Team No Comments

Share prices stumble after just two months of less loose policy from the Fed

Please find below, an update in relation to share prices, received from AJ Bell yesterday – 23/01/2022

Well, that didn’t take long. The Fed began to pump less Quantitative Easing (QE) into the financial system in November and the stock market’s wheels have started to wobble after barely two months of less cheap money, let alone move to withdraw it.

Investors are already starting to ask themselves how much the US Federal Reserve can do to tighten monetary policy before it either puts the brakes on the economy, breaks the stock market or both – and the answer might be not very far at all.

Some of the asset classes, funds and individual stocks which have performed best, attracted the hottest money flows and drawn the biggest headlines have started to flag, or even fall sharply. All are generally toward the riskiest end of the asset class spectrum, where the rewards can be highest, but the risks are too, should something go wrong.

Small caps are wobbling. America’s Russell 2000 index is now trading below where it was twelve months ago, and the UK’s FTSE Small Cap benchmark is losing a little momentum.

Source: Refinitiv data

Meme stocks are taking a pasting. You have to hope that anyone who has held on to GameStopAMC Entertainment and others to thwart the hedge funds who were short-selling these names have not ended up cutting off their own noses to spite their face. Buyers in the very early days may still be in the black, but anyone who piled in late to join the fun or try to make a fast buck could now be deeply in the red.

Source: Refinitiv data

Cryptocurrencies have swooned once more.

Source: Refinitiv data

And the poster child for fans of momentum, tech and potential disruptive winners, the ARK Innovations Exchange-Traded Fund (ETF), continues to sink.

Source: Refinitiv data

It may not be a coincidence that the Fed has started to reduce the amount of monetary stimulus it was pumping into the US economy via Quantitative Easing. It started to cut QE from a run-rate $120 billion a month by $15 billion a month in November and then by $30 billion a month from December.

That should mean the Fed’s $8.8 trillion balance sheet stops growing in March. After that, the central bank may turn to Quantitative Tightening (QT) and start to withdraw stimulus and shrink its balance sheet.

Meanwhile, the markets have started to price in at least four one-quarter percentage point interest rate increases from the US central bank by the end of this year.

Source: CME Fedwatch

Recent precedents for tighter monetary policy (or even simply, less loose, less accommodative policy) are enough to give investors pause for thought:

  • In 2013, financial markets rebelled at the very talk of tighter policy and the so-called Taper Tantrum persuaded the Fed to back off.
  • Between December 2015 and December 2018, under Janet Yellen and then Mr Powell, the Fed raised rates from 0.25% to 2.50%. It also shrank its balance sheet by $700 billion, or some 17%, between 2017 and 2019. But it then stopped as the US economy began to slow and signs of stress began to show in the US interbank funding markets in autumn 2019. As a result, the Fed’s balance sheet had started to grow again several months before the pandemic prompted fresh interest rate cuts and more QE in the spring of 2020.

Source: FRED – St. Louis Federal Reserve database, US Federal Reserve

There are good reasons for such caution. Global debt is so much higher now than it was in 2013 or even 2018, so the economy will be much more sensitive to even minor changes in interest rates.

More specifically for share prices and company valuations, tighter monetary policy – at a time when indebted Governments are throttling back on their fiscal stimulus programmes and looking for fresh sources of income from tax or social levies – has four possible implications:

  • Higher interest rates may mean an economic slowdown, again because there is so much more debt in the system. As the old saying goes, economic upturns don’t die of old age, they are murdered in their beds by the US Federal Reserve. In addition, consumers’ ability to consume will be crimped if inflation outstrips wage growth and their incomes start to stagnate or fall in real terms.
  • Higher rates reflect inflation, and faster (nominal) GDP means investors do not have to pay a premium for long-term future growth (for secular growth names like technology and biotechnology) when potentially faster, near-term cyclical growth (‘value’) can be bought for much lower multiples (even if it comes from oils, miners, banks).
  • Inflation can eat away at corporate margins and profits. Right now, they stand both at pretty much record highs, as do valuations, at least in the USA, based on ratios such as market cap-to-GDP and Professor Robert Shiller’s cyclically-adjusted price-to-earnings (CAPE) ratio. If earnings start falling, valuations could do so, too, if confidence wobbles. Instead of the double-whammy that provides gearing to the upside, as investors pay higher multiples for higher earnings to give ever-higher share prices, markets see the opposite: earnings fall, investors pay lower multiples for lower earnings and share prices fall faster.
  • Higher interest rates mean analysts and investors deploy an increased discount rate in their discounted cash flow models to calculate the net present value (NPV) of future cash flows from long-term growth stocks. A higher discount rate means lower NPV. A Lower NPV means a lower theoretical value of the equity and that means a lower share price.

All four are clearly worrying previously rampant financial markets but that in theory should not be the concern of the US Federal Reserve, or indeed any central bank. Their job is to keep inflation on the straight and narrow, to ensure it does not destroy wealth and prosperity and imbalance the economy.

But a decade and more of zero interest rates and QE – unintentionally or intentionally (judging by a string of speeches from former Fed chair Ben S. Bernanke dating back to at least 2003) – have persuaded or forced investors to take ever-increasing amounts of risk to get a return on their money.

Central banks are presumably concerned that having tried to create a wealth effect by stoking asset prices, the opposite effect could kick now in, hitting confidence and consumers’ ability and willingness to spend.

If inflation really does prove to be sticky, or even keep going higher, central banks may therefore be stuck between a rock and a hard place. They will want to control inflation on one side but their ability to jack up interest rates and withdraw QE may be constrained by record debts and concerns about the economy, employment (and financial markets’ stability) on the other.

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

24th January 2022

Team No Comments

Oil hitting $100 could take the FTSE 100 to new record highs

Please see below article received from AJ Bell yesterday afternoon, which explains that inflationary pressures are building as crude markets hit their highest level since 2015.

