Team No Comments

Evergrande a grand problem?

The impending default or restructuring of Evergrande, China’s second-biggest property developer, dominated China’s news last week. Please see below article received from Legal and General yesterday afternoon, which discusses the effects of this on the broader market.

Localised, so far

Evergrande accounts for 6.5% of liabilities in China’s property sector, and its sales make up roughly 10% of all property transactions in the country. Evergrande could therefore pose a systemic risk, but so far stress in the financial sector has been localised. Interbank spreads are not elevated and the renminbi has held up well.

After a string of incidents that have given equity investors concerns about China – such as regulation of tech, education and casinos – its stock market has slipped behind international peers, but over a longer-term perspective it remains close to recent highs.

Evergrande’s problems could still affect the broader economy beyond the financial channel. People are no longer buying off-plan properties from the company; if this feeds through to Evergrande’s building activity, it could leave a noticeable impact on GDP. August property sales and starts were already in contractionary territory, and GDP is under pressure from Covid-19 outbreaks and lockdowns.

We believe the authorities have the levers to steady the ship, however, and will do so soon. This would likely involve a liquidity provision via a reserve requirement ratio (RRR) cut, fine-tuning of property financing policies, and measures to ensure Evergrande can continue its regular operations.

There is a manageable path forward, in our view, but China’s history of managing delicate situations in financial markets is not unblemished, so this remains a risk to watch in the weeks ahead.

Blockages but not stoppages

The release of the Federal Reserve’s Beige Book earlier this month led to discussion about the effects of supply-chain disruptions on corporate earnings. Last week’s Goldman Sachs US Industrials conference was an opportunity to hear directly from the companies in the middle of the supply-chain issues.

Five things caught our eye:

1. Overall, there was a very consistent message across companies. All are dealing with supply-chain challenges, but all are also talking about strong demand and a growing order backlog, which bodes well for 2022.

2. There is no uniform picture of the disruptions across individual companies and sub-sectors. Some are reporting supply-chain issues getting better than they were in the second quarter; others are seeing things deteriorate. It really seems to depend on your very specific sub-sector.

3. Pricing-power optimism is high. That matches the strong pricing-power sentiment evident in other data sources, and suggests most companies think they can pass on higher input costs if needed.

4. Companies did not take the opportunity to guide lower or to issue a profit warning, so they seem confident they can hit third-quarter numbers despite supply-chain issues.

5. There was a muted market reaction to all the supply-chain commentary. Most stocks were down over the week, but that’s not materially different from the wider market. The comments didn’t shock investors, so expectations for the third quarter appear to have largely adjusted.

It’s too early to sound the all-clear on that front, as there are clear blockages, but it seems there are no economy-wide stoppages, which we believe makes for a good start to the traditional ‘profit warning’ season.

Currency market at a standstill

One of our currency traders told us last week that she has been seeing the same spot levels in developed currency markets for months now. It’s not that we love volatility, but there is a lack of action in the currency space. Idea generation is easier when prices are on the move as momentum traders will enforce the trend up to the point where positioning and sentiment become stretched, and a contrarian approach starts to look more promising.

We know volatility is low across financial markets, reflected in the realised volatility of assets and implied volatility in option markets having dropped sharply since the pandemic peak in March last year. But where equity volatility (e.g. the VIX index) and bond volatility (e.g. the MOVE index) have recently moved more sideways, currency volatility in developed markets continues to grind lower (e.g. the CVIX index).

The impact on prices of this low-volatility environment is quite different too. It’s a boon to equity markets, with one market after another reaching new all-time highs; a blessing for credit issuers keeping spreads historically tight; and a godsend to bondholders, with longer-end yields reversing much of the sharp increase from earlier this year despite high inflation prints. Stable spreads and yields may sound dull, but they allow fixed-income investors to continue earning that credit spread and capture the rolldown of longer-dated bonds.

In currencies, things are different. Carry is almost non-existent with interest-rate differentials at a historical bottom, while spot prices have stopped moving. To quantify our trader’s observation, we calculated the average distance between today’s spot price and the six-month trailing average across all 45 developed crosses. That average is just 1%, close to its lowest point over 20 years, which illustrates that developed currency markets are stuck.

We don’t have many active currency positions open and don’t take much risk in this asset class at the moment. It’s tempting to chase smaller and smaller movements, but in our view it wouldn’t be good portfolio management and so we prefer to be patient and wait for bigger opportunities to come.

We will continue to publish relevant content and news as we head into Autumn in the UK.  

Stay safe.

Chloe

21/09/2021

Team No Comments

Alibaba and Apple face increasing regulatory scrutiny

Please find below details in relation to the market values of Alibaba and Apple, received from AJ Bell, yesterday afternoon.

The tide seems to be turning against large tech no matter where they are listed as regulators hit back

Thursday 16 Sep 2021 Author: Martin Gamble

E-commerce giant Alibaba has lost roughly half its market value since founder Jack Ma criticised China’s financial regulators last October.

That has led to the current backlash against not just the technology sector but also the gaming, education and entertainment industries. A Goldman Sachs basket of US-listed Chinese shares has halved since peaking in early 2021.

For Alibaba, all roads seem to lead to its mobile payment platform company Ant whose initial public offering, thought to be worth around $37 billion, was suspended last November.

