Please see below article received from AJ Bell yesterday, which highlights the effect that central bank policy and the Delta variant have on the volatility of global markets and economic recovery.
“Many investors are familiar with the saying that ‘markets like to climb a wall of worry,’ but few are less well versed with the opposite which is they ‘slide down the slope of hope.’ That is what may be happening right now as markets fret about the Delta variant and whether it could stop the global economic recovery from developing as quickly as the near-40% rally in the FTSE 100 from its lows would demand,” says AJ Bell Investment Director, Russ Mould.
“But another factor could be at work (besides the traditional light volumes and case of blues which can dog markets in summer), and that is central bank policy, because some leading monetary authorities seem to be draining liquidity rather than supplying the tidal wave of cheap money which, many argue, is a prime reason why asset prices are rising despite the difficult backdrop.
“The Bank of Canada has cut back the scope of its Quantitative Easing programme for the third time, the Reserve Bank of Australia has also eased the rate of asset purchases and New Zealand has stopped buying assets altogether. None of them are going as far as shrinking their balance sheet, but they are growing them more slowly or, in New Zealand’s case, finally holding it in check.
“Even the US Federal Reserve is getting in on the act. The American central bank is using reverse repos in vast quantities, even as it continues to run QE at $120 billion a month, with the result that it is siphoning liquidity away from the financial system with one hand even as it pumps it in with another.
Source: FRED – St. Louis Federal Reserve
“Without wishing to get too technical:
A repo (or repurchase agreement) sees a financial institution sell Government bonds (in this case US Treasuries) to another one, either a bank or central bank, on an overnight basis. It then buys them back the next day, usually as a slightly higher price. The idea is the seller can raise immediate liquidity if they happen to need it. (It also enables the counterparty to make a financial return pretty much without risk, given the extremely short time horizon involved and the collateral that backs the trades).
The repo rate spiked suddenly in the USA in autumn 2019 in what was seen as a sign that the Fed’s then Quantitative Tightening plan (of raising rates and withdrawing QE) was working well – so well that banks were scrambling for cash as the financial system began to creak. Under Jay Powell, the US central bank backtracked on QT and – as the pandemic hit – cranked up QE to ever-more dizzying levels in 2020. That tidal wave if liquidity mean the US overnight repo rate is 0.07% – down from that panicky 6.9% one-day spike two Septembers ago.
Source: Refinitiv data
A reverse repo (or reverse repurchase agreement) a bank or central bank sells Government bonds in exchange for cash to a range of counterparties, over a pre-determined timeframe (often overnight). This therefore drains cash out of the financial system, at least if a central bank is doing it and the Federal Reserve is hard at work here right now. At the last count, the Fed’s outstanding reverse repo liabilities were $860 billion, the equivalent to more than seven months’ worth of QE.
Source: FRED – St. Louis Federal Reserve
“In many ways it is hard to talk market talk of the Fed turning hawkish seriously – the dot plot of two quarter-point rate rises from a record-low by the end of 2023 is more like a budgie clearing its throat for a quick chirp rather than a vicious swoop from a bird of prey.
“But perhaps the US Federal Reserve is laying the groundwork for tightening monetary policy after all and taking these initial steps to test how financial markets (and the economy) will react.
“For the moment, there is no sign of financial stress anywhere in the system, at least according to the tried-and-tested St. Louis Fed Financial Stress and Chicago Fed National Financial Conditions indices. Both are trading very close to their all-time lows.
Source: FRED – St. Louis Federal Reserve
“The S&P 500 still trades close to all-time highs, so again the Fed will be hoping the turn in the liquidity tide does not rock too many boats here. A spike in the VIX and the stumble in the S&P will leave Fed officials on alert, though, as autumn 2019’s repo rate spike saw WeWork’s much-hyped flotation fall apart, Bitcoin sink 25% in a month and wider equity and bond markets both get the jitters, albeit very briefly.”
Source: Refinitiv data
Please check in again with us soon for further news and market analysis.
Please see below ‘Markets in a Minute’ article received from Brewin Dolphin yesterday evening, which provides market analysis on a global scale. The commentary discusses rising inflation in the UK and US as well as Asia’s considerable economic recovery.
Most major stock markets fell last week amid a higher-than-expected surge in inflation and increasing cases of Covid-19.
In the US, the S&P 500 and the Nasdaq slipped 1.0% and 1.9%, respectively, after data showed inflation jumped by 0.9% in June – almost double the figure forecast by economists. Federal Reserve chairman Jerome Powell reiterated his view that inflation pressures are temporary, which helped to moderate losses.
The pan-European STOXX 600 fell 0.6% after figures showed new Covid-19 cases in the EU and EEA had surged by 64.3% from the previous week, raising concerns about the continent’s economic recovery. The European Centre for Disease Prevention and Control said 20 countries had seen an increase in new cases, although hospitalisations remain stable.
The UK’s FTSE 100 also slid 1.6% as inflation fears resurfaced and rising infections outweighed optimism about ‘freedom day’.
Over in Asia, China’s Shanghai Composite ended the week up 0.4% after figures showed gross domestic product (GDP) rose by 7.9% in the second quarter from a year ago, while retail sales and industrial production in June surged by 12.1% and 8.3%, respectively, from a year ago.
Stocks slump as Delta variant spreads Equities slumped on Monday (19 July) as the spread of the Delta variant of Covid-19 weighed on investor sentiment. The Dow recorded its worst day in three months, sliding 2.1%, while the S&P 500 and the Nasdaq lost 1.6% and 1.1%, respectively.
The FTSE 100 posted its biggest one-day fall since May and finished below the 7,000 mark. Travel and leisure stocks suffered on news that fully vaccinated arrivals from France will still need to quarantine. British Airways owner IAG slumped 5.2% and easyJet declined 6.7%. Energy stocks also struggled after OPEC+ agreed to increase supply from August, leading to a decline in crude oil prices.
UK and European stocks rebounded at the market open on Tuesday, with the FTSE 100 and the STOXX 600 both adding 1.1%. Japan’s Nikkei 225 tumbled to a six-month low following Monday’s selloff.
US and UK inflation soars
Figures released last week showed inflation in the US and the UK accelerated in June, leading to renewed speculation that central banks could start to rein in their support for the economy.
In the US, headline consumer prices rose by 0.9% from the previous month and by 5.4% from a year earlier, marking the fastest pace of annual growth since 2008. Core inflation (excluding food and energy) rose by 4.5% from a year ago, the highest since 1991.
The surge was largely driven by the biggest monthly bounce in used vehicle prices for more than 60 years. Prices rose by 10.5% between May and June, meaning second-hand cars were being bought for around 45% more than a year earlier. Prices of new cars also rose by 2% month-on-month – the biggest increase since 1981.
Meanwhile, UK data showed the headline consumer prices index rose to 2.5% in the 12 months to June, the fastest pace for nearly three years, as prices continued to recover from their early pandemic lows. Higher food and fuel prices drove the increase, as did rises in the cost of eating and drinking out, clothing and footwear, and second-hand cars.