With Brent crude oil at seven-and-a-half-year highs above $88 per barrel there is mounting speculation that prices could hit $100 for the first time since 2014.

The FTSE 100 is also within striking distance of the 7,903.50 intra-day high attained on 22 May 2018. Oil producers are among the big stocks in the FTSE 100.

Oil is moving higher as concerns over the impact on demand of the Omicron variant have faded, as well as supply disruption. An escalation of hostilities on the border between Russia and Ukraine could act as a further jolt to the crude market, only adding to the current inflationary pressures.

These in turn could be positive for the FTSE 100 given its make-up. AJ Bell investment director Russ Mould says: ‘The UK stock market may not be a bad place to be if inflation stays entrenched and confounds any efforts by central banks to rein it in.

‘This is because the leading gainers (year-to-date) operate in industries where demand is fairly price inelastic, such as energy and tobacco; where higher interest rates and steeper yield curves may help profit margins and earnings, at least up to a point, such as banks and insurers; or they own real assets where supply is expensive to build and where that supply is growing more slowly relative to money supply, such as miners.’

We will continue to publish relevant market news and content, so please check in again with us shortly.

Chloe

21/01/2022

Team No Comments

Brooks Macdonald: Daily Investment Update

Please see yesterdays Daily Investment Update from Brooks Macdonald:

What has happened

A wild ride for sovereign bonds yesterday led to another leg lower in equity markets with only around 10% of US large cap stocks managing to achieve a gain on the day. The catalyst for this was another incremental repricing of interest rate expectations, there was no specific event to cause this, but sentiment appears to be increasingly falling behind a tightening narrative.

Energy

One sector that did manage to avoid the US equity selloff was energy which has been supported by the strong year-to-date gains in both Brent and WTI oil. These numbers come on the back of a strong 2021 however the last quarter of last year saw oil retrench from its highs as Omicron fears grew. The impact of rising energy costs can be seen in the UK’s CPI headline release today which beat analyst forecasts at both the headline and core levels with a 0.5% month-on-month move higher. Higher energy costs create challenges for policymakers, not only due to its direct impact on inflation but also the indirect inflationary impact as it works through complex supply chain processes. Central bankers are also having to weigh up the impact of consumer inflation on demand with CPI now outstripping wage growth in many countries. There have been supply chain issues within the oil sector and the rapid improvement in sentiment around the Omicron variant has caused expected demand to increase markedly.

Financials

As is tradition, US financials have been leading the US earnings cycle, but so far the results have been mixed despite the sector being in favour during the rotation this year. Most banks have pointed to the revenue impact of lower trading revenues in the last quarter of 2021 and have guided that profitability will be impacted by higher wage inflation. Within the banking sector there is a spectrum of those more reliant on capital market activity compared to more traditional banking models that are beneficiaries of a higher yield story. Yesterday’s price action will be a salient reminder to investors of the lack of homogeneity in the sector.

What does Brooks Macdonald think

With the Fed communication blackout there is relatively little on which investors can hang their hat at the moment. The rotation has been painful for many active investors and most are asking whether the Fed will step away from their tightening narrative given the market impact so far, or whether concerns around inflation are sufficient that tackling consumer price rises is the primary concern this time.

Bloomberg as at 19/01/2022. TR denotes Net Total Return

Please continue to check back for our latest blog posts and updates.

Andrew Lloyd DipPFS

20/01/2022

Team No Comments

Brewin Dolphin – Markets in a Minute

Please see below this week’s Markets in a Minute update from Brewin Dolphin – received late yesterday afternoon – 18/01/2022

Equities fall as US inflation surges to 7%

Concerns about rising inflation and its impact on central bank policy continued to weigh on global equities last week.

In the US, the S&P 500 and the Dow lost 0.3% and 0.9%, respectively, as consumer prices rose at their fastest annual pace in almost 40 years. Disappointing fourth quarter earnings from major banks weighed on the financials sector, whereas energy stocks rallied as oil prices increased.

Fears about faster-than-expected interest rate hikes spilled over into Europe, where the STOXX 600 declined 1.1% and Germany’s Dax slipped 0.4%. The FTSE 100 managed another week of gains, rising by 0.8% following encouraging UK gross domestic product (GDP) figures.

Weak investor sentiment was also evident in Asia, where the Nikkei 225 and Shanghai Composite shed 1.2% and 1.6%, respectively.

FTSE 100 extends gains as GSK rejects offer

The FTSE 100 extended gains on Monday (17 January), rising 0.9% to 7,611. GlaxoSmithKline was among the top performers after it rejected a £50bn offer from Unilever for its consumer healthcare business, saying it “fundamentally undervalued” the business and its prospects. In economic news, figures from Rightmove showed the average price of property coming to market rose by 7.6% in January from a year ago – the highest annual rate since May 2016.

The Shanghai Composite gained 0.6% after figures showed the Chinese economy grew faster than expected in the final quarter of 2021, with GDP growth of 4.0% compared with a year earlier. In 2021 as a whole, GDP grew by 8.1%.

US markets were closed on Monday for Martin Luther King, Jr Day.

At the start of trading on Tuesday, the FTSE 100 was down 0.7% as investors digested the latest jobs data from the Office for National Statistics (ONS). The UK unemployment rate fell to 4.1% from 4.5% in the September to November period, while vacancies hit another record high as employers struggled to fill positions. Wage growth fell behind inflation in November, meaning real wages shrank for the first time since July 2020.

Inflation woes persist

The closely watched US consumer price index (CPI), released last Wednesday, did little to calm fears about inflation and interest rates. The data from the Labor Department showed inflation rose by 7.0% year-on-year in December, marking the fastest annual pace since 1982.

On a monthly basis, the CPI rose by 0.5% following a 0.8% gain in November. There were continued strong gains in rental accommodation and used car prices, and a smaller 0.5% rise in food prices. Gas prices declined by 0.5% after surging by 6.1% in both the previous two months.