On 13 September 2021, Alibaba’s shares were again under pressure after state regulators said they wanted to break up Alipay, Ant’s leading mobile payment app which has over 1 billion users.

Beijing wants to create a separate independent app for the loans business which issued around 10% of the country’s non-mortgage consumer loans last year.

In addition, it is requiring Ant to share user data in a new credit scoring system which would be partly state-owned, according to the Financial Times.

The real issue for the regulators is maintaining control of the monetary system, argues current affairs magazine The Diplomat.

Alipay customers use a currency issued by the platform’s parent company Alibaba, rather than the state currency renminbi, when they use their phones to make a transaction.

It just happens that the Alipay currency has a one-to-one exchange rate with the state currency (renminbi) and is backed by reserves held by Alibaba. The problem is that Alibaba isn’t regulated as a commercial bank and therefore operates outside the financial system.

The Chinese central bank is looking to solve this problem by being one of the first to issue its own digital money and integrating Alipay and other private payment systems, regaining control of the currency.

It’s not just China cracking down on large technology companies. Phones and computer giant Apple lost a pivotal case against gaming company Epic Games, maker of the hugely successful Fortnite. Apple had blocked the game after Epic tried to bypass the Apple app store payment system.

While US District Judge Yvonne Gonzalez Rogers stopped short of calling Apple a monopolist and found that the commission it charged app developers (30%) wasn’t a violation of competition law, Rogers said Apple’s conduct was anti-competitive.

The ruling means Apple is forbidden from stopping other companies’ apps including buttons or external links that direct customers to purchasing mechanisms as well as in-app purchases.

Benedict Evans, an independent technology analyst, says Apple generated around $15 billion last year from app commissions which only represents 5% of company revenue, so even if they were to eventually disappear it would be small beer in the bigger picture.

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

David Purcell

17th September 2021

Team No Comments

Watch margin debt as tech giants keeps powering S&P 500

Please see below article received from AJ Bell yesterday afternoon, which examines which factors could disrupt the stocks currently leading the US market to record highs.

The S&P 500 index continues to barrel higher, setting fresh peaks as it does so. The American benchmark has advanced for seven straight months, its best run without a loss since its 10-month romp between April 2017 and January 2018, even if some of the market technicals have not convinced everyone.

As this column noted last month, the small-cap Russell 2000 index and the Dow Jones Transportation index have yet to set fresh peaks, to imply the current advance lacks the breadth that provides confidence in the foundations of the upward move.

In this context it is interesting to note the first dip in US margin debt since February 2020, just as the pandemic hit and investor confidence quickly drained away.

Margin debt is the amount of money an investor borrows from their broker via a margin account to buy shares (or even short sell them).

This looks smart when markets are rising (as the investor or trader can get more exposure) but looks less clever when markets are falling. Indeed, falling asset prices can force so-called margin calls where the investor or trader must start repaying the loan – and sometimes they must sell other positions to fund that repayment, creating a negative feedback loop in markets.

This first dip in margin debt must be watched, especially in light of Securities and Exchange Commission queries about regulatory filings from the investment platform Robinhood and questions about its business model and whether payment for order flow is appropriate.

It remains to be seen whether this dampens some of the liquidity flow which has done so much to elevate certain sections of the US stock market but it may be no coincidence that what looked like some of the frothier areas have started to flag.

HOT AND COLD

Whether trading losses are sparking a slight decrease in risk appetite or whether a more cautionary approach (perhaps considering Federal Reserve reverse repo operations and talk of tapering) is lessening demand for initial public offerings, cash shells known as SPACs and growth and tech stocks is hard to divine.

But what is clear is that some of the hottest areas of the US market are showing some sign of cooling.

New market entrants have started to lose their appeal, judging by the performance of the Renaissance IPO ETF and Renaissance International IPO ETF. The former is currently tracking the performance of 72 American new floats, the latter 62 global ones.

The International vehicle may be suffering owing to its 44% weighting toward China and the US-oriented version is at least trying to claw back lost ground.

Enthusiasm for cash shells set up to acquire what they fancy is also waning. The Next Gen Defiance SPAC Derived ETF, which tracks a basket of nearly 300 SPACs is down by more than a third from its high.

This is perhaps less of a surprise when you consider the data from SPACinsider.com which shows how 308 SPACs are looking for a target even though 263 have already floated. In the end, supply may be outstripping demand.

Even Cathie Wood’s ARK Innovation ETF, the darling of growth and momentum-seekers, has found the going to be a bit tougher of late. The $22 billion behemoth, whose biggest holdings are Tesla, Teladoc and Roku, trades a fifth below its high (although supporters will counter that it is up by a quarter from its spring lows).

None of this is conclusive and the attempted rallies in the ARK Innovation ETF and the Renaissance IPO ETF could yet signal the next upward surge in US equities. Investors would do well to keep an eye on them and trends on the monthly margin debt figure from FINRA as useful indicators of market sentiment.

Yet for the US market to really roll-over its leaders must falter. And in fairness there is little sign yet of investors falling out of love with Facebook, Apple, Amazon, Netflix, Google’s parent Alphabet and Microsoft.

Their aggregate $9.8 trillion market cap is the equivalent of more than three times that of the FTSE 100 and they represent a quarter of the S&P 500’s value between them. If the S&P is to stumble, these names will have to do so.