US retail sales beat expectations
Last week also brought the latest data on US retail sales, which unexpectedly rose in June by 0.6% from the previous month, according to the US Census Bureau. Economists polled by Reuters had forecast a drop in sales of 0.4%. On an annual basis, sales surged by 18.0% and are now above their pre-pandemic level.
The rebound came despite purchases of motor vehicles declining for the second month in a row amid a lack of supply caused by the global semiconductor shortage. US retail sales are measured by receipts not volume, which meant higher prices from supply constraints flattered the figures.
Although consumers seem to be spending more, separate data released last week suggested they are also growing more cautious. The University of Michigan’s preliminary gauge of consumer sentiment fell to its lowest level since February, largely because of worries about inflation.
“Consumers’ complaints about rising prices on homes, vehicles, and household durables have reached an all-time record,” said Richard Curtin, the survey’s director.
Japan manufacturing index soars
Over in Japan, confidence among Japanese manufacturers rose in July to its highest level for twoand-a-half years, as global demand helped the country’s export-driven economic recovery. According to the Reuters Tankan poll, sentiment was boosted by strong confidence at car, chemical and metal products manufacturers, which offset poor conditions among textiles and paper.
However, the survey also showed service sector sentiment turned pessimistic in July, falling to -3 from a flat reading in June, as Covid-19 mitigation measures continued to curb spending. Tokyo is currently under its fourth coronavirus state of emergency, which is due to last until 22 August. On Wednesday (14 July), the capital recorded its highest number of new infections in almost six months.
We will continue to publish relevant articles and news, so please check in again with us soon.
Please see below article received from Invesco yesterday afternoon, which explains how investment managers are adopting an ‘ESG approach’ in order to achieve net zero targets.
As we approach the United Nations (UN) Climate Change Conference of the Parties (COP26) in November, we expect increased scrutiny of how investment portfolios are aligning to meet the climate goals of the Paris Agreement and how exposed portfolios are to risks under different climate scenarios. These are topics of growing importance to investors. At Invesco Fixed Income (IFI), we have been examining the practical implications of applying net zero methodologies to global investment grade credit portfolios to ensure that we can support our clients who are looking to align their investing approaches to their own net zero commitments.
Building net zero-oriented investment strategies
The Net Zero Investment Framework (NZIF) created by the Paris Aligned Investment Initiative (PAII) provides a methodology for building investment strategies that are consistent with the goal of achieving global net zero greenhouse gas emissions by 2050. The NZIF also aims to increase investment in the range of “climate solutions” to facilitate achieving net zero. The NZIF recognizes that achieving net zero involves a multi-year transitional effort across the global economy and its approach combines portfolio construction, engagement, and policy advocacy. The framework is more holistic than simple carbon emissions optimizations and looks at where companies sit along a net zero alignment spectrum with a particular emphasis on the material emitting sectors of the economy where transition is vital.1
Assessing portfolio alignment to net zero
For fixed income portfolios to become aligned with net zero pathways, we need issuers (from both material and low emitting sectors) to align themselves with the objective of achieving net zero emissions. We see a growing number of global investment grade issuers publicly commit to net zero, and the NZIF sets out specific alignment criteria that issuers must meet to be judged as achieving net zero or making progress towards it. Assessing the actual progress that companies are making against their commitments is critical to this effort.
Data availability, particularly timely emissions information, is an issue that currently hinders the full assessment of transition progress industry-wide, though we do expect improvements in this area as the focus on net zero continues to ramp up among issuers, asset owners, and asset managers. Beyond emissions, data availability is not yet universal across the six core NZIF alignment criteria, which complicates assessing portfolios fully today. The NZIF references three global initiatives – Climate Action 100+ Net Zero Benchmark, the Transition Pathway Initiative, and the Science Based Targets initiative – whose methodologies provide a baseline for evaluating the key global emitters and also can inform the development of in-house, asset manager net zero processes to increase the proportion of portfolios that can be assessed.
It is important to emphasize that issuers with high emissions intensity may still be held in net zero-focused portfolios. However, these material emitting issuers will likely be the focus of close engagement to encourage them to set out and execute on a clear strategy to low carbon, with divestment a final option when progress is not being made against alignment goals.
Being able to clearly categorize portfolios in the context of the NZIF is key. From this baseline, targets can be set, and decisions are taken accordingly. IFI is starting to map portfolios and benchmarks along the net zero alignment spectrum (see Figure 1) with the intention of then deciding what an appropriate evolution should look like over time.
Figure 1. Mapping to the net zero alignment criteria enables an evaluation of portfolio positioning and areas to focus on
Source: Invesco, June 3, 2021. For illustrative purposes only.
Investment in climate solutions
While the NZIF encourages increased investment in “climate solutions” (e.g., emerging technologies that are helping the achievement of net zero goals), investment grade portfolios generally have relatively modest exposure currently. This is not surprising, in our view, given the public fixed income market’s inherent bias toward more established issuers (“old economy”) versus cutting-edge green startups (“new economy”), due in no small part to the minimum business size needed to support publicly traded debt. However, we are optimistic that this area can grow significantly, given the rapid uptake of electric vehicles, energy efficiency solutions, and renewable energy, where investment grade issuers have meaningful exposure. We also see some logic to incorporating green bonds into the “climate solutions” segment, especially bonds strongly aligned with UN Sustainable Development Goals. The EU taxonomy should also help to create much needed standardized reporting.
Analyzing the impact of climate change on portfolios
Climate scenario analysis is complementary to the NZIF and allows investors to see how their portfolios would perform in different climate outcomes, including net zero, by 2050, but also in adverse scenarios to demonstrate the risks of inaction. Our analysis incorporates the use of Planetrics climate risk modeling, which estimates a value impairment at the portfolio level of a relatively modest -1%, even in adverse scenarios (a hot-house world or delayed transition).2 There are several reasons for this, but the significant equity cushion, favorable geographical exposures (developing markets more exposed to physical climate risk than developed) and relatively low duration of the asset class are all important factors. This conclusion should not detract from the valuable insights and mitigation that can be achieved from closer analysis of issuer, sectoral, or geographical exposures, but we think it helps put the risk in this relatively nascent area into perspective.
Growing investor focus on net zero
With COP26 approaching, we are expecting investor interest in net zero alignment to increase significantly in response to its goal of mobilizing finance to secure global net zero by mid-century. The effort to meet net zero will likely require financing alignment to occur across the whole asset class spectrum, which is why the net zero investment framework also covers equities, sovereign debt, and real estate in addition to corporate bonds. Corporate bond portfolios will have an important role to play in this transition. Even though the impacts on bond values from different climate scenarios may be less marked than on other asset classes such as equities, we still expect investors to be increasingly keen to understand how their portfolios align with the pathway to net zero as well as how they fare in different climate scenarios.