Separate data showed inflation is having an impact on consumer sentiment. The University of Michigan’s preliminary index showed consumer sentiment slipped by 2.5% in early January from the previous month, and now stands at its second-lowest level in a decade. The top concern among respondents was inflation, and the percentage who said they were worse off financially than a year ago reached its highest since 2014.

The latest inflation reading has boosted expectations that the Federal Reserve will start increasing interest rates from March, with four or even five rate hikes this year.

China inflation slows

In contrast to the US, inflation in China slowed more than expected in December, fuelling speculation that policymakers could loosen monetary policy further and cut interest rates. The CPI increased by an annualised 1.5%, down from 2.3% the previous month and lower than the 1.8% rise expected in a Reuters poll. Food prices fell by 1.2% year-on-year.

The producer price index, which hit a 26-year high in October, rose by 10.3%, down from 12.9% in November. This came after the government took measures to stabilise high raw material prices.

UK GDP better than expected

Here in the UK, data released last week showed the economy finally surpassed its pre-pandemic size in November, after growing by a bigger-than-expected 0.9% from the previous month. The economy was 0.7% larger than in February 2020, the month before the country went into its first lockdown, the ONS said. The UK economy shrank by more than 9% in 2020, one of the biggest slumps among the world’s richest nations.

The ONS said services, production and construction output all increased in November. Services and construction are now 1.3% above pre-coronavirus levels, while production remains 2.6% below.

Many economists expect to see a fresh hit to GDP growth for December, when the spread of the Omicron variant resulted in Plan B measures being introduced and severe staff shortages. This could then hinder overall fourth quarter GDP growth. The ONS said GDP in the fourth quarter will either reach or surpass its pre-coronavirus level, provided the December 2021 estimate does not fall by more than 0.2% and there are no downward revisions to the October and November figures.

On Thursday, data showed there were record levels of staff absence around the turn of the year and a slump in restaurant bookings. Across the private sector, 2.7% of staff were absent in late December because of Covid symptoms or self-isolation, the highest since the ONS began collecting these figures. Meanwhile, 44% of businesses in the food and hotel sector saw an increase in cancellations in December, rising to 64% for businesses in the ‘other services’ category, which includes firms such as beauty parlours.

Please continue to check back for our latest blog posts and updates.

Charlotte Clarke

19/01/2022

Team No Comments

Protecting against inflation: Storm in the ports

The outlook for inflation is the most important call for asset allocators this year. This paper is the first of a three-part series on the causes of inflation, and its consequences for investors. In this paper we look at the supply side problems that have caused a spike in goods prices and question how quickly they will fade. Next week we will discuss why the labour market is pivotal in the inflation debate. Finally, we will consider the options available for investors to protect their capital.

Too much money chasing too few goods

Surging goods prices have been a key contributor to inflation, and currently stand at record levels across many developed markets (Exhibit 1). The explanation for why this has occurred can be divided into three categories:

  1. booming demand, 2) supply that has failed to keep up, and 3) major transportation issues that have made deliveries slower and more expensive.

Soaring demand is a major factor behind the sharp rise in core goods inflation. Pandemic related mobility restrictions have limited the ability of consumers to spend on experiences, but with incomes protected via cash payouts and enhanced unemployment benefits, households have instead chosen to stock up on “stuff”. Despite this spending splurge, demand should remain strong in 2022.

Households are still sitting on excess savings from the pandemic, worth close to 10% of domestic GDP in both the US and the UK, while rising stock markets and property prices have also boosted consumer net wealth.

The key metrics to monitor?


The split of US consumer spending between goods and services. With US services spending still 3% below the pre-pandemic trend (compared to goods spending which is now 20% above its pre-pandemic trend), the scope for a rotation away from goods and towards services is clear (Exhibit 2). Further progress in the shift from a pandemic to endemic Covid-19 situation will be required, particularly if international travel is to restart in earnest.

Emerging Market production pressures

Just as demand for goods has soared, the ability of Asian manufacturers to respond to the demand shock has been hampered by more stringent pandemic restrictions and slower vaccination rollouts. As the Delta variant spread, national lockdowns were required for much of last summer in Malaysia and Indonesia, while Thailand and Vietnam were forced to lockdown high-risk regions. Each of these nations have now moved away from their “zero-Covid” approaches which bodes well for some improvement in 2022, but this episode has clearly highlighted the fragility of global supply chains. Even if global exports are running at 95% of capacity, if the missing 5% contains components that are essential to be able to finish final products, the manufacturing world has a major problem on its hands. This issue has been especially acute in the auto industry. With Asia responsible for 75% of global semiconductor production, US and European auto production has been hit very hard, driving used car prices higher. Semiconductor companies are now working to increase production and capacity, but many auto manufacturers are indicating that chip shortages are likely to persist for at least the first half of this year.

China remains one of the last major nations to actively pursue a “zero-Covid” strategy. The nation’s ability to quickly control outbreaks has been highly effective so far, although this has been at the cost of substantial supply chain disruption. A month-long shutdown last summer of Yantian Port created delays akin to the Suez Canal blockage, as did a two week shutdown of Ningbo- Zhoushan – China’s second busiest port – after a worker tested positive for Covid-19. Given Omicron’s much greater transmissibility, uncertainty around the efficacy of the Sinovac vaccine and little sign of Beijing wanting to change their approach until at least after the Winter Olympics, there is a clear risk of intermittent disruption in China for several months to come.

The key metrics to monitor?


Asian manufacturing PMIs (Purchasing Managers’ Index), specifically the components focused on levels of output and supplier delivery times (Exhibit 3). Delivery times remain long but are generally improving, while output has picked up recently. The resilience of these metrics against the Omicron variant bears watching.

Global transportation troubles

For the goods that have managed to reach the end of the production line complete, major issues in transportation networks have made their journey to consumers both slower and more costly. The uneven timing of national lockdowns and reopenings have created supply and demand imbalances for shipping across the world, resulting in costs surging by as much as seven times pre-pandemic rates on routes from east to west (Exhibit 4). Capacity in global shipping was already quite constrained prior to the pandemic, and while new orders for container vessels have picked up sharply, this new capacity is unlikely to come online until 2023 at the earliest.

