 to a $24.8 billion gain, making the growth rate mathematically impossible to calculate).[iii] The other top sectors, Materials (90.1% y/y) and Industrials (69.2%), received a clear reopening boost and benefitted from easy year-over-year comparisons. Both sectors earnings were weak in Q3 2020, tied to lockdowns’ impact on economic activity globally, creating low-hanging fruit for earnings to improve when reopening boosted demand for raw materials and manufacturing.[iv] But we don’t think the same can be said of two sectors that were close on their heels: Tech (36.3%) and Communication Services (35.0%), whose Interactive Media & Services industry is home to several Tech-like giants.[v] Both sectors were resilient during lockdowns, with minimal damage to earnings in Q2 2020 and modest growth in Q3 2020.[vi] In our view, their ability to generate fast growth off relatively difficult year-over-year benchmarks speaks to just how strong their fundamentals are now.

Exhibit 1 offers one way to see this: gross profit margins. That is, sales minus cost of goods, divided by cost of goods. This is a quick and dirty measure of a company’s core profitability before adjustments for taxes, debt service and other accounting items that are often subject to one-off skew. Our research finds companies with slim margins generally have to get outside financing to fund expansion (think: bank loans or bond issuance) and have a hard time swallowing rising costs. Those with fat margins are much more self-sufficient. They can plow profits back into the business, self-financing future growth. They also have more bandwidth to weather cost pressures. Tech and Communication Services have the fattest gross margins in the S&P 500, which may not shock. But you might be surprised to see both have overall improved margins this year.

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Looking Beyond the ‘Brexit Is Bad’ Narrative

With the two-year anniversary of the UK’s departure from the EU about two months from now, we have seen some financial commentators argue Brexit remains disastrous for the UK economy to this day, saying the additional paperwork and associated higher costs have squashed UK businesses that depend on frictionless shipping across the English Channel. We agree Brexit has likely had some effects, but the degree to which Brexit is responsible for weak UK trade data is debatable in light of global developments. That so many UK observers we follow seem to emphasise Brexit over extant global issues shows how this event, now long since behind markets, has become a near-permanent feature of background chatter in the UK, in our view.

Our review of UK trade data reveals Brexit-related distortions since June 2016’s vote to leave the EU. As Exhibit 1 shows, trade with the EU spiked leading up to March and October 2019, the earlier Brexit deadlines that were delayed at the last minute. Our research found businesses raced to front-load exports and stockpile ahead of potential no-deal Brexits in which the UK left the EU without a replacement trade agreement, which many observers we follow warned risked bringing draconian tariffs and customs barriers overnight. We saw a repeat as businesses pulled activity forward late last year before the post-Brexit transition period ended and the UK officially left the EU’s customs union and single market.[i] In our view, trade was always likely to drop after those initial bursts of activity—somewhat significantly—and take some time to revert back to longer-term trends. The deadlines simply pulled some demand forward, in our view, leaving it weak in their wake.[ii]

Exhibit 1: The UK’s EU Imports and Exports Since January 2015

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The Inscrutable Bank of England

Welp, after Bank of England (BoE) Governor Andrew Bailey seemingly went to great pains in recent weeks to signal the BoE would raise its benchmark short-term interest rate Thursday, it didn’t. Coverage we follow suggests this is the kind of action that led one Member of Parliament to dub Bailey’s predecessor, Governor Mark Carney, an “unreliable boyfriend.”[i] Similar chatter to that abounded following Bailey’s post-non-hike press conference.[ii] For investors, we think this illustrates why you shouldn’t take monetary policymakers’ suggestions about future actions—their “forward guidance”—at their word.

Whilst Bailey said the BoE’s decision to keep its Bank Rate on hold at 0.1% was a “very close call,” the Monetary Policy Committee’s (MPC) 7 – 2 vote seemingly belies that.[iii] The MPC also voted 6 – 3 to stick with the previously announced December end to increasing its gilt holdings under quantitative easing (QE, monetary policy institutions’ asset purchases intended to reduce long-term interest rates and spur loan demand), eschewing calls for a quicker cessation from some analysts we follow.[iv]

Normally, policy meetings with no changes are a snoozefest to us. But this one left many commentators we follow shaking their heads. Less than a month ago, Bailey warned that the BoE needed to prevent higher inflation expectations from becoming entrenched as energy prices spiked.[v] As he put it, “That’s why we, at the Bank of England have signalled, and this is another signal, that we will have to act. But of course that action comes in our monetary policy meetings.”[vi]

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Your Friday International Economic Data Roundup

The world’s economic calendar was light on UK data this week, but happily for people who like digging into numbers, the rest of the world released a flurry of fun stats. In our view, economic data are generally backward-looking and don’t predict equity returns. Economic statistics report what happened in a previous month, quarter or year, whilst our research shows stocks generally price in what investors collectively expect to happen over the next 3 – 30 months. But we did find some nuggets of global interest, so let us share.

America’s record-high trade deficit is not the real story.

The US imported $80.9 billion worth of goods and services more than it exported in September, prompting the usually flurry of financial commentators hyping the record-high deficit.[i] In our view, the trade gap (exports minus imports) is a largely meaningless statistic with no bearing on a country’s economic health. Our research shows a deficit (imports exceeding exports) isn’t inherently negative, and a surplus (exports exceeding imports) isn’t automatically a sign of strength. After all, imports generally represent domestic demand, and because of the way international commerce works, a surplus of inbound investment inflows offsets a trade deficit. We think the trade gap is nothing more than an accounting factoid.