Given the numerous factors incorporated into a decision to invest in a fixed income portfolio (fundamental credit quality, environmental, social, and governance (ESG) credentials, net zero alignment, climate change exposure), we believe investors cannot adopt a “one size fits all approach.” IFI is closely monitoring ESG risks across its portfolios and especially in the rapidly evolving net zero alignment space. We believe having a wellresourced and experienced credit team is important for assessing the issues raised here and to inform our investment decisions. IFI seeks to ensure that credit spreads adequately reflect downside risks, including ESG factors, or, where this is not the case, that “at-risk” names are avoided.
We will continue to publish further market insight and news as the UK approaches ‘freedom day’ on the 19th of July. Please check in again with us soon.
Please see below ‘Markets in a Minute’ article received from Brewin Dolphin yesterday evening, which provides an update on the markets’ response to the ongoing coronavirus pandemic, the rising UK housing market and economic developments in the US.
Stock markets were mixed last week as the spread of the Covid-19 Delta variant dented optimism about the global economic recovery.
In the US, the S&P 500 and the Nasdaq recorded a fifth consecutive week of gains, rising 1.7% and 2.0%, respectively. Investor sentiment was boosted by betterthan-expected labour market data and a surge in consumer confidence.
In contrast, the pan-European STOXX 600 slipped 0.2% amid concerns about inflation and a spike in coronavirus cases. The UK’s FTSE 100 also fell 0.2%, while France’s CAC 40 declined 1.1% and Germany’s Dax managed a 0.3% gain.
Fears about the rebound in infections spilled over to Asia, where Japan’s Nikkei 225 declined by 1.0%. The Japanese government is considering extending Covid-19 restrictions beyond 11 July, which could affect how many spectators are allowed in Olympic venues.
Morrisons bidding war boosts FTSE
The FTSE 100 rose 0.6% on Monday (5 July), led by an 11.6% surge in Wm Morrison shares after US buyout firm Apollo Global said it was considering making an offer for the supermarket chain. It came after Fortress Investment Group made a £6.3bn takeover bid over the weekend.
UK stocks were also buoyed by the latest IHS Markit / CIPS UK services PMI, which measured 62.4 in June, the second-highest reading since October 2013.
The pan-European STOXX 600 ended Monday’s trading session up 0.3% after figures showed eurozone business activity expanded at the fastest rate in 15 years in June. In contrast, markets in Asia were mixed after the latest Caixin / Markit services PMI showed a sharp decline from 55.1 in May to 50.3 in June.
Stock markets in the US were closed on Monday for the Independence Day public holiday.
The FTSE 100 started Tuesday’s trading session 0.1% lower after the pound rallied against the dollar on news the lifting of Covid-19 restrictions in England will go ahead on 19 July.
Cases rise in Europe for first time in ten weeks
A surge in coronavirus cases weighed on major European indices and bond yields last week. The World Health Organization (WHO) confirmed the number of new Covid-19 cases in Europe had risen for the first time in ten weeks because of increased mixing, summer travel and the rapid spread of the Delta variant.
Hans Kluge, the WHO’s regional director for Europe, said new infections had jumped by 10% and the variant was already causing increased hospitalisations and deaths. At least 63% of people in Europe are still waiting for a first dose of a coronavirus vaccine. Christine Lagarde, president of the European Central Bank, warned of the threat posed by virus variants to the economy, stating: “A Delta variant that spreads quickly is an uncertainty, and it is an uncertainty that will weigh on the balance of risks today.”
In the UK, where vaccination rates are higher, the number of daily deaths remains low despite a surge in infections. On Sunday, there were 24,248 coronavirus cases and 15 deaths, according to UK government figures reported by Sky News.
US consumer confidence at 16-month high
Over in the US, The Conference Board’s index of consumer confidence rose to 127.3 in June – the highest level since the onset of the pandemic in March 2020.
The present situation index, based on consumers’ assessment of current business and labour market conditions, rose from 148.7 to 157.7. The expectations index, based on consumers’ short-term outlook for income, business and labour market conditions, improved to 107.0 from 100.9.
“While short-term inflation expectations increased, this had little impact on consumers’ confidence or purchasing intentions,” said Lynn Franco, senior director of economic indicators at The Conference Board. “In fact, the proportion of consumers planning to purchase homes, automobiles and major appliances all rose – a sign that consumer spending will continue to support economic growth in the short term.”
US consumer confidence
US stock markets were also supported by stronger-thanexpected labour market data. According to the Labor Department, employers added 850,000 nonfarm jobs in June – the most since August 2020. Meanwhile, weekly jobless claims fell to a pandemic-era low of 364,000 for the week ending 26 June, a decline of 51,000 from the previous week.
UK house prices rise at fastest pace since 2004
House prices in the UK grew at the fastest annual rate in 17 years in June, according to the latest figures from Nationwide. The average price of a UK home rose by 13.4% from a year ago to £245,432. On a monthly basis, prices increased by 0.7%.
Northern Ireland and Wales saw the largest gains, up by 14.0% and 13.4% from a year ago. Scotland saw the weakest rate of annual growth at 7.1%, followed by London at 7.3%.
Robert Gardner, Nationwide’s chief economist, said some of the annual increase was due to base effects as June 2020 was unusually weak because of the first lockdown. However, the market continues to show momentum, with prices in June almost 5% higher than in March.
“Activity will almost inevitably soften for a period after the stamp duty holiday expires at the end of September, given the strong incentive for people to bring forward their purchases to avoid the additional tax,” said Gardner. “Nevertheless, underlying demand is likely to soften around the turn of the year if unemployment rises as most analysts expect, as government support schemes wind down. But even this is far from assured.”
We will continue to publish relevant content and news, so please check in again with us shortly.
Please see below article recently received from AJ Bell, which warns of the potential impact that tax relief reform could have on pensions and investors.
Recent press reports suggest the Treasury is eyeing cuts to pension tax incentives to help pay the cost of COVID. Reforms said to be under consideration include introducing a flat rate of pension tax relief, cutting the lifetime allowance or taxing employer contributions.
Beyond the political fire and brimstone a pensions tax raid would cause among Conservative backbenchers and voters, there would be significant practical implications for any of the proposals floated by the Treasury.
Cutting tax relief for individuals risks undoing the groundwork laid by automatic enrolment and sowing mistrust in the stability of the retirement savings framework.
Hitting employers, meanwhile, might raise a fast buck for the Chancellor but would risk strangling off the UK’s pandemic recovery.
There were always going to be tough fiscal choices as the country slowly shifts away from dealing with the health emergency of Coronavirus and focuses on the financial hole blown in the Exchequer’s balance sheet.
It is critical any proposals for pension tax reform consider both short and long-term priorities, and in particular the challenge of ensuring current and future generations’ retirement prospects are not fatally damaged.