Land-based problems have also been evident. In the US, the twin ports of Los Angeles and Long Beach account for almost 40% of the country’s imported goods, but major congestion has led to ships waiting an average of two to three weeks before being able to pull into a berth. With empty containers piling up in port and a lack of truck drivers for the final delivery leg, reducing congestion has become a political priority for the US administration.

The key metrics to monitor?


We will be monitoring two metrics particularly closely: 1) shipping costs in key east to west routes, and 2) the number of container ships anchored in LA and Long Beach. Both have recently showed signs of stabilisation having peaked in the autumn, but are still at levels indicative of significant stress.

The impact of Omicron

With the Omicron variant spreading rapidly across Europe and the US but yet to really hit Asia at the time of writing, clearly the macro impact of the latest mutation remains uncertain. Our base case is that Omicron will serve to prolong the supply chain pressure from both the demand and the supply side. In terms of demand, the impact should not be as great as that witnessed in 2020 and 2021, given more targeted fiscal support and households having already bought lots of the big-ticket items they wanted. That said, greater restrictions on mobility would delay the rotation from goods to services spending. In terms of supply, Covid-related disruption would create further restrictions on Asia’s production capacity, particularly in countries where vaccination rates are lower, or vaccines are less effective.

Conclusion

We expect supply chain issues to persist in 2022, with significant improvements only likely to be seen from the second half of the year onwards. Problems have been created by both excess demand and a shortage of supply, while the fragile nature of the just-in-time approach to global manufacturing has been laid bare. Demand is set to remain robust this year, but a rotation from goods to services spending is crucial to relieving some of the stress seen in goods prices. Whether inflation then falls back to the stubbornly low levels observed in the last cycle depends on the labour market – a topic we will turn to next week.

Please check in with us again soon for further relevant content and market-related news.

Chloe

18/01/2022

Team No Comments

Why oils, metals and banks hold the key to the FTSE 100 in 2022

Please see below, an article from AJ Bell examining the key determinants of the FTSE 100 performance in 2022 – received late yesterday afternoon – 16/01/2022

The FTSE 100 is up by around 10% over the past 12 months, and it is now trading within a couple of percentage points of the all-time closing high of 7,878 reached back in May 2018. Vaccinations, an end to lockdowns (in England, at least), ultra-loose monetary policy from the Bank of England, fiscal support from the Government, and a global economic recovery are all possible reasons for the headline index’s steady advance from the pandemic-induced panic low of 4,994 in March 2020.

“The question now is if catalysts are required for the FTSE 100 and UK equities to make further gains, and the sort of advances which justify exposure within the realms of a balanced asset allocation.”

But advisers and clients must look forward when they plan portfolios, not backwards, so the question now is if catalysts are required for the FTSE 100 and UK equities to make further gains, and the sort of advances which justify exposure within the realms of a balanced asset allocation.

Dividend payments are one possibility. A prospective yield of 3.9% for 2022 from ordinary dividends, with the prospect of further special payments on top, may appeal to some, although with UK headline inflation running at 5.1%, according to the consumer price index, that part of the investment case for the FTSE 100 and UK equities looks less enticing than it once did.

Merger and acquisition activity is another. Over 70 UK quoted firms received bids in 2021 and two FTSE 100 firms were acquired: insurer RSA (in a deal that was announced in 2020) and grocer Morrisons. Overseas buyers snapped up both and a pound that has failed to regain its pre-Brexit poll levels from 2016 may have had a role to play here, as it made these assets look cheaper to euro- and dollar-denominated buyers.

Bid activity suggests there is value to be had, but value still needs something to happen to crystallise it. And perhaps that takes us on to earnings momentum.

Go with the flow

The good news is that earnings momentum remains positive for the FTSE 100 as analysts continue to increase their profit estimates.

“The good news is that earnings momentum remains positive for the FTSE 100 as analysts continue to increase their profit estimates. The less good news is that aggregate profits growth for the index is expected to slow to a virtual crawl following 2021’s rebound.”

Aggregate earnings forecasts for the FTSE 100 in 2022 and 2023 continue to rise

Source: Company accounts, Marketscreener, analysts’ consensus forecasts

The less good news is that aggregate profits growth for the index is expected to slow to a virtual crawl following 2021’s rebound. Not all of the numbers are in yet, but total pre-tax profits for the FTSE 100 are expected to have doubled in 2021. While it is unrealistic to expect such a torrid pace to continue, advisers and clients could be forgiven for looking askance at estimates which look for 6% profits growth in 2022 and just 1% in 2023.

Aggregate earnings growth for the FTSE 100 is expected to slow dramatically in 2022 and 2023

Source: Company accounts, Marketscreener, analysts’ consensus forecasts

A matter of mix

The reason for this sudden go-slow lies largely with the FTSE 100’s mix of constituents. Without wishing to be too pejorative about it, the index is largely made up of the unpredictable (oils and miners), the indigestible (banks and insurers) and the downright stodgy (utilities, telecoms and to a lesser degree pharmaceuticals). A racy mix it is not, at least in the low-growth, low-inflation, low-interest-rate environment that has dominated for the past decade or more.

The FTSE 100 is heavily slanted towards miners, financials and oils

Source: Refinitiv data, Marketscreener, analysts’ consensus forecasts

But even here may be where opportunity lies because there is just the chance that the environment is changing. Markets are no longer preoccupied with where inflation has gone and how low interest rates could go, but where inflation could peak and how high interest rates may have to go to rein it in.

“Markets are no longer preoccupied with where inflation has gone and how low interest rates could go, but where inflation could peak and how high interest rates may have to go to rein it in. In this environment, the FTSE 100 could come into its own.”