Spotting what could cause that is the hard bit, such is their dominance, and in the absence of regulation it may take a jump in interest rates or a wider, unexpected shock to prompt investors to sell such core holdings, just as happened with the oil price shock and inflation in 1973-74.

This did for the previously unassailable ‘Nifty Fifty’, an informal designation for 50 popular large-cap stocks in the 1960s and 1970s.

Please check in with us again shortly for further news and market analysis.

Take care.

Chloe

13/09/2021

Team No Comments

Daily Investment Bulletin

Please see below, Daily Investment Bulletin, received from Brooks Macdonald yesterday afternoon, which provides information on economic developments impacting European and US markets.

What has happened

Monetary policy and COVID provided the drum-beat for investors on Tuesday. In Europe, markets fell as investors appeared to be nervous around the chances that the European Central Bank (ECB) might taper from its current ‘significantly higher’ level of PEPP (Pandemic Emergency Purchase Programme) asset purchases when ECB governors meet on Thursday. Meanwhile, over in the US, markets were similarly weak as the COVID delta variant continued to weigh on sentiment in the wake of last week’s weaker US jobs report. At a sector level, technology stocks were a relative outperformer on the day.

UK government signals tax rise on workers, businesses and shareholders

UK prime minister Johnson announced a tax hike for workers, businesses and shareholders on Tuesday. Billed as necessary to help support the NHS as well as social care spending needs, national insurance, which is tax on earnings, will rise by 1.25% from April 2022 for both employees as well as employers. As the Institute for Fiscal Studies noted on Tuesday, ‘it is really a 2.5 per cent tax rise on earnings … today’s announcements constituted a Budget in all but name’. The Institute of Directors also rounded on the tax plan this week, calling it ‘an extraordinary time to be considering adding to the cost of employing people’. As well as the increase to national insurance tax, there is also a hike on dividend tax with an increase of 1.25%. According to the plans announced, from April 2023, national insurance tax rates will revert back to the current level and the rise will be replaced by a new dedicated ‘health and social care levy’, which will become a separate tax on earned income from April 2023. Separately, the government also confirmed on Tuesday that the ‘triple-lock’ formula for annual state pension increases would be suspended for one year. Instead, the calculation will be based on the greater of 2.5% or inflation, while the third component of average wage increases would be disregarded for one year.

US plans COVID ‘six-pronged strategy’

On Tuesday it was confirmed by White House press secretary Psaki, that US President Biden would later this week on Thursday outline a ‘six-pronged strategy’ and which would involve ‘working across the public and private sectors to help continue to get the pandemic under control’. The announcement is likely to include an update on the plans, initially announced in August, around delivering COVID vaccine ‘booster jabs’ likely later this month. According to US CDC’s vaccine tracker (US Centers for Disease Control and Prevention), 75% of US adults have now had at least one vaccine dose.

What does Brooks Macdonald think?

The UK rise in national insurance contributions breaks a key Conservative manifesto pledge not to increase any of the main rates of tax. That said, it’s worth remembering that this promise pre-dates the COVID pandemic which went on to up-end many governments’ spending plans around the world. In terms of what it means for markets, perhaps more significant is the broader cadence from policy makers, in that following the unprecedented levels of fiscal support during the pandemic last year, this year, fiscal prudence seems to be the dominant theme. At the edges, this also perhaps adds a bit of a headwind for those investors looking for a sustained fiscal impetus to drive a durable reflationary narrative. As we have said before, with 2021 being a year of transition, this is not the year to try to decisively swing the asset allocation ‘bat’ behind any one particular investment style. Instead, balance in portfolios remains key.

Source: Bloomberg as at 08/09/2021. TR denotes Net Total Return.

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

David

9th September 2021

Team No Comments

Weekly Market Commentary – Spanner in the works from the US Jobs Report

Please see below commentary received from Brooks Macdonald yesterday evening, which presents market analysis following the European Central Bank’s latest monetary policy meeting. 

This week begins with a holiday Monday in the US for Labor Day, with markets closed in the country. In reality, this is just a brief respite before the pace picks up a gear, and there’s quite a lot to keep investors focused. 

The big event this week is the ECB’s latest monetary policy meeting due on Thursday, where attention will be on whether or not they decide to start to taper back their recent higher-level of asset purchases. Elsewhere, we also have central bank policy decisions from Australia (on Tuesday), and Canada (on Wednesday). 

The recent US Jobs Report significantly missed expectations

In the US, investors will be trying to figure out what last week’s US jobs miss means for the Federal Reserve (Fed) and for the timing of any tapering decision. Later this week, the US Producer Price Index (PPI) is due on Friday, which sets up the inflation-focus ahead of US Consumer Price Index (CPI) due the following week. Finally, according to recent reports from Bloomberg, US President Biden might decide this week who is going to be the next Fed Chair. Powell’s current term as Chair ends in February next year, but expectations are that he is likely to get a second term, not least given reports last month that US Treasury Secretary and former Fed Chair Janet Yellen has endorsed Powell’s renomination.