Introducing a flat rate of pension tax relief
Given the priority of the Government is to raise cash for the post-COVID economic recovery, a flat rate of pension tax relief would likely need to be set well below 30% to achieve this.
In fact, analysis carried out by the respected Pensions Policy Institute* suggested setting a flat rate of pension tax relief at 30% would actually cost the Government money, while a rate of 25% might save between £2-£3billion a year and 20% around £6-£8 billion a year.
Such huge savings would clearly come at a cost to individuals. For example, if a flat rate of 20% was introduced, a 35-year-old earning £60,000 and paying 4% of salary into a pension could miss out on £50,000 of retirement income by the time they are 67. Those earning more or making larger contributions would face an even bigger hit to their plans.
However, the big challenge in going down this road – both practically and politically – lies in the public sector, where some workers continue to enjoy generous guaranteed defined benefit pensions.
In order to apply a flat rate of relief to these pensions a tax charge would need to be calculated and applied directly to employees by HMRC.
Doctors and senior NHS staff who have been on the front line dealing with the pandemic would likely end up with tax bills running into thousands of pounds as a result.
Reduce the pensions lifetime allowance from £1,073,100 to £900,000 or £800,000
The lifetime allowance has been tinkered with relentlessly by successive Governments, reducing from £1.8 million a decade ago to just £1 million by 2016/17. Two years later it was pegged to CPI inflation – but this link was removed for the rest of this Parliament by Rishi Sunak in March. This constant tinkering has led to huge complexity and uncertainty for retirement savers.
If we were to get yet another cut to the lifetime allowance to £900,000 or even £800,000, as has been suggested, more diligent savers would be at risk of breaching the limit.
To put this in context, reducing the lifetime allowance to £800,000 would mean after tax-free cash has been taken the retirement income someone could take at age 66 would be well below the average salary in the UK.**
This would feel like an extremely low bar to set for people’s retirement aspirations.
Tax employer pension contributions
Of the pension tax proposals floated this was the one with the least amount of detail attached – which is saying something.
At the moment employer pension contributions are exempt from National Insurance, so it is theoretically possible the Treasury could reverse this position – or perhaps apply a limited charge – in a bid to raise revenue.
However, going down this road would cause uproar among businesses already struggling to deal with the fallout from the pandemic. It could also be counterproductive if landing these firms with extra costs forced them to hold off on investment.
Over the long-term, any increase in the costs of providing pensions would likely see a damaging levelling down of provision.
Pension tax reliefs have been under review since Gordon Brown was the Chancellor in 1997, remember his tax raid? Every government looks at them.
Whilst changing tax reliefs could save money for the State, we need to look at the bigger picture. What would be the impact on pension savings? If people save less in pensions, they will rely more on the State. This is not what any government wants.
I think tinkering with employer pension contributions tax relief would be particularly damaging. Employers need to help fund employee’s pensions.
Hopefully, we won’t see any change in this area, but we also know that we need money now too to support the country in key areas, covid debt interest payments (long term repayment?), to re-build the NHS/Social Services/Residential Care etc., and to help kick start the economy in the UK.
The other issue is timing, Rishi Sunak needs all of us to go out and spend money now to help the economy recover. He can’t scare us into not spending, we will fall back into recession.
Please see below article received from AJ Bell yesterday, which discusses the long-term picture after the latest US Federal Reserve meeting delivered a shock.
During the first 200 years of its existence, the US accumulated a cumulative federal debt of $1 trillion, the equivalent of 30% of its GDP (gross domestic product). In the last 40 years, that figure has surged to $28 trillion.
The good news is that the US economy has grown too, as annual GDP has advanced from around $3 trillion to $23 trillion. As a result, America’s national debt-to-GDP ratio has therefore grown from roughly 30% to 128% and that is bad news for two reasons.
First, it means that it is taking ever-increasing amounts of debt to generate an extra dollar of GDP.
Second, it leaves the US sitting well above the 80% to 90% debt-to-GDP ratio described by economists Kenneth Rogoff and Carmen Reinhart as a key tipping point, whereby economic growth would slow thanks to (unproductive) debt servicing costs – although that research, used by many governments as the basis for austere fiscal policies in the last decade, has since been widely challenged.
Whether you side with Reinhart and Rogoff or their detractors, the challenge that faces the US Federal Reserve is undeniable.
The US central bank needs to keep interest rates as low as it can to help the US government fund its interest payments even as it maintains welfare programmes, spends on defence, education and other vital needs, such as investment in public infrastructure.
That may leave the Fed having to raise interest rates to fend off inflation, maintain the value of the dollar relative to other currencies and maintain its credibility with financial markets and also holders of US treasuries, since they are effectively bankrolling America’s economy.
Investors now have to assess which way they think the Fed (and the White House) will go and to what degree the central bank’s ultimate policy path is priced into bonds, equities, commodities and currencies.
In the end, every option available to the chair Jay Powell and president Biden may help in some areas but do damage in others, as if to confirm the view of Stanford University professor Thomas Sowell that: ‘There are no solutions, only trade-offs.’
To make a reasoned decision here – and then draw up an appropriate asset allocation – investors will need to think like the Fed and its officials. History is very clear that there are only four ways out once a national debt reaches America’s current levels, relative to GDP:
Rapid economic growth. This is the best option, but it is not proving easy, if the period from 2009 and the end of the financial crisis is any guide. This underpins the push toward Modern Monetary Theory and the argument that governments should spend on productive assets and focus on the long-term payback rather than worry about near-term borrowing.
Default. This is not ideal, as serial offenders like Argentina will attest. It leaves you locked out of international debt markets and means you must pay higher coupons even if you can persuade someone to lend to you. It can also prompt capital flight, hitting both your currency and value of other assets and financial markets. The US will not countenance anything that jeopardises the dollar’s status as the world’s reserve currency (although most other developed countries face the same dilemmas and policy options).
Inflate. This is more like it and is exactly what the US and UK did when debt ballooned thanks to the Second World War. Rebuilding programmes and public spending fuelled growth, interest rates were kept below inflation and lenders were repaid in effectively devalued currency as a result. Yet again, though, this leaves the Fed with the dilemma of stoking some inflation but not too much that investors take fright and both financial markets and the wider economy are destabilised, as happened in the 1970s.
War. This is the option that no-one in their right minds would consider, even if the new Cold War between China and America feels like it is getting steelier by the month, even if president Biden is now in the White House rather than Donald Trump. Taiwan is still a potential flashpoint for ‘Hot War’, both territorially and technologically, thanks to Taipei’s predominance in the global silicon chip supply chain.
Path of least resistance
If growth is unlikely (or least relies on wanton government borrowing and overspending) then inflation still appears the likeliest outcome, but the Fed will not want to tighten policy too far, too fast. Just look at how financial markets are welcoming talk of two Fed rate hikes to the far-from-challenging level of 0.75% by the end of 2023. Equity and commodity price wobbled and volatility indices such as VIX moved higher.