In this environment, the FTSE 100 could come into its own. It has underperformed in the world stage since the Brexit vote (if not before). Underperformance can mean unloved and unloved can mean undervalued, at least from a contrarian’s perspective. And undervalued is always a potentially interesting starting point, with the FTSE 100 looking decent value relative to its own history on around 13 times earnings for 2022.

Granted, its unusual, or at least distinctly twentieth-century, earnings mix (lacking in technology, abundant in commodities) may mean the FTSE 100 deserves a low rating relative to international peers such as the USA, which is packed with tech, biotech, social media and online winners, and an equally large range of potential future disruptors.

FTSE 100 may take its lead from commodities in 2022

Source: Refinitiv data

But if inflation runs hot and stays hot, then ‘real’ assets such as commodities, or paper claims on them via shares in mining and oil producing, may not be such a bad place to be. Nor may banks, which would welcome, at least to some degree, higher interest rates and a steeper yield curve, as they will help to fatten up net interest margins and thus profits (so long as higher borrowing costs do not weigh too heavily on customers’ ability to meet interest payments and return principal). The FTSE All-Share Banks index is up by 10% this year already and can point to an advance of more than 25% over the past 12 months, so the market is starting to look upon the banks more favourably than it has for a while.

Banking stocks are warming to steeper yield curves

Source: Refinitiv data

An index that gets 62% of its forecast profits and 51% of its forecast dividends from miners, financials and oils may therefore sound a bit unpredictable, indigestible or downright stodgy. But if inflation takes a hold, then the FTSE 100 might start to look more tempting.

Equally, if even modest interest rates slow the global recovery right down, or even tip it over into a recession, or a new viral variant does that job, then the UK’s heavyweight index could yet struggle to move past that May 2018 peak and continue to lag its global peers, many of whom already trade at or near new all-time highs, including America, France, Germany and India.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Alex Kitteringham

17/01/2022

Team No Comments

European political and regulatory outlook 2022

Please see below, a European political and regulatory outlook from Invesco – received late yesterday afternoon – 13/01/2022

Key takeaways

Covid-19 continued to present a threat to European economies in 2021 and revealed deep fissures in the political landscape. The pandemic didn’t just leave its mark on the political scene but also in the regulatory sphere — a trend that will continue in 2022.

We expect key political drivers to include the recent German election and the upcoming French presidential vote, which comes amid concerns over Russia and China’s influence. The cost of the green transition, inflation and Brexit will also be major themes this year.

On the regulatory side, policymakers will make further refinements to ESG frameworks; roll out initiatives to enhance retail investor participation; increase their focus on financial stability; and turn their attention to the supervision of digital financial services.

Covid-19 continued to present a threat to European economies in 2021 and revealed deep fissures in the political landscape. The pandemic isn’t just leaving its mark on the political scene but also in the regulatory sphere, where regulators are grappling with the lessons to be learned from the market volatility and so-called ‘dash for cash’ at the start of the pandemic in March 2020.

We turn our gaze to 2022 and seek to highlight what we see as the major political and regulatory risks on the horizon.

Section 1: Political outlook

  1. Our analysis identifies 8 key themes that will influence the political landscape:
  2. The outcomes of European elections in France (this year) and Germany (in 2021) are likely to colour approaches to further EU integration, opening the field for a triumvirate with Italy.
  3. Battles over the rule of law in Hungary and Poland will raise questions about the nature of the EU and its members, as well as fears regarding Russia’s intentions.
  4. The EU’s strategic autonomy to act against a backdrop of increasing global polarisation between the US and China will influence trade, defence and economic thinking.
  5. Reviewing the fiscal rules that govern the eurozone will shape the EU’s ability to invest in the green and digital transformations.
  6. Implementing the UK and EU’s climate commitments will finally turn promises into action, with fights expected on the pace, and who should bear the cost, of the transition.
  7. With above-target inflation likely to persist in both the euro area and the UK, the cost of living will likely re-emerge as a political battleground.
  8. Further antagonism between the UK and the EU over the implementation of Brexit will continue to weaken incentives to build cooperation in other areas, such as financial services.
  9. Opposition to UK planning reforms could undermine Boris Johnson’s election pledge to ‘level-up’ the UK outside London and the South East.

 European leadership and integration

France and Germany are the traditional motors of European integration, and it’s often difficult to get anything done in Europe without the endorsement of these two states. It is therefore significant that Germany has a new government that will start to reach cruising speed in 2022 while France will head to the polls in April 2022.

In Germany, the so-called “traffic light” coalition made up of the Socialists, Liberals and Greens took office in December 2021. This was a watershed moment that brought to a close the stability and statesmanship that Angela Merkel brought to Germany and to Europe more widely.

In France, President Macron will face voters in April 2022, along with a fragmented field of candidates. While current polls indicate that Macron remains the favourite to win the election, the campaign has been marked by increasing populist sentiment, particularly from the right and far-right that are hoping to capitalise on anti-immigrant attitudes.

The outcomes and consequences of these elections will have a strong impact on what can get done in Europe in 2022, as well as the years to come. Although the new German government is likely to be closer to France in terms of European integration, the ability of a new and untested coalition to bring key European partners with them is likely to be weaker than under Merkel. France may have less appetite for grand integration projects for fear of it triggering heightened populist sentiment at home.

The Franco-German axis may be weakened, but it may also to include the Italians as Mario Draghi brings stability and statesmanship that has been absent in Italy for some time and gives it a strong voice in European matters. The recent Quirinale Treaty between France and Italy could be a first step in building a strong triumvirate at European level that would be pro-European integration.

 Threat from the East

While not new, the battle over the rule of law in the Eastern bloc, and in particular in Poland and Hungary is likely to continue simmering in 2022. For many member states and the European Parliament, the values on which the EU is built are at stake due to the issues presented in Poland and Hungary. These challenge the EU’s ability to advocate about democratic values abroad if they can’t keep their own members from backsliding.