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No, Big Wage Gains Aren’t Automatically Bad News for Prices

Pop quiz: When is fast wage growth bad news? Common sense might say the answer is “never,” as making more money is always a good thing for those on the receiving end of higher paychecks. But that viewpoint wasn’t too prominent in news coverage we reviewed when data released last week showed US wages rising 4.2% y/y in Q3, the fastest rise in over 30 years.[i] Nor have we seen much excitement amongst UK financial commentators over the prospect of soaring jobs vacancies, which employers seem to be struggling to fill, bringing higher pay. Instead, across many of the outlets we follow, the consensus viewpoint is that because rising wages followed months of above-average inflation, they are allegedly signs of a potentially brewing wage-price spiral.[ii] Meaning, a vicious cycle in which businesses raise wages to attract workers when inflation is high, then raise prices to preserve margins, fuelling more inflation, necessitating even higher wages and more price increases, lather, rinse, repeat. As logical as this might sound, however, our research shows it has little bearing in reality, and we think investors can cross it off their list of worries.

The wage-price spiral was all the rage in the 1960s after an economist named A.W. Phillips created a model showing a link between the unemployment rate and inflation. This model, now known as the Phillips Curve, has underpinned monetary policy in the US and UK for decades. It posited that when unemployment is high, businesses don’t need to raise wages to attract workers, which keeps inflation low. But when unemployment is low, according to the model, wages and inflation rise. Some Phillips Curve models use unemployment and wages, whilst others use unemployment and inflation. All hinge on wage-price spiral theory.

Nobel laureate economist Milton Friedman took this on in a 1968 speech entitled, “The Role of Monetary Policy,” which he delivered as an address to the American Economic Association. In it, he posited that the Phillips Curve was flawed because it focused on nominal wages, not real or inflation-adjusted wages. That essentially led to a model that argued inflation drives inflation, which is fatally circular. You can find his entire argument here if you are interested—it is long but thorough and clear.

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Federal Reserve Reduces Asset Purchases. World Yawns.

The US Federal Reserve (Fed) officially tapered—slowed—its quantitative easing (QE) bond purchases Wednesday, and far from triggering the tantrum many financial commentators we follow warned of earlier this summer, it ended up being a giant snooze. Instead of being rocked by the news, the S&P 500 flipped from slightly negative on the day before the announcement to close up 0.7%.[i] The 10-year US Treasury yield rose all of 4 basis points (0.04 percentage point) on the day, from 1.55% to 1.59%.[ii] Most commentary we read on the move seemed laced with sleep aid, with the notion of what many commentators have long called a “taper tantrum”—prevalent mere months ago—largely disappearing down George Orwell’s famous memory hole. About all we saw in terms of negative sentiment were questions about when the Fed would raise short-term interest rates and whether doing so would choke growth. We think this reiterates a timeless lesson: Markets pre-price widely expected events, including monetary policy decisions, which our research shows don’t have a preset market impact.

We don’t often give monetary policymakers kudos, but we would like to start by presenting Fed head Jerome Powell and friends the (ironically named) Mark Carney Award for Acting in Accordance with Forward Guidance, rather than saying A but doing B at the last minute.[iii] The minutes from the Fed’s July meeting revealed monetary policymakers “judged that it could be appropriate to start reducing the pace of asset purchases this year.”[iv] In his late-August (virtual) address at the (virtual) Jackson Hole, Wyoming gathering of global monetary policymakers, Powell reiterated that stance and said he thought inflation had made enough “substantial further progress” toward the Fed’s long-run 2% year-over-year target to warrant tapering. Minutes from September’s meeting teed up this month as Taper Decision Day and outlined a potential path for “monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities (MBS).”[v] That is precisely what the Fed announced yesterday, with the reduction beginning this month. The policy statement left some wiggle room to change course in the future if economic data veer unexpectedly,[vi] but otherwise, QE is set to conclude in June.

And that was that! No fireworks. No big market swings. The tantrum many commentators we follow wrote about over the summer just hasn’t happened. The S&P 500 is now up 5.1% since those July meeting minutes were released in mid-August.[vii] 10-year Treasury yields are up 33 basis points.[viii] That is even smaller than its move from May to December 2013, the period when the Fed was publicly discussing tapering its post-financial-crisis quantitative easing programme.[ix] In our view, this echoes the general non-reactions to this year’s other big monetary policy developments. Moves by the Bank of England (BoE), European Central Bank, Bank of Canada and Reserve Bank of Australia to inch back from policies targeting lower long-term interest rates all came and went without much fuss.[x]

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Inflation Is Up, Gold Seems Dull

A long-held investment tenet amongst commentators we follow claims gold is a great way to insulate or hedge an investment portfolio against inflation, which is a broad rise in prices across the economy. But consider: Despite the UK Consumer Price Index (CPI) hitting 3.2% y/y—a rate last seen in 2012 and an upturn echoed across the developed world—gold is down -5.4% on the year.[i] In our view, this is a clue to a broader truth: History shows gold’s inflation-hedging reputation rings hollow.

Exhibit 1 illustrates this year’s sharp divergence. Despite UK CPI’s accelerating from 0.6% y/y in December and a similar acceleration of American inflation, gold has floundered.

Exhibit 1: No Hedge Year to Date

Source: FactSet, as of 29/10/2021. Gold price per troy ounce, 31/12/2020 – 28/10/2021, and UK CPI, December 2021 – September 2021. As the Royal Mint explains: “A troy ounce is a system of weights used for precious metals and gems, based on a pound of 12 ounces as opposed to the traditional 16.” The Consumer Price Index is a national measure of prices across a broad range of goods and services.

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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.