Yet the US 10-year treasury yield fell, the last thing you would expect if inflation is coming, especially when yields are already miles below the current rate of increases in the cost of living.
These trends may not be as mutually exclusive as investors might think. The Fed is still running QE (quantitative easing) flat out to massage yields lower. There is more uncertainty now over its policy direction than there has been for some time. Investors seek havens, like bonds, at times of concern.
Perhaps the bond and stock markets are getting ready for the return of volatility and bumpier times ahead. But then the chances of the Fed raising rates or hauling in QE may recede further, as the end of the debt-fuelled bull market and economic upturn would surely be seen as deflationary and any policy response would have inflation as its ultimate goal.
We will continue to publish relevant content, market updates and news as we optimistically push towards the end of lockdown restrictions in the UK.
Please see below a comprehensive and insightful investment article received from JP Morgan, which provides educated predictions for the second half of the year and considers what might lie in store for global economies.
THEME 1 – INFLATION SIMMERING BUT NOT YET BOILING OVER
Developed economies are expected to continue their strong post-lockdown bounceback in the second half of the year. Vaccine rollout is well advanced in the US and UK, and continental Europe is quickly catching up. Despite recent spending, we estimate that households still have considerable excess savings as we head into the second half of the year, amounting to about 12% of GDP in the US, 7% in the eurozone and 10% in the UK.
Not all sectors of the economy are returning to normality: travel restrictions are likely to remain in place until governments are more confident that vaccination levels can cope with new strains of the virus. However, consumers are spending where they can and tourism’s loss appears to be home renovation and construction’s gain. Housing markets are booming in much of the developed world.
For now, it is rising consumer prices, rather than house prices, that central banks are monitoring. After over a year of pandemic-related disruptions, supply is struggling to keep pace with surging demand. Alongside soaring global commodity prices, input costs are on the up, with many companies passing cost increases on to end consumers. US CPI inflation is likely to remain above 3% into next year, and eurozone and UK inflation also looks set to rise in the coming months (see On the Minds of Investors: Monetary and fiscal coordination and the inflation risks).
Central banks believe these inflationary pressures will prove transitory. Whether this turns out to be the case depends in large part on the behaviour of labour markets. If workers are able to bargain for higher pay, inflationary pressures will become more entrenched.
Unfortunately, labour markets are as hard to predict as goods markets at this point. For example, in the UK, the unemployment rate has risen to 4.7%, but is well below the 8.5% peak it reached following the Global Financial Crisis. But 8% of the workforce are still on furlough, making it hard to gauge the true degree of labour market slack. In the US, the unemployment rate did rise sharply and, at 5.8%, still sits 2.3 percentage points above the pre-pandemic low. And yet firms are saying they are having more difficulty recruiting than at any point on record.
Inflation is likely to create market jitters in the second half of the year, but ultimately we believe it will take a lot to shift the central banks away from their current preference for tightening too late, rather than too early. Talk of tapering by the Federal Reserve (Fed) will no doubt become louder over the summer, but our base case sees a reduction in asset purchases beginning only at the start of 2022, with rate hikes not until at least the following year. In the eurozone, large asset purchases are set to continue for a long time in the context of still subdued inflationary pressures, even if we see some shuffling of purchases among the European Central Bank’s (ECB’s) various purchase programmes. Recent commentary from the Bank of England (BoE) suggests that policymakers may be open to tightening policy a little more quickly in the UK, but it should still be a debate for next year rather than this.
This new, more patient reaction function from the central banks is not without risks. A willingness to let the economy run hot sets up a strong near-term rebound. Yet, once the time for rate hikes arrives, we see a risk that central banks (especially the Fed) will have to tighten policy more quickly than the market currently expects.
Supportive policy from developed world central banks will help emerging economies catch up. While some economies, such as China, came through the pandemic relatively quickly, others are still struggling to contain the virus. However, we expect the vaccine delay in key parts of the emerging world to be a matter of quarters rather than years and believe economic activity should prove relatively resilient given the strength of global goods demand and commodity prices.
Overall, we think the outlook for near-term global growth remains strong. As the bounce from pent-up consumer spending fades, we expect government and business spending to pick up the baton. Focused on ‘building back better,’ governments are lining up multi-year infrastructure projects. This marks a stark contrast to the last cycle, in which government austerity proved a consistent drag on activity and inflation.
It is also remarkable to see how quickly investment is bouncing back, again in stark contrast to the last cycle. Indeed, if inflation is the greatest downside risk for investors to monitor, investment spending is the key upside risk, since it could potentially herald the start of a new era for productivity growth and help alleviate inflationary pressures.
Overall, the macro backdrop for the second half of the year remains strong. Growth in the developed world may slow by year end, but is likely to remain above trend, broadening out to investment spending and becoming more evenly distributed across geographies. Inflation concerns are likely to linger, but ultimately we think it will take a lot of bad news for central banks to meaningfully alter their current plans for a glacial removal of stimulus. While this approach may create further risks down the road, economic activity and corporate earnings look well supported for now.
THEME 2 – STICK WITH ROTATION INTO VALUE
The key question for equity investors is how moderately higher inflation and bond yields will affect corporate profits and valuations. Given significant pent-up consumer savings and elevated capex intentions, sales growth will likely be strong. When sales are strong, profits tend to rise, even if input costs are rising.
Higher bond yields could raise borrowing costs but this can also be offset by higher sales, while higher wages tend to boost sales as well as costs. Meanwhile, any additional taxes that hit the corporate sector are likely to be at least partially offset by the demand boost from additional government spending.
So, against the current economic backdrop, it seems unlikely that rising costs will fully offset the anticipated benefit from strong sales growth. Higher inflation is therefore likely to coincide with higher profits, as is normally the case.
The bigger concern for investors is whether higher bond yields will hurt equity valuations, since it raises the discount rate on companies’ future earnings. However if bond yields are rising because growth expectations are rising, then valuations don’t have to decline. Indeed, it is common for valuations to rise (and fall) at the same time as bond yields. Even if rising bond yields do lead to lower valuations, then as long as profits rise by more than valuations decline, stocks can still rise. Our base case is that rising corporate profits, driven by strong demand, will offset any decline in valuations for most stocks.
Growth versus value is another key debate as we head towards 2022. So far in 2021, last year’s losers have outperformed last year’s winners, with value stocks significantly outperforming growth stocks. Despite this, growth stocks still trade on high valuations compared with history and relative to value stocks.
Given that we believe 12-month forward earnings expectations are likely to keep rising for most stocks, the biggest risk to our continued optimism on equities is that valuations on the more expensive growth stocks decline by enough to offset the earnings upside.
However, our base case is that any further compression in the valuations of growth stocks will just limit the extent of their upside, rather than fully offset the expected increase in earnings. While we do not expect further price/earnings (P/E) expansion on value stocks, valuation compression seems less likely than for growth stocks, given much lower starting valuations.