For Poland and Hungary, the issue is as much about domestic politics as it is about the financial incentives on offer from the EU, with Poland having threatened to bring the EU decision-making process to a standstill if EU funds are withheld. It’s not only about Poland and Hungary. Czechia, Slovenia and Bulgaria are also at risk of breaches of rule of law.

But there is division within the remaining member states on how to respond. Although the European Parliament is urging the European Commission to invoke the rule of law provisions in the EU budget — which enables the Commission to withhold funding until steps have been taken to address rule of law issues— Germany and others have called instead for dialogue.

The one glimmer of hope on the horizon is that there are elections in Hungary in May 2022 and recent polls indicate that the opposition candidate that aims to unite all opposition parties against Prime Minister Viktor Orban has a realistic prospect of unseating the incumbent. With Prime Minister Andrej Babis of Czechia having also recently lost elections, is the tide turning on populism in the East?

Even if the debate over the rule of law is primarily an internal issue within the EU, it also has geopolitical dimensions given the increasing assertiveness of Russia and pressures on the EU’s Eastern border from Belarus. As a result, some countries such as Germany have been wary of a direct confrontation with wayward Eastern states for fear of alienating those countries and driving them into the arms of Russia.

 Strategic Autonomy and National Security

The EU’s focus is often internal but increasingly the theme of “strategic autonomy” is discussed within EU circles. In part a response to former US President Donald Trump’s exposure of EU reliance on the US and growing Chinese assertiveness on the world stage, the question of the EU’s place in the world — squeezed in between the US and China, as well as its ability to act independently — continues to be actively discussed.

The EU is increasingly eager to review its dependence on the US for defence and its reliance on the dollar clearing, which has limited the EU’s ability to run an independent foreign policy. The strained relationship with the Trump Administration and the Biden Administration’s recent missteps including the disorderly withdrawal from Afghanistan and the recent AUKUS nuclear submarine deal have raised questions about EU-US relations within European policy circles. In particular, the EU fears being forced to choose between the US and China, which it is loath to do.

The EU’s relationship with China is equally complex. It branded China a negotiating partner, economic competitor and systemic rival in 2019 — and the EU continues to struggle to define a clear China strategy. While the commercial imperative remains strong, with China having become Germany’s top trading partner, the stalled investment treaty negotiated at the end of 2020 shows that the economics cannot be fully divorced from the politics, with voices increasingly urging the EU to use its influence to address the human rights issues and other security threats in China. For example, a recent motion by the European Parliament called for the EU to get tougher with China when it comes to human rights violations; spreading disinformation; assessing the origins and spread of Covid-19; and banning companies from 5G and 6G networks that do not fulfil security standards, all while continuing to work together on climate change and other areas of mutual interest.

Concerns regarding the US, China and strategic autonomy are likely to continue to exert a strong influence across several areas, including trade and defence but also economic topics such as the internationalisation of the euro and work on central bank digital currencies where the EU fears falling behind the US and China.

Instinctively closer to the US, the UK is confronting many of the same questions as the EU regarding China – seeking to maintain access to the commercial opportunities of the Chinese market while being increasingly vocal on human rights issues; taking steps to protect its critical infrastructure from Chinese influence; and pursuing a more active role in scrutinising the takeover of British companies in sectors deemed sensitive for national security. The (non-retrospective elements of the) National Security and Investment Act came into force from 4 January 2022, increasing the risk that certain takeovers and mergers could be significantly delayed due to increased government scrutiny.

Reviewing the Stability and Growth Pact

The rule governing the EU and eurozone fiscal policies, known as the Stability and Growth Pact (SGP), was suspended when Covid-19 hit and remains suspended until 2023. However, 2022 is likely to be dominated by debates as to how to re-introduce the rules and whether the SGP needs to be overhauled given the significant budget deficits and debt overhangs that many countries suffer from due to the pandemic.

With the EU average debt-to-GDP ratio above 100%, there is concern that a strict re-introduction of the rules[1], could force a significant number of countries to introduce austerity measures. This would potentially plunge the EU back into recession and prevent member states from undertaking the necessary investments in climate change and digital to reform their economies for the future. There is also concern that the rules have become increasingly complex and hard to monitor adequately. However, a number of the so-called “frugal” member states consider the current rules sufficiently flexible and have limited appetite to reform the framework.

The success, or otherwise, of the Covid Recovery Fund, could also play a role here as many see it as a potential blueprint for a more permanent EU-level fiscal capacity that might serve as a bridge between the current SGP rules and the need to invest in the green and digital transformations across the EU.

The review of the fiscal framework comes at a time when Europe is suffering from high inflation. While the European Central Bank considers current inflation rates transitory and has so far resisted calls from hawks to increase interest rates, it remains to be seen how long this view will prevail, particularly if other central banks start to consider higher inflation is here to stay and start raising rates.

Net Zero and EU Green Deal

If 2021 and COP26 was the year of climate promises, then 2022 is set to be the year of climate delivery. Both the UK and the EU have committed to ambitious carbon reduction targets of 68% and 55% respectively by 2030.

The debate in 2022 will be focused on how we get there. In the EU, the European Commission published in July 2021 a package of proposals known as “Fit for 55”, which will amend a range of EU law, including the Emissions Trading Scheme, the Renewable Energy Directive and the Energy Taxation Directive with the aim of aligning the EU regulatory framework with the EU’s climate targets. However, the cracks are already starting to appear. The EU Taxonomy, which aims to classify which activities are “green” has already run into the buffers as various members seek to protect their own industries — such as France on nuclear or the Scandinavian region on forestry — which risks rather fraught negotiations across the package to ensure that EU states feel that the burden of achieving net zero is fairly distributed across countries and sectors.

In the UK, following a flurry of government strategy papers in the run-up to COP26, attention will also turn to implementation of the Prime Minister’s 10-point plan and the cross-government Net Zero Strategy. With ambitious decarbonisation targets to achieve by the end of this decade, political debate will centre on the cost of ‘going green’ to consumers, as the government seeks to switch energy levies from electricity to gas; to incentivise the take-up of domestic heat pumps to replace gas boilers; and to finance further new nuclear generating capacity. Against this backdrop, further Government-mandated corporate climate disclosures will be rolled out and the Treasury will unveil the UK’s version of the EU’s Green Taxonomy (expected to include nuclear) before the end of the year.

