News

Please see the below article from Tatton Investment Management detailing their thoughts on markets over the past week, received this morning:

Buy the rumour, sell the fact

Despite competing market narratives, stock markets were generally stable last week. China was the only exception; it managed to fit a boom-bust cycle into the space of a few days. There are plenty of uncertainties, but we’re still confident about the long-term outlook.

Bond yields climbed after surprisingly high US inflation. Markets’ implied path for US interest rates flattened; the expected trough in rates (coming early 2026) is now half a percentage point higher than what markets predicted in early October – as we said might happen. But this isn’t about the Fed turning hawkish. Inflation-linked bond yields rose quicker than nominals, meaning higher inflation expectations. The summer soft patch for US growth is over, but risk markets are still pretty happy about the growth-rates balance. The hurricane damage might strangely boost near-term growth, because of rebuilding efforts.

Higher US yields and a stronger dollar hurt UK bonds, which in turn bruised UK stocks. That is a problem for the government heading into a tough autumn budget. The treasury’s mixed messages haven’t helped. Chancellor Reeves warned about tax rises one day then backed off the next. Foreign investor flows need more certainty, which will only come after the budget.

China’s government is still the biggest flip-flopper, though. Investors were excited about ‘bazooka’ stimulus, but a much anticipated conference last week promised a measly amount of spending. Chinese stocks lost 13% from Tuesday to Friday, as investors worried that Beijing’s was just a paper bazooka. Incredibly, stocks were still up overall last week – showing just how wild China’s swings have been.

The biggest shock risk is still the Israel-Iran conflict, but there were signs of possible de-escalation last week. Iran’s leadership appears very week, and gulf states are pressuring the US to prevent an Israeli strike on Iranian oil fields. Oil prices fell in the early part of the week, and only rebounded after US growth and inflation data. The threat remains, but the underlying global growth picture is strong despite disturbances.

What to expect this earnings season

Markets await the US’ third quarter corporate earnings season. US earnings get more attention than other regions – partly because its equity market dominates global market cap, but also because American companies have to report every quarter. Profit results always move markets, but they are particularly important in an uncertain US economic outlook. Markets want a ‘soft landing’ (interest rate cuts without recession) which would need resilient earnings. The good news is that analysts expect a fifth straight quarter of profit growth from S&P 500 companies. There will inevitably be ‘surprises’ through the season, but reporting tends to follow a pattern.

With Q3 only just over, we are getting a drip feed of results and will see the bulk of reports in late October and early November. Cyclically sensitive financials tend to report first, since they always need up to date books. Tech companies tend to report later. Since these are such a huge part of the stock market, the biggest earnings reactions can also come later. This is epitomised by ‘Nvidia day’; the chipmaker’s reports have become massive market-moving events in recent years. The ‘surprises’ (how results fare against projections) are key, but companies have become adept at managing expectations so they can ‘beat’ them and get a share price bump.

S&P earnings growth is projected between 4-5%, but company forecasts always get strategically weakened heading into the season, so the actual figure will probably be higher. The only concern is that earnings forecasts have been revised down more than usual this time – which could just be more companies getting wise to the ‘beat’ strategy or a sign of actual decline. We think an actual earnings growth disappointment is unlikely, but this is a warning sign. It’s a risk which could mean volatility into the year end.

A new kind of antitrust

The US Department of Justice (DoJ) wants to break up Google, according to last week’s court filing. It comes after a US judge ruled the company a “monopolist” in August, for practices like paying to be the default search engine and charging rent on in-app purchases. A breakup could be even bigger for markets than Microsoft’s ordered breakup (which was overturned) 24 years ago. Parent company Alphabet is worth $2tn, and global market cap is much more concentrated on tech giants these days. But Alphabet’s shares barely moved on the news. Investors seem to think the actual result (after appeals) will be kicked down the road and ultimately diluted.