For example, consensus expects 12-month forward earnings on the Russell 1000 growth index to be 19% higher by the end of next year, compared with 17% higher for the Russell 1000 value. Both indices should therefore rise, but even a modest decline in growth stock valuations relative to value stocks could lead growth stocks to underperform.
At the very least, it is worth being aware that a large part of the reason for the outperformance of growth stocks since 2009 has been the substantial increase in their valuations. A repeat of that tailwind seems unlikely from this starting point, and it is possible that it could now become a headwind, if valuations on growth stocks continue to decline. Value stocks, by contrast, are unlikely to see P/E compression, given valuations remain relatively modest.
It is also worth noting that financials are by far the largest part of value indices globally. Over the last decade, their relative performance has been highly correlated with 10-year bond yields. We therefore expect financials – and hence probably broader value indices – to outperform, if we’re right that bond yields will rise further from here.
Overall, we believe equities will move higher but at a slower pace, and with the potential for the usual bumps in the road. We also have a moderate preference for value over growth stocks, based on relative valuations and our view that bond yields will continue to rise.
At the index level, this means the US could underperform other regions, because of its large weighting to more expensive growth stocks. US value stocks could continue to perform well though, while more value-oriented markets such as Europe and the UK could outperform. For investors keen to avoid putting all their eggs in the value basket, we believe emerging markets offer long-term growth opportunities at a more reasonable price than some other markets.
THEME 3 – RETAIN FOCUS ON ASIA’S DECADE
Asian equities began 2021 with a lot of promise. Favourable longterm trends in demographics and technology, in combination with better containment of the pandemic, provided a strong tailwind for the region (see On the Minds of Investors: Asia’s decade: Getting ahead of the growth opportunity).
Since February, it seems that the tide has turned. Absolute performance stalled, while US and European equities stormed ahead. While part of the story relates to better developed market prospects following President Biden’s massive fiscal stimulus, the relatively poor performance of China since February has been a significant source of the underperformance of Asian equities.
This may seem surprising given that China’s economic outlook for the year appears compelling. Due to its early success in containing the pandemic, China looks on track to achieve more than 8% GDP growth in 2021.
However, three near-term challenges have investors concerned. First, Beijing has begun tightening policy after an expansion during the crisis amounting to growth in credit stock of over 30% of GDP. Second, a number of new announcements about tech regulation have generated worries about Beijing’s reform agenda. And third, in Asia the vaccination programme has been slower than those of many developed economies leading to lingering virus concerns.
We are not overly worried that these headwinds will provide a lasting drag on either economic or market performance. Any tightening of credit will be gradual and measured. Consumer inflation is currently contained, giving China’s central bank little reason to raise policy rates in the coming months. Therefore, current policy measures should be understood as normalising and not as outright tightening.
While not overly worried about tightening, neither do we believe China’s reform efforts should deter international investors. Faced with monopoly concerns, worries about financial stability and changing public sentiment, regulators are taking a more hawkish approach towards leading tech and financial companies. Recent high-profile fines for companies breaking competition laws, as well as the closing of regulatory loopholes, may signal the end of the highly supportive environment that these firms have enjoyed in recent history.
Given the weight these firms have in both Chinese and broader Asian indices, their underperformance has had a significant impact on overall returns. While the market leaders might be constrained by potential new rules in the short term, we believe their long-term growth outlook remains compelling, and valuations are now more attractive.
And on vaccinations, China is now making significant headway in catching up on vaccinating its population (EXHIBIT 7). In India, meanwhile, only 19% of the population are over the age of 50, so while the current outbreak is taking a heavy toll, it shouldn’t be too long before the most vulnerable have been vaccinated. In some smaller Asian countries, the slower pace of vaccine rollout may lead to ongoing problems with local outbreaks, delaying a full economic recovery this year.
In summary, while we acknowledge that President Biden’s stimulus has provided a near-term turbo boost to the US economy, we do not think developed market outperformance will last over the medium term. US and European policymakers will soon face the very same tough questions as their Chinese counterparts today – when and how to normalise the enormous amount of stimulus. So in 2022 and the following years, dynamics are likely to change as the distortions in corporate earnings caused by the pandemic and the policy responses recede. In this environment of more moderate growth, structural themes such as rising household incomes and technology adoption in Asia should gain importance relative to the cyclical stories that dominate today’s market performance. Since we are already in the middle of the year, it will be just a matter of time before investors shift their focus to the earnings outlook for next year, which should be beneficial for Chinese as well as broad Asian equities.
In the second half of the year, the outlook for Chinese local bond markets continues to be compelling. Moderate consumer inflation, solid corporate earnings and a low probability of rate hikes are supportive for the asset class. However, after the 10% appreciation of the renminbi in the past 12 months, we think that investors should expect a reduced tailwind from currency effects.
THEME 4 – CONSIDER PORTFOLIO IMPLICATIONS OF COP26
In early November, major nations will reconvene to discuss global plans to tackle climate change. COP26 (the 26th UN Climate Change Conference of Parties) will see leaders revisit the commitments that were made under the Paris Agreement in 2015, assess the progress to date and set a roadmap for the future. The legally-binding commitment made in 2015 was to limit global warming to well below two degrees Celsius, compared to pre-industrial levels, by the end of the century.
What is different about this annual meeting is that the US is back at the table, providing renewed momentum. Top of the agenda will be to compare national greenhouse gas emissions outcomes to those planned, and assess whether they are sufficient to achieve global climate objectives.
The conclusion is likely to be that greater efforts are required – though many governments have already accelerated their plans. The EU plans to reduce its emissions by 55% by 2030, while achieving net zero emissions by 2050 has recently become the new benchmark. In 2020, the UK and France were the first major economies to write their net zero emissions targets into law, and many other countries, including the US, are now following their example. China has given itself an additional decade with net zero emissions targeted for 2060.
The realignment of the US with global climate initiatives is a gamechanger. Having organised a global climate summit on Earth Day and supported a G7 announcement to end fossil fuel subsidies by 2025, the US will probably support a new Grand Climate Accord during COP26.
With the major economies already aligning behind the goal, reaching net zero emissions may well become the new official global target. This will require dramatic changes to the global economy, and we expect a wave of new policy and major investments in green infrastructure to be announced at COP26. However, to reach net zero emissions, policymakers will also need to increase private sector incentives to reduce carbon emissions, so carbon pricing initiatives such as emissions trading schemes (ETS), and carbon taxes are also likely to be key topics of conversation at COP26 (see On the Minds of Investors: The implications of carbon pricing initiatives for investors).
However, such discussions could lead to trade tensions as countries try to lay blame – and the need to change – at others’ doors. By country, China is the biggest emitter of greenhouse gases (EXHIBIT 8). But looking at the data by capita suggests the US has the most work to do. Others will argue the most appropriate comparison takes into account stages of economic development or reliance on manufacturing for GDP. This may hinder the group’s ability to agree on a common solution.