Brexit

The second anniversary of the UK’s exit from the European Union will be marked on 31 January. While day-to-day cooperation at working level between the UK and EU remains strong across a range of areas, the post-Brexit political relationship is characterised by a lack of trust and accusations of bad faith on both sides.

The Northern Ireland Protocol, agreed as part of the original Withdrawal Agreement, is an area of contention. The UK’s challenge to the terms and the implementation of the Protocol has further eroded trust – but also yielded some movement from the EU on goods inspections. However, fundamental UK objections to the role of the European Court of Justice and the application of EU state aid rules are unlikely to be reconciled, meaning antagonism over the Protocol, as well as other sensitive issues such as fisheries, will likely persist. This will continue to weaken EU incentives to enhance cooperation in areas such as migration, scientific research and financial services – continuing to put at risk items such as the Joint UK-EU Financial Regulatory Forum, which was envisaged in the Trade and Cooperation Agreement. 

Cost of living

Rising energy prices and above-target inflation brought cost-of-living issues back into political focus across Europe at the turn of the year. In the UK, the immediate effects are being felt in the retail energy supply market, which is being redrawn with the collapse of a significant number of smaller suppliers, further concentrating the customer base in the hands of the largest providers. If inflation persists, greater political scrutiny is likely to be applied to the costs to households of ‘going green’, resulting in the continuation of the long-run UK fuel duty freeze (potentially delaying the switch to electric vehicles), a delay in the government’s ambition to switch the costs of subsidising green energy from electricity bills to gas bills and pressure to delay the Government’s timetable for encouraging homeowners to replace gas boilers with low-carbon heat pumps. The debate may also weaken enthusiasm for committing to additional new nuclear generation, given the pass-through of part of the costs to consumers.

Similarly, the EU is also concerned about the rising energy prices, triggering conversations about whether such pressures are transient or more long-term and therefore warrant a structural response through reform of EU energy market regulation. The current backdrop of high energy prices and record high carbon prices could also bleed into negotiations on the EU Green Deal where the spectre of the French “gilets jaunes” protests continue to haunt politicians.   

Levelling up

Alongside “Get Brexit Done”, “levelling up” was Boris Johnson’s other 2019 Election refrain. Following the Covid hiatus, the Prime Minister is now under pressure to outline a coherent levelling-up strategy that can deliver benefits to communities – focused outside London and the South East – ahead of the next general election.

With a relabelled a government department to lead the charge, a major policy paper to define the agenda and a set of Government actions is expected soon. However defined, building more homes is likely to be both central to the agenda and one of the toughest political challenges the PM faces next year. The government backed down on previous reforms to liberalise planning rules in the face of a rebellion from Conservative MPs, so a new approach is being devised. Given the impossibility of the government being able to significantly increase the number of new homes being built, in areas where demand is high and while only building on brownfield sites, there is a risk that the new proposals follow the path of their predecessor and the housing agenda remains stuck on the status quo. 

Section 2: Regulatory outlook

  1. Our analysis identifies 5 key themes that will influence the regulatory landscape in EMEA:
  2. Refinement of the framework governing sustainable finance and environmental, social and governance (ESG) issues to address the climate transition.
  3. Continued focus on the resilience and supervision of the non-bank sector and the stability of financial markets more broadly following the March 2020 period of volatility.
  4. New initiatives to enhance retail investor participation in financial markets and continued focus on retail investor disclosures.
  5. Improving the functioning, effectiveness and transparency of financial markets.
  6. Developing the framework governing the regulation and supervision of digital financial services and operational resilience. 

Sustainable Finance and ESG

The continuing development of sustainability- and ESG-related requirements applying to supervised entities will continue to be a priority for policymakers globally. For example, policymakers will continue to commit significant resource to refining the frameworks governing sustainability-related disclosures for products and financial market participants across jurisdictions.

The data required by firms to meet such disclosure obligations will also be a focus as they take forward initiatives seeking to enhance the availability of, and access to, reliable ESG data. In this regard, the development of ESG taxonomies will continue apace, with focus moving beyond “climatemetrics” towards defining the broader environmental social component of such taxonomies.

Additionally, from August 2022, intermediaries in the EU will be required to consider investors’ ESG preferences when distributing investment products, with a significant impact on their activities as well as those of product manufacturers. 

Financial stability

The impact of the Covid-related market volatility experienced in March 2020 has drawn significant attention from policymakers over the last 18 months or so and we expect this to continue in 2022. Indeed, we anticipate policymakers’ analyses to evolve into proposals for regulatory reform to enhance the resilience of the non-bank sector, in particular with respect to the functioning of short-term money markets and money market funds (MMFs), as well as liquidity risk management within open-ended funds more generally.

The European Commission has already put forward amendments to the EU frameworks governing the operation and supervision of retail and alternative investment funds, with the aim of finalising proposals clarifying rules on fund liquidity risk management, loan origination and delegation over the course of 2022. Likewise, in the UK, we expect the Bank of England and the Financial Conduct Authority (FCA) to take forward their joint initiative on enhancing the resilience of the non-bank sector, with a particular focus on finalising a regulatory approach to asset liquidity classifications and swing pricing.

 Retail investing

In the continuing low interest rate environment, and with more responsibility being placed on individuals to plan for their financial futures, improving retail investor participation in financial markets will be a key theme in 2022. For example, the European Commission is expected to bring forward an EU Retail Investment Strategy with the aim of addressing this theme by, in part, enhancing the effectiveness and transparency of the current EU inducements regime. In the UK, the FCA will continue to develop its cross-sectoral Consumer Duty, reinforcing firms’ obligation to consider their retail clients’ best interests when undertaking activities on their behalf. Final rules are expected in Q3 2022.