Just as markets had digested Fed Chair Powell’s Jackson Hole script, Friday’s US jobs report has put a bit of a spanner in the works. A week ago, Powell had indicated that with an inflation goal already met and an employment goal in sight, the Fed might soon start to taper its $120bn a month of asset purchases. But then Friday happened, and US non-farm payroll data showed just 235,000 jobs added in August. This is a big miss, given markets had been expecting a print more than three times bigger, versus 725,000 expected1

It was also well outside of the bottom of the forecast range (of 400,000 to 1 million). To put it in context, despite a positive revision to July, this was the lowest monthly jobs add in seven months. Behind the weakness, there was a sharp slowdown in hospitality and retail job creation. Employment in ‘retail trade’ declined over the month by 29,000 jobs, and there was also a loss of 42,000 jobs in ‘food services and drinking places’2. As the US Bureau of Labor Statistics report noted, ‘employment in leisure and hospitality is down by 1.7 million, or 10.0 percent, since February 2020.’ All in all, it’s hard not to see how this report will give some support to the view that the COVID-19 Delta variant is having an impact on both the pace of the economic recovery and the labour market recovery. In terms of how it might influence Fed-thinking, it will be interesting to see what Fed members say about the jobs report, and this week, we have a number of scheduled Fed-speaker events worth keeping an eye on. 

Investors will look to see if the ECB will slow down the Pandemic Emergency Purchase Programme (PEPP)

The highlight for markets this week will be the ECB’s latest monetary policy decision due on Thursday, along with ECB President Lagarde’s press conference that follows the statement as usual. The big question for investors is whether or not the ECB will decide to slow down the recent ‘significantly higher’ rate of Pandemic Emergency Purchase Programme (PEPP) purchases into calendar Q4. In the last week or so, we’ve seen a more public airing of views from both hawkish and dovish ECB governing members. On the outlook for inflation, on the one hand we’ve seen Germany’s Bundesbank chief Weidmann saying ECB members shouldn’t disregard the risk that inflation could accelerate faster than currently anticipated. Against this, ECB chief economist Philip Lane, who recently argued that inflation surprises still did not challenge his views about the temporary nature of price pressures as wage growth, remained muted in his view. All in all, it’s difficult to come down on one side or the other ahead of Thursday.

With the miss in the US jobs report, it is perhaps inevitable that investors will worry that a resurgent COVID-19 infection picture is impacting on the pace of the US economic growth recovery. As for the monetary policy outlook, for the Fed to green-light a future taper programme, the labour market needs to show continued improvement, and Friday’s print won’t have helped that cause. At the end of the day, we have to keep in mind that it’s only one data point. Instead, it now leaves the focus for markets on the Fed’s next monetary policy meeting later this month, on 21 – 22 September. However, the odds that the Fed will press the button on a taper start-date at this September’s meeting are now a little bit longer.

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

Stay safe.

Chloe

07/09/2021

Team No Comments

Powell reassures markets that the Fed wont rush rate hikes

Please find below an update from Invesco, received late on Friday, reassuring markets that the Fed won’t rush rate hikes.

Kristina Hooper, Chief Global Market Strategist, Invesco Ltd

Key takeaways

Some Fed officials took a hawkish tone

At Jackson Hole, several Federal Reserve officials were emphatic that tapering needs to begin – and soon.

Powell’s remarks calmed markets

But Powell offered a kinder, gentler view of tapering, declining to establish a timeline.

No rush on rate hikes

Powell also noted that rate hikes have a more stringent set of conditions and are uncoupled from tapering plans.

Last week — in the dead of August — the Kansas City Fed held its annual Jackson Hole Symposium. In a true sign of the times, the symposium was not actually held in Jackson Hole this year, as had been originally planned; instead, it was held virtually. This underscored the reality that things are not back to normal.

Some Fed officials took a hawkish tone

In the run-up to Federal Reserve Chair Jay Powell’s speech, several Fed officials were emphatic that tapering needs to begin soon. Kansas City Fed President Esther George said she expects the Fed to start tapering shortly. Dallas Fed President Robert Kaplan called for tapering to be announced by September and to begin by October or soon thereafter. Perhaps most surprising — and most hawkish — were the words of St. Louis Fed President James Bullard.

Bullard worried that the Fed’s balance sheet expansion is creating a housing bubble. He said that the tapering process should be finished by the end of the first quarter. What’s more, he articulated serious concerns about inflation; he seems sceptical that inflation is actually transitory and argued that by March 2022, the Fed would be able to assess whether inflation had moderated. He suggested that if inflation hadn’t moderated, the Fed would have to get “more aggressive,” which I would presume to mean rate hikes, and that would be sooner than expected. Not surprisingly, these hawkish comments rattled markets.

Powell’s remarks calmed markets

But then came Powell’s speech, and markets breathed a sigh of relief.  It’s true that things are certainly not back to normal, and Powell made that clear. He recognized that the pace of the recovery has exceeded expectations — and has been far swifter than the recovery from the Great Recession, with even employment gains having come faster than expected. However, he underscored the unusual nature of the recovery – he described it as “historically anomalous” — with personal income actually having risen. He said that while labour conditions had improved significantly, they were still “turbulent.” And of course, he pointed out that the economic recovery is being threatened by the resurgence of the pandemic.