Obstacles to progress may prove particularly frustrating for Europe, which is far more advanced in this area, and keen to ensure that its own high regulatory standards are matched elsewhere, so that measures such as higher carbon prices in the EU don’t damage the profitability or competitiveness of the region’s companies (EXHIBIT 9). If the EU, China and the US cannot agree on a path towards a common carbon price, the EU may need to find a short-term solution to ensure that its climate efforts do not disadvantage European businesses.
One solution that appears to be growing in appeal in Europe is a carbon border adjustment mechanism (CBAM). This import tariff would be designed to ensure that the environmental footprint of a product was priced the same whether it was manufactured locally or imported.
Investors should be aware of how announcements at and after COP26 might influence their portfolios. Some companies will benefit from new green infrastructure investments, or from being relatively well prepared for the transition compared with their peers. Others may lose out – particularly firms that will face higher costs due to higher carbon prices, and especially if they are unable to pass these costs on in higher prices.
THEME 5 – SEEK PROTECTION FROM CHOPPY WATERS
As economies continue to open up, we are expecting a strong rebound in growth, with potentially sticky inflation. When central banks take their foot off the pedal and begin to apply the brakes, bond market returns suffer. The first quarter, which saw a loss of over 4% for US Treasuries – their largest quarterly drawdown since 1980 – is a case in point. With this backdrop, clients are wondering what role bonds should play in a balanced portfolio in the coming years (see On the Minds of Investors: Why and how to re-think the 60:40 portfolio).
There is no doubt that the return outlook for fixed income is challenging. In the past, the coupons that bonds paid at least cushioned the blow of rising rates. For example, during the Fed’s last hiking cycle (December 2015-December 2018), the price of US Treasuries fell by around 2% but the coupon paid over the period more than made up for that loss, such that total returns were still positive at around 4% over that period. Over the same period, global investment grade government bonds managed to return roughly 12%. Today, with starting yields and spreads so low, there is very little income to cushion against rising rates (EXHIBIT 10).
It might be tempting then to exclude bonds from portfolios altogether. However, that would lead to much higher portfolio volatility and little protection against unforeseen downside risks. For example, should the virus mutate to the extent that vaccines are no longer effective, government bonds would likely be one of the few assets generating positive returns.
In our view, investors should consider fixed income strategies that have the ability to invest globally in search of greater income protection, and which can move flexibly in the event of changing economic winds.
One global solution that, in our view, looks particularly attractive today is Chinese government bonds, which currently yield over 3% and benefit from a strong credit rating. A relatively low average duration also makes them less vulnerable to rising yields. Chinese bonds have proved to have a low correlation to both global bond and equity markets, making the market a good source of portfolio diversification (EXHIBIT 11). The Chinese onshore fixed income market is the second largest after the US Treasury market, but its representation in global benchmarks is still small. As its weighting grows, investors should benefit from the rising demand.
Beyond fixed income, investors can look to other alternatives for diversification. Macro strategies can adjust their correlation to equities and other asset classes and move dynamically according to changing market conditions. In periods of uncertainty – in which investors need portfolio protection – macro funds have historically outperformed equities (EXHIBIT 12).
The real market jitters would occur if a disorderly rise in inflation were to be realised. We view this as a tail risk, but given it would be unlikely to be good for either stocks or bonds, it’s one we should not be complacent about. Real estate and core infrastructure have low correlations to equity markets but their income streams are often tied to inflation, so can serve as a good inflation hedge. Of course, there are no free lunches, and such assets usually come with liquidity constraints, but those who can invest for the longer term may benefit from the inflation protection they can provide.
THEME 6 – CENTRAL PROJECTIONS AND RISKS FOR THE NEXT 6–12 MONTHS
Our core scenario is a continued recovery that broadens out and becomes more synchronised. Inflation worries provide some bumps, but monetary policy normalisation is slow. However, we remain in an unusual environment, and it’s as important as ever to keep an eye on the risks to our central view. On the positive side, inflation concerns could recede more quickly than we think as supply bottlenecks unstick, allowing central banks to remain accommodative for even longer. On the negative side, if those supply bottlenecks become more entrenched and vaccine progress falters, we could find ourselves dealing with stagflation.
Please check in again with us soon for further market updates and relevant content.
Please see below ‘Markets in a Minute’ article received from Brewin Dolphin yesterday evening, which provides a global update on markets and economic recovery as we strive towards a ‘new normal’ in a post-pandemic world.
Most major stock markets rose last week despite figures showing US inflation surged in May to its highest level in 13 years.
The S&P 500 gained 0.4% to reach a new record high of 4,247, with healthcare stocks among the strongest performers. The technology-heavy Nasdaq added 1.9% as a sharp decrease in longer-term bond yields supported growth stocks.
The European Central Bank’s announcement that it would increase its pace of asset purchases boosted the pan-European STOXX 600, which ended the week up 1.1%. The UK’s FTSE 100 added 0.9% following encouraging GDP data, whereas Germany’s Dax was flat after figures revealed an unexpected decline in industrial production and factory orders.
Over in Asia, Japan’s Nikkei was largely unchanged after GDP shrank by an annualised 3.9% in the first quarter, better than the preliminary reading of a 5.1% contraction. China’s Shanghai Composite was also flat as investors weighed a fresh outbreak of Covid-19 cases in Guangzhou against renewed talks with the US on trade and investment links.
Investors shrug off lockdown easing delay
UK and European stocks continued to rise yesterday (14 June) despite reports that the UK was due to delay the final phase of lockdown easing. Prime minister Boris Johnson confirmed the reports in a briefing held after the market closed, saying restrictions would now be lifted on 19 July – four weeks later than originally planned.
The FTSE 100 added 0.2% on Monday, with strong oil prices helping the likes of Royal Dutch Shell, while travel and leisure stocks underperformed. The pan-European STOXX 600 also gained 0.2% to trade just off record highs. Most indices remained in the green at Tuesday’s open, with the FTSE 100 adding 0.3% amid a drop in the UK unemployment rate to 4.7%.
Over in the US, investors are turning their attention to the Federal Reserve’s upcoming policy decision and press conference on Wednesday. With inflation rising and the economy improving from its pandemic-era lows, investors will be closely monitoring Fed officials’ comments for any sign that it will begin easing its monetary and fiscal stimulus.
US inflation highest since 2008
Last week’s news was dominated by the latest US inflation figures, which revealed the headline consumer prices index (CPI) accelerated to an annual rate of 5.0% in May. This was higher than the 4.7% reading expected by economists and above April’s 4.2% figure. It marked the highest reading since August 2008 and partly reflected low base effects from last year when the coronavirus pandemic was at its peak.
Core inflation, which excludes volatile items like food and energy, leaped to 3.8% year-on-year, the highest level since 1992. On a monthly basis, consumer prices rose by 0.7% in May – well above the consensus forecast of 0.4%.