Policymakers also see improving the usefulness of retail investor disclosures as key to enhancing retail investor participation in financial markets. We expect regulators in the EU and the UK to make changes to the content of packaged retail investment and insurance products’ (PRIIPs) Key Information Document (KID) template in 2022, with EU authorities requiring Undertakings for the Collective Investment in Transferable Securities (UCITS) funds to produce a PRIIPs KID by the end of the year. Separately, work undertaken by ESMA in collaboration with EU national competent authorities last year on UCITS costs and charges, and the ongoing review of the implementation UK value assessment requirements, will increase regulatory scrutiny on the transparency, cost and performance of retail products.

 Functioning of financial markets

Over the last year, EU and UK policymakers have undertaken several consultations assessing the potential effectiveness of proposals to improve the regulatory framework governing financial markets. Looking forward to 2022, we anticipate that policymakers will prioritise initiatives that seek to ensure the emergence of a privately provided consolidated tape (CT) of record for market data, alongside a reduction in complexity of pre- and post-trade transparency regimes. Indeed, the European Commission has already suggested rule changes to this effect.

Moreover, current market-wide reforms seeking to enhance the effectiveness of investment and market infrastructures, such as activities in respect of the London Interbank Offered Rate (LIBOR) benchmark’s cessation or the implementation of the EU’s settlement discipline regime, will also continue in 2022.

 Digital Finance and Operational Resilience

In the year ahead, policymakers in the EU and UK will continue to encourage innovation and the emergence of digital products and services. While significant resources will continue to be put towards existing regulatory sandboxes and pilot regimes, we expect EU-wide and UK rules governing markets in crypto assets to be finalised alongside separate frameworks for the operation of market infrastructures based on distributed ledger technology (DLT). We also expect exploratory work on central bank digital currencies to continue next year, as well as initiatives relating to Open Finance and e-IDs; artificial intelligence; and the development of common data standards.

Finally, there will be a continuing focus, in 2022, on the implementation of EU rules governing cloud outsourcing while, in parallel, policymakers seek to finalise the EU’s new Digital Operational Resilience Act (DORA) within the first half of the year. In the UK, firms across the financial sector will likewise be focusing on implementing the regulatory changes necessary to comply with new rules relating to operational resilience which will apply from March 2022.

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

14th January 2022

Team No Comments

Brooks Macdonald – Daily Investment Bulletin

Please see below an article published by Brooks Macdonald yesterday (12/01/2022) detailing their views on markets over the last week:

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Please keep safe and healthy.

Carl Mitchell – Dip PFS

Independent Financial Adviser

13/01/2022

Team No Comments

Markets in a Minute

Please see this week’s Markets in a Minute update from Brewin Dolphin:

These regular investment bulletins help us keep up to date with what is happening in the markets.

Please continue to check back for our latest blog posts and updates.

Andrew Lloyd DipPFS

12/01/2022

Team No Comments

Brooks Macdonald – Weekly Market Commentary

Please see below this week’s market commentary from Brooks Macdonald – received late yesterday afternoon – 10/01/2022

Weekly Market Commentary | Treasury yields rise rapidly as Omicron concerns ease

By Edward Park

  • Increased optimism around Omicron, mixed with Federal Reserve hawkishness, catalysed a rapid rise in mid and long term Treasury yields
  • Friday’s payroll numbers came in lower than expected with supply issues still prevalent in the labour force
  • This week’s US CPI numbers will be an important test of whether the inflationary pressures continue in the US economy

Increased optimism around Omicron, mixed with Federal Reserve hawkishness, catalysed a rapid rise in mid and long term Treasury yields

The last week saw increased optimism around the Omicron variant at the same time as the Federal Reserve (Fed) made it clear that they were ready to use all policy measures at their disposal to combat inflation should it prove to be enduring. In terms of specifics, reports on Tuesday hinted that the Fed may begin quantitative tightening earlier this cycle and the release of the December meeting minutes on Wednesday confirmed this was the view of the committee. This created the perfect storm for Treasuries where 10-year yields rose sharply, catalysing a selloff in interest rate sensitive equity sectors such as technology.

Friday’s payroll numbers came in lower than expected with supply issues still prevalent in the labour force

Friday’s non-farm payroll figures disappointed markets at a headline level with just 199,000 jobs created in December compared to expectations of around 400,0001. The unemployment rate came in at 3.9%2 which implies that a lack of supply may be behind the lacklustre headline number rather than a lack of demand for workers. The average hourly earnings figure, a key part of the future inflation narrative, beat expectations at 0.6% month on month3. The participation rate for the US workforce still remains below its pre-COVID-19 level. An important question is whether those that were in the workforce pre-COVID-19 return. The sharp rise in asset prices (homes and equity markets) could lead to an acceleration of retirement plans, reducing the participation rate, though this is hard to quantify at this point.

This week’s US CPI numbers will be an important test of whether the inflationary pressures continue in the US economy

There are two interpretations of the Fed’s hawkishness last week; one that they have their mind set on tightening policy, the other that they have been trying to buy increased optionality ahead of the uncertainty of inflation. This week’s US Consumer Price Index (CPI) release on Wednesday will be of critical importance and may determine whether the committee continues its shift towards a more hawkish stance or whether there is some pause for breath. Of course, one datapoint will not make a trend, however the early 2022 releases will start to paint a picture of how sticky the current pandemic-distorted inflation is.

The future of US monetary policy is the central question in markets at the moment. At the end of this week we enter the communications blackout window ahead of the next Fed meeting. In the interim, we have a number of Fed speakers but tomorrow sees the nomination hearing for Fed Chair Powell in front of the Senate Banking Committee. The language Powell uses will be closely watched for signs of further hawkishness even if the market is fairly confident that the vote on Powell’s second term itself will be a formality.

Please continue to check back for our latest blog posts and updates.

Charlotte Clarke

11/01/2022