Powell also underscored the unevenness of the economic recovery, that the Americans least able to carry the burden are the ones who have had to do just that. He emphasized that the services sector has been disproportionately affected, noting that total employment “is now 6 million below its February 2020 level, and 5 million of that shortfall is in the still-depressed service sector.”1

A kinder, gentler tapering

While George, Kaplan and Bullard took a more hawkish stance on tapering, Powell offered a kinder, gentler view. He recognized that the “substantial further progress” test for inflation had been met, but did not announce the start of tapering, or even call for it to be announced by September. He acknowledged that at the July Federal Open Market Committee (FOMC) meeting, most participants believed it would be appropriate to taper this year. And he recognized that in the month since the last FOMC meeting, there has been more progress on the economic front — but that there has also been further spread of the COVID-19 Delta variant. My read on this is that tapering is likely to be announced soon, but that Powell would like to maintain some flexibility given the uncertainties presented by COVID.

Powell seemed more certain in his assessment that inflation is largely transitory. He offered up compelling arguments to support that view, especially pointing to longer-term inflation expectations remaining anchored. I found this gave credibility to his more dovish stance.

The key takeaway: A ‘conscious uncoupling’

Powell channelled his inner Gwyneth Paltrow in asserting that rate hikes are uncoupled from tapering. In other words, he suggested that we shouldn’t expect rate hikes to begin just because tapering has ended. He asserted that rate hikes have a different and far more stringent test: “until the economy reaches conditions consistent with maximum employment and the economy is on track to reach 2% inflation on a sustainable basis.”1 This was perhaps the most important takeaway from the speech, given that markets seem far more concerned with when rate hikes will begin rather than when tapering will begin.

Looking ahead

All eyes will be on the August jobs report, due out at the end of this week. There are whispers that this could be a blowout with more than 1 million non-farm payrolls created. If that happens, I believe the Fed would be even more comfortable announcing tapering in September and starting to taper in October.

Further off into the distance, questions are swirling about whether Powell will be re-nominated as Fed Chair. While I suspect there may be a little grumbling from the extremes on both aisles of Congress, my money is on his re-nomination. However, speculation about this — and the future of the vice chairs (the vice chair and the vice chair for supervision) — will certainly occupy some markets watchers’ time in the coming months.

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

David

6th September 2021

Team No Comments

Markets in a Minute – Stocks rebound as Fed calms rate hike fears

Please see below ‘Markets in a Minute’ article received from Brewin Dolphin yesterday evening, which provides up to date analysis on rising global stock markets.

Global stock markets rose last week as the US Federal Reserve signalled that interest rate hikes are still a long way off despite the recent rise in inflation.

The Nasdaq surged 2.8% and the S&P 500 gained 1.5%, with full approval of the Pfizer vaccine helping to offset concerns about the attack at the Kabul airport in Afghanistan. A surge in crude oil prices boosted energy stocks.

In Europe, the STOXX 600 added 0.8% amid encouraging economic data and comments from the European Central Bank that high inflation should prove temporary. The UK’s FTSE 100 also rose, despite figures showing a marked slowdown in the services sector.

Over in Asia, Hong Kong’s Hang Seng recovered from the previous week’s rout to gain 2.3%. Japan’s Nikkei also performed strongly, adding 2.3% despite another extension to the country’s Covid-19 state of emergency.

US indices reach record highs

US stocks started this week in the green amid ongoing optimism that the Federal Reserve will not immediately taper its support for the economy. The S&P 500 and the Nasdaq hit new record highs on Monday (30 August), ending the day up 0.4% and 0.9%, respectively. August was the S&P 500’s seventh consecutive month of gains – its longest winning streak since a ten-month run ending in December 2017.

The FTSE 100 struggled for direction on Tuesday, slipping 0.4% during its first trading session following the bank holiday weekend. The pan-European STOXX 600 also slipped 0.5% after data showed consumer price inflation rose by 3.0% in August – the highest level since 2011.

The FTSE 100 was up 0.8% at the start of trading on Wednesday, ahead of the release of the closely watched US ADP jobs report.

Fed clarifies position on interest rates

Last week’s economic headlines were dominated by Fed chair Jerome Powell’s speech at the Jackson Hole symposium, in which he signalled that while the central bank could begin dialling back its support for the economy later this year, interest rate hikes are still a long way off.

The Fed has repeatedly stated that it will maintain its pace of asset purchases until it sees ‘substantial further progress’ towards its goals of 2% inflation and maximum employment. On Friday, Powell said the first of these thresholds has been met, and clear progress has been made on the second.

Powell reiterated his view that the recent rise in inflation will prove temporary, and insisted that any tapering of economic support would not be a direct signal to increase interest rates. (Higher interest rates are a headwind for stocks because bond yields rise, making stocks look less attractive in comparison.)

UK business output growth slows

Here in the UK, figures suggested growth in the manufacturing and services industries slowed in August amid staff shortages and supply chain constraints. IHS Markit’s preliminary composite purchasing managers’ index (PMI) measured 55.3 in August, down from 59.2 in July. The reading was still above the 50.0 mark that separates growth from contraction, but marked the slowest expansion of output since the UK private sector returned to growth in March.

The services sector suffered the biggest loss of momentum, falling to 55.5 in August from 59.6 in July. Manufacturing output slipped to 54.1 from 57.1 the previous month.

Chris Williamson, chief business economist at IHS Markit, said: “Although the PMI indicates that the economy continues to expand at a pace slightly above the pre[1]pandemic average, there are clear signs of the recovery losing momentum in the third quarter after a buoyant second quarter. Despite Covid-19 containment measures easing to the lowest since the pandemic began, rising virus case numbers are deterring many forms of spending, notably by consumers, and have hit growth via worsening staff and supply shortages.”