US stocks rallied despite the rise, suggesting investors agreed with the Federal Reserve’s stance that the current inflationary spike is transitory in nature. Indeed, the University of Michigan’s survey of consumer sentiment revealed Americans expect prices to rise by 4.0% in 2021, down from 4.6% in the previous month’s survey. The five-toten-year inflation outlook also fell to 2.8% from 3.0%.
Stock prices were also supported by an increase in the preliminary consumer sentiment index to 86.4 in the first half of June from a final reading of 82.9 in May. The gauge of current economic conditions edged up to 90.6 from 89.4, and the measure of consumer expectations rose to 83.8, the highest since February 2020.
UK GDP rises for third month in a row
Over in the UK, investors were cheered by the latest gross domestic product (GDP) data from the Office for National Statistics. GDP is estimated to have grown by 2.3% in April, marking the fastest monthly growth since July 2020. The service sector grew by 3.4% as consumer-facing services reopened in line with the easing of Covid-19 restrictions.
GDP remains 3.7% below the pre-pandemic levels seen in February 2020, but is now 1.2% above its initial recovery peak in October 2020. Compared with April 2020, the worst month of the pandemic, monthly GDP in April 2021 is estimated to have grown by a huge 27.6%.
ECB hikes inflation forecast
Elsewhere, the European Central Bank (ECB) announced it would increase the pace of its asset purchase programme over the coming weeks, despite calls from some policymakers to start reining in its monetary stimulus. It said bond purchases would continue at a ‘significantly higher’ pace than during the first few months of the year.
“Such a tightening would be premature and would pose a risk to the ongoing economic recovery,” said ECB president Christine Lagarde, adding it was too early to discuss when the emergency programme would end.
At the same time, the central bank increased its forecast for the harmonised index of consumer prices in the eurozone from 1.5% to 1.9% for 2021 but said the index would fall to 1.4% in 2023 as energy price rises evaporated. It also increased its forecast for economic growth in the euro area to 4.6% for 2021 and 4.7% for 2022. This comes amid falling Covid-19 infections, the lifting of lockdown restrictions, and a bounce back in business activity and consumer confidence.
Please check in with us again soon for further updates and relevant content.
Please see below ‘Markets in a Minute’ article received from Brewin Dolphin yesterday evening, which provides an overview of current market behaviour in reaction to global economic developments.
Most global stock markets edged higher last week as oil prices surged and data pointed to strong economic growth in the months ahead.
In the US, the S&P 500 ended its four-day week up 0.6% after crude oil prices climbed to their highest level for more than two years, boosting energy stocks. Share prices were also lifted by Friday’s weaker-than-expected US nonfarm payrolls report, which helped to alleviate fears of a shift in the Federal Reserve’s policy stance.
Over in Europe, the STOXX 600 added 0.8%, Germany’s Dax rose 1.1% and France’s CAC 40 gained 0.5% after the final purchasing managers’ survey for the eurozone suggested GDP would rise strongly in the second and third quarters. The UK’s FTSE 100, which was closed last Monday for the spring bank holiday, rose 0.7% despite concerns that the Delta variant of Covid-19 would delay the final lifting of lockdown restrictions.
The extension of the Covid-19 state of emergency in several prefectures in Japan weighed on the Nikkei 225, which declined 0.7%. China’s Shanghai Composite slipped 0.2%, ending a three-week run of gains.
Investors shrug off weak Chinese data
Most indices managed to hold on to gains yesterday (Monday 7 June) despite weaker-than-expected Chinese trade data. China’s imports grew by 51.1% in May from a year earlier, below the 54.5% growth predicted by analysts in a Bloomberg poll. Exports slowed to 27.9% in May from 32.3% in April, missing analysts’ forecasts of 32.1% growth.
Nevertheless, Asian markets closed in the black on Monday, with the Shanghai Composite and Nikkei 225 advancing 0.2% and 0.3%, respectively. The panEuropean STOXX 600 also erased earlier losses to close up 0.2%. News that UK house prices rose to a new peak in May boosted housebuilders, helping the FTSE 100 finish Monday’s session 0.1% higher.
UK and European shares were broadly higher at Tuesday’s open, although a fall in German factory output knocked 0.1% off the Dax.
US adds fewer jobs than expected
Last week saw the release of the closely watched US nonfarm payrolls report, which revealed the US added 559,000 jobs in May – fewer than the 675,000 extra jobs that economists were expecting. Economists had already lowered their forecasts following the huge miss in April when 278,000 jobs were added versus an expected one million jobs.
Labour participation in May was also lower than expected at 61.6%, below the pre-pandemic level of 63.4%. The number of unemployed stood at 9.3m, far higher than the pre-pandemic level of 5.7m.
However, the report wasn’t all doom and gloom. Job growth in May was driven by the services sector, with leisure and hospitality adding 292,000 new jobs, which is a further sign that the economy is normalising as vaccines are rolled out. In addition, the unemployment rate fell from 6.1% to 5.8%, and the number of permanent and temporary layoffs declined.
Overall, the report showed that while the US jobs market is improving it isn’t ‘overheating’, which would likely be the trigger for the Fed to tighten its monetary policy.
Eurozone services sector growth surges
Growth in the eurozone’s services sector hit a three-year high in May as lockdown restrictions eased. IHS Markit’s eurozone services PMI rose to 55.2 from 50.5 in April, marking the third successive month of expansion. Ireland and Spain saw the fastest growth, while Germany saw the slowest.
The composite PMI, which also includes manufacturing, surged to 57.1 in May from 53.8 in April, while business optimism for the year ahead hit the highest level for more than 17 years.
Chris Williamson, chief business economist at IHS Markit, said: “The service sector revival accompanies a booming manufacturing sector, meaning GDP should rise strongly in the second quarter. With a survey record build-up of work-in-hand to be followed by the further loosening of Covid restrictions in the coming months, growth is likely to be even more impressive in the third quarter.”
UK house price growth hits double digits UK annual house price growth rose to 10.9% in May – the highest level in nearly seven years. On a monthly basis, prices rose by 1.8% following a 2.3% rise in April. The average house price is now £242,832, an increase of £23,930 over the past 12 months, according to Nationwide.
The lender said the UK’s housing market has achieved a complete turnaround over the past 12 months. A year ago, activity collapsed in the wake of the first lockdown with housing transactions falling to a record low of 42,000 in April 2020. Activity surged towards the end of last year and into 2021, reaching a record high of 183,000 in March.
Robert Gardner, Nationwide’s chief economist, said the extension to the stamp duty holiday isn’t the key factor behind the spike in transactions, although it is impacting the timing.
“Amongst homeowners surveyed at the end of April that were either moving home or considering a move, three quarters (68%) said this would have been the case even if the stamp duty holiday had not been extended,” he stated. “It is shifting housing preferences which is continuing to drive activity, with people reassessing their needs in the wake of the pandemic.”
We will continue to publish relevant content and news as the vaccination drive in the UK is extended to include those aged 25 or over.