Eurozone economy keeps expanding

In contrast, business activity in the eurozone continued to grow in August at one of the strongest rates of the past two decades. Despite supply chain delays, the IHS Markit flash eurozone composite PMI held close to its 15-year high, slipping slightly from 60.2 in July to 59.5 in August.

Growth in the services sector overtook that of manufacturing for the first time since before the pandemic, as lockdown restrictions continued to ease. At 59.7, service sector growth was only marginally lower than July’s 15-year high. Manufacturing output also remained strong at 59.2, down slightly from 61.1 in July.

The report showed inflation in input costs and selling prices remained elevated, although the European Central Bank’s chief economist, Philip Lane, sought to allay fears by telling Reuters that recent inflationary pressures are likely to prove temporary.

China to cooperate on US auditing

Elsewhere, China’s securities regulator said it will ‘create conditions’ to cooperate with the US over how it supervises the auditing of Chinese companies, potentially signalling the end of a long-running dispute between the two countries. Previously, China refused to let US securities regulators inspect the financial audits of its US[1]listed companies on the grounds they could hold state secrets. Earlier this year, Chinese firms were warned they could be delisted if they refused to comply with the US audit rules, raising concerns the two countries’ financial systems could become decoupled.

According to the South China Morning Post, the China Securities Regulatory Commission hasn’t yet released details on how audits will be made more transparent.

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

Stay safe.

Chloe

02/09/2021

Team No Comments

A unique event on Prudential’s ‘smoothed’ funds – a Unit Price Reset

Please see below details relating to the unique event impacting Prudential’s ‘smoothed’ funds.

The Pru PruFund ‘smoothed’ range of funds have been in existence since 2004 in an investment product.  Late yesterday afternoon, for the first time in c 17 years, Prudential announced a Unit Price Reset (UPR).  This is an increase in fund value in this case.

It looks similar to a Unit Price Adjustment (UPA) and is also a part of the ‘smoothing’ mechanism for PruFund funds.  If you look in their guide to the smoothing process, you can see it mentioned on the bottom of page 3;

https://www.pruadviser.co.uk/pdf/PRUF1098101.pdf?utm_term=PruFund%20Quarterly%20EGR%20&utm_campaign=PruFund%20&utm_content=email&utm_source=Act-On+Software&utm_medium=email&cm_mmc=Act-On%20Software-_-email-_-Latest%20EGRs%20and%20UPRs%20for%20the%20PruFund%20range%20of%20funds-_-guide%20to%20the%20smoothing%20process

Why is this happening now?

We have been through an unprecedented time in 2020 with the sharpest and quickest falls in markets and then subsequent recoveries.  The underlying fund performance has been strong since March 2020 and this UFR ensures that this is fully delivered to you.  To quote the Pru ‘It’s being done because it’s the right thing to do for all policyholders.’

It’s about treating customers fairly, in this case for clients like you in the Pru’s ‘smoothed’ funds.  Unusual circumstances can require unfamiliar solutions – all subject to a rigorous framework and governance and overseen by a specialist actuary, a specialist committee and signed off by the Prudential Assurance Company board.

How does impact on me?  The following UPRs have been announced:

ProductFundUnit Price Reset
Flexible Retirement PlanPruFund Growth+5.66%
Flexible Retirement PlanPruFund Risk Managed 4+4.56%
Trustee Investment PlanPruFund Growth+5.66%
Prudential ISAPruFund Growth+5.66%
Retirement AccountPruFund Growth Series D+5.66%
Retirement AccountPruFund Risk Managed 4 Series D+4.56%
Retirement AccountPruFund Growth Series E+3.63%
Retirement AccountPruFund Risk Managed 4 Series E+3.69%
Retirement AccountPruFund Risk Managed 5 Series E+5.02%

The difference in the UPRs is based on the current position, for example, if UPAs have been applied more frequently, as is the case with Series E funds.  It is also based on your risk profile, different funds such as the Risk Managed 4 and 5 funds have a different risk profile.

The only funds that have not been affected by this UPR is the brand-new range of smoothed funds, the five funds that are PruFund Planet.  I’ve outlined the main funds in the table above that affect our clients. It’s nice to get some good news at the moment, hopefully this will add to your enjoyment of the Bank Holiday weekend!

Steve Speed

26/08/2021

Team No Comments

Inching closer to the exit

Please see below article received from Legal & General yesterday afternoon, which reviews the markets’ reaction to the disorderly withdrawal of US and UK troops in Afghanistan and the ongoing global battle with coronavirus.

Last week, we received the minutes of the Federal Open Market Committee (FOMC) meeting held at the end of July. Tapering was the word of the day. A reduction in the pace of asset purchases is now overwhelmingly expected by the year’s end. When thinking about the risks to global markets posed by tapering, we believe it is worth remembering three things.

Minutes minutiae

First, never has a pending policy change been discussed so much, by so many, for so few insights. Market shocks tend not to be driven by things that are almost entirely predictable.

Second, aggressive tapering happened last year, and nobody really noticed. In the first three months of the COVID-19 crisis, from March to May 2020, the Federal Reserve (Fed) bought $1.6 trillion of Treasuries. In the subsequent 14 months, it has bought just over $1.1 trillion. The pace of asset purchases has slowed down by 85% since those early days. Since then, the S&P 500 is up over 50%, credit spreads are tighter, and real yields are lower. Anyone arguing that asset-purchase flows are the “only game in town” has a tough time explaining that.

Third, the 2013 taper tantrum was a stressful time for emerging-market investors, but a non-event for investors in US equities. The S&P 500 had a peak-to-trough drawdown of 5.5% in the middle of 2013. That’s it.

So, what could a genuine tapering surprise look like? The potential action is not in the timing but in the pace. Last time around, tapering took 10 months; formally announced in December 2013, it ran until October 2014. It was then another 14 months from the end of tapering to the first rate hike, so it was a two-year process before we reached the serious business of rate hikes.

We think the timelines can be compressed this time around, but still struggle to see the conditions for a rate hike before mid-2023. Even the most hawkish voices on the FOMC are talking about end-2022 as the likely “lift-off” date.

That means that the real yield on cash (almost certainly) and on government bonds (probably) will remain deeply negative for the foreseeable future. There is plenty of discussion about overvalued equity markets, but the forward earnings yield on the MSCI World is still in the region of 5%. That looks mighty tempting in a world with $16 trillion of negative-yielding debt.

Regime change in Afghanistan

The world has witnessed incredibly dramatic scenes in Afghanistan. But what pointers are markets taking from the collapse of the Western-backed government?

The Afghani currency has tumbled by nearly 10%, but it is too exotic for even the most high-octane frontier market funds. It is impossible to know how the unfolding tragedy will evolve, but the markets are adept at drawing dotted lines from one political theatre to others. We can think of three implications:

  • It raises immediate concerns about the pending withdrawal of US troops from Iraq. The combat mission there is due to end by December, with the remaining 2,500 US troops leaving. Given that Iraq produces the best part of four million barrels of oil per day, political instability there has a firmer transmission route to global risk sentiment than Afghanistan.
  • The effectiveness of the US deterrent in other parts of the world has arguably been undermined by the rapid withdrawal of support in Kabul. In particular, China’s state media have immediately drawn the link from Kabul to Taipei. The Global Times has been quick to play up the “unreliability of US commitment to its allies”, arguing that in the event of war “the island’s defence will collapse in hours and the US military won’t come to help”. This is not exactly subtle messaging, but it does force markets to think harder about the superpower tensions.
  • During the 2014-15 migrant crisis, the European Union received 1.6 million requests for asylum. We think of that migration wave being a consequence of the Syrian civil war, but roughly one-sixth of asylum seekers were from Afghanistan and Pakistan. Three years ago, we wrote about the potential for uncontrolled refugee flows to act as a catalyst for higher political risk premia across Eastern and Southern Europe. Asylum policy is set to become a divisive political issue once again, with worrying implications for French and Italian politics. “Le spread” and “lo spread” will be the centre of the market’s attention before long if refugee flows are not well managed.

Kiwi fails to take flight

New Zealanders are pioneers in many things: kiwifruit, rugby, manuka honey. But they are also world leaders in central-bank innovation. The Reserve Bank of New Zealand Act came into effect in 1990, and it wasn’t long before the innovation of “inflation targeting” spread all the way around the world.

Since the pandemic, its innovation has taken two forms: formally adding a housing concern to its policy mandate, and acting as the frontrunner in the move to normalisation. At the beginning of last week, the market assumed the first increase in rates since 2014 was a foregone conclusion. That confidence was derailed by COVID-19.

Since February last year, New Zealand has reported just under 3,000 COVID-19 cases with fewer than 30 deaths. The “zero COVID” strategy has been immensely successful but requires an aggressive response to even the smallest incidence of community transmission. Re-imposing a lockdown across the country triggered a 2.5% swoon in the New Zealand dollar and saw expectations of rate hikes pushed back to later in the year.

The risks here are evident across the Tasman Sea, where COVID-19 cases in New South Wales continue to double every 10 days despite a lockdown now entering its 10th week. Sydney is in a trap with no obvious escape route. The markets have to price the risk that Auckland will soon be stuck in the same bind.

This is a reminder that currencies remain pretty sensitive to developments in interest rates. Interest-rate differentials have not been a factor for several years because G10 interest rates haven’t been moving. That could change in 2022, with some early movers starting to normalise.

The skew of risks around the interest-rate path outlined by central bankers also remains to the downside. Despite lots of rhetoric about inflation concerns, last-minute worries about growth can still kibosh hiking plans.

Finally, zero-COVID strategies require constant vigilance. There’s an obvious read across here to China. The news there over the past week has looked better, with case numbers declining again, but trying to keep a highly infectious disease out of the country altogether will be an ongoing battle with economic collateral damage. Our China outlook for the rest of the year is notably more downbeat than the consensus as a result.

We will continue to publish relevant content and news as we enter the final couple of weeks of summer in the UK.

Stay safe.

Chloe

24/08/2021

  

Team No Comments

Weekly Market Update

Please see below “Investment implications of recent Chinese policy interventions” received from JP Morgan this morning, which provides details relating to recent changes made by Chinese regulators.

Having outperformed other regional stock markets for much of the pandemic, Chinese stocks have fallen sharply over the past few months (Exhibit 1). Concerns around the Chinese economy slowing were blamed for the initial move, but more recent declines have been triggered by regulatory tightening focused in specific sectors. This piece sets out why we remain positive on the medium-term outlook for Chinese assets, although we recognise that it may take some time for the scope of regulatory tightening to become clearer before sentiment towards the stock market improves.

Exhibit 1: Chinese and developed market equity returns

Source: MDCI, Refinitiv Datastream, J.P. Morgan Asset Management. Past Performance is not reliable indicator of current and future results. Data as of 16 August 2021. 

How should investors interpret the latest regulatory changes? 

Recent moves from policymakers are best understood in the context of Beijing’s efforts to balance short-term growth against longer-run policy objectives. 

In the technology sector, Chinese regulators are taking steps to address inappropriate use of market power, limit regulatory arbitrage opportunities and increase market competition. Cybersecurity is another emerging focus, with companies’ treatment of user data receiving particular attention. There are clear parallels to regulatory actions witnessed in developed markets in recent years. Companies that have chosen to pursue overseas listings – often Chinese technology names trading on US exchanges – are also coming under additional scrutiny and may be particularly vulnerable to future rulings. While broadly we are seeing technology regulators take a more active stance, we do not believe it is in China’s strategic interests to punish its domestic champions, particularly in the context of the longstanding US-China rivalry. Instead we think regulators want to ensure that technology giants are competing with the next cohort of innovators in a fair and well-functioning market.

The education sector has also seen significant regulatory changes. The Chinese government will no longer approve the setup of new private tutoring companies, and existing companies which tutor the school curriculum will be required to transform into non-profit institutions. While private sector tuition remains discretionary in most western countries, after-school tutoring has become so pervasive in China that authorities now view it as a key social policy challenge. The latest measures are designed to alleviate both the mental burden of extra tuition on students and the financial burden for parents, with a view to stemming the decline in China’s birth rate over time. In this context, we do not expect that the severe actions taken in the education sector will become widespread across the private sector. 

The tone of recent policy interventions has highlighted that Beijing is keen to ensure that corporate behaviour remains aligned with the administration’s long-term policy goals. That said, we do not believe this represents a fundamental shift in another key long-term objective: to open up Chinese markets to foreign capital. Substantial efforts to integrate both Chinese equities and bonds into international indices are ongoing. In our view, policymakers will be acutely aware that they do not want regulatory actions to undermine the attractiveness of Chinese assets to the global investment community. 

What do we expect next? 

The Politburo meeting at the start of August provided greater insight into the economic and regulatory policy direction for the rest of the year. 

Further reforms are still on the cards for some of the ‘new economy’ sectors where the Chinese authorities wish to achieve better social outcomes or improve the competitive environment. Regulatory uncertainty will remain elevated until the scope of reforms becomes clearer, particularly for politically or socially sensitive industries. It is important to recognise, however, that many of China’s new economy leaders will still have room to chart future growth; they have been working closely with the government for many years and will continue to do so. 

There will also be sectors that benefit from future policy changes. Examples include climate-focused technology to support greenhouse gas reductions, industries related to accelerating the rollout of electric vehicles, and sectors critical to achieving self-sufficiency within key parts of the technology supply chain. 

From an economic perspective, the Chinese government recognises the imbalances in the economic recovery, with small and medium-sized enterprises and low-income households having lagged to date. As a result, targeted fiscal stimulus is likely to be preferred to monetary policy in supporting growth for the rest of the year. Monetary policy has shifted to a more neutral stance following modest tightening in the first half of the year, although further easing is possible if growth momentum continues to fade. Broadly, Beijing appears to be fine-tuning growth back on to a more stable path, having gone through the “boom phase” of its recovery last year.

The impact of the spread of the Delta variant remains something of a wildcard. The Chinese government was highly effective at stemming the spread of previous variants, but cases have been on the rise again. Vaccine rollout is proceeding at pace, although real-world studies of the efficacy of different vaccines remain limited. This will be an issue to watch closely over the coming months. We don’t expect a repeat of the sharp slowdown witnessed in the Chinese economy last year, but given China’s desire to pursue a “zero-Covid” strategy, there is a risk that restrictions will be applied periodically. This could well have knock-on impacts in the global supply chain; recent shutdowns linked to Covid-19 in Ningbo-Zhoushan – the world’s third busiest port – are a prime example.

What are the investment implications?  The sharp declines over the past few months have served as a reminder that Chinese equities do come with a higher level of volatility than many other markets. Over the past 25 years, the annualised return from the Chinese stock market is over 5% in local currency terms, despite average intra-year declines of close to 30%. Calling the bottom of any market correction is an impossible task, although valuations have now fallen substantially, from over 18x 12-month forward earnings at the peak earlier in the year to below 14x today for MSCI China. While valuations may remain under pressure until the markings of the regulatory playing field become clearer, ultimately, we expect investor attention to gradually return to company-specific fundamentals. 

In our view, Chinese assets remain an essential part of both global equity and global bond allocations. Beijing has made a huge push to open its capital markets to international investors, and we expect this to remain a priority. Short-term volatility has not fundamentally changed the long-term investment opportunity in China, which is based on technological innovation and the rise of the domestic consumer. The key for investors is to access the Chinese markets in the right way: via a diversified portfolio of both onshore and offshore companies and with an active approach that can differentiate between the winners and losers of the government’s long-term policy goals. 

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

David

23rd August 2021