This might be overconfidence, based on old assumptions about antitrust law. The Biden administration has made clear it’s focussed on potential structural harms rather than the classic price gouging issues that antitrust regimes were originally built to tackle. The political understanding of monopoly has shifted to think that big is bad, even if there’s no direct evidence of consumer harm. Federal Trade Commission (FTC) head Lina Khan is the symbol of this approach. While the FTC isn’t involved in the Google case, it has brought many tech-busting cases during Khan’s tenure.

Khan is an interesting point for the future of US antitrust law. She was hired to reinvigorate antitrust regulation, but few of her high-profile cases have succeeded. She might not be reappointed under the next administration even if Kamala Harris wins, considering Harris donors dislike her aggressive approach. But whether that would mean a softer approach is harder to say. Donald Trump is assumed to be softer on tech, but his voter base dislikes big tech. Harris is assumed to be tougher, but her corporate donations far exceed Trump’s. Google’s outlook is uncertain, but investors might be complacent in thinking the problem will go away.

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

Charlotte Clarke

14/10/2024

Please see the below daily update article from EPIC Investment Partners:

According to data from the Investment Company Institute, money market funds experienced an inflow of $11 billion during the week ending October 9, bringing the year-to-date total to over half a trillion dollars. Historically, during phases of monetary easing, money market funds have attracted substantial cash inflows due to their liquidity and perceived safety. As of October 9, 2024, total assets in money market funds reached $6.47 trillion, a new record.

The Federal Reserve’s September 2024 ‘dot plot’ projections indicate further reductions in the federal funds rate, with expectations for rates to decline to 3.4% by 2025 and 2.9% by 2026. With the Fed’s dual mandate now seemingly focused on employment, yesterday’s rise in initial jobless claims to 258,000—the highest in a year—will likely reinforce the rate cut agenda. 

Almost unnoticed, bond funds have also begun to attract investor interest. Over the past 12 months, the Bloomberg Global Aggregate Index has risen by nearly 10%, easily surpassing returns on money market funds or cash. Historically, bond funds have shown notable gains during periods of declining interest rates. During previous rate-cutting cycles, such as those in 2001 and 2008, initial cash flows into money market funds were often followed by reallocations to bond funds as investors sought higher yields.

Money market funds often serve as an interim repository for liquidity injected by Federal Reserve easing measures. As conditions stabilise and uncertainty diminishes, investors typically shift from low-risk assets like money market funds to higher-return investments such as bond funds. Despite recent rate cuts, money market funds continue to offer yields superior to bank deposits due to slower rate adjustments. Additionally, the inverted yield curve, where short-term yields exceed long-term ones, supports the attractiveness of money market funds as a short-term option.

However, as rate cuts continue, bond funds are likely to become more attractive. Declining short rates generally lead to rising bond prices, enhancing potential returns. Investment-grade bonds, including government, corporate, and emerging market debt, are expected to offer higher yields than cash-equivalent instruments. Investors often focus too heavily on current yields, missing potential capital gains from bonds in a declining rate environment.

Drawing from recent cricket events, the record-breaking partnership between Harry Brook and Joe Root, which took England to 823 for seven declared, underscores the importance of timing. Just like the perfect brew of PG Tips, where timing is key to get the right flavour, investors must be mindful of when to transition from cash reserves in money market funds to bond funds. In cricket, hesitation can be the difference between scoring a boundary or losing a wicket. Similarly, investors must act decisively when transitioning from cash reserves in money market funds to bond funds. Hesitation could mean missing out on favourable conditions presented by declining interest rates.

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

Andrew Lloyd

11/10/2024

Please see the below article from EPIC Investment Partners, analysing the latest economic data releases in China and discussing their implications for policy making and investment decisions. Received this afternoon – 10/10/2024

Chinese household savings (measured as the annual increase in household deposits) have ballooned in recent years. In the ten years to 2017 household savings averaged Rmb4.75tr annually. This climbed to Rmb9.53tr over the next four years to 2021 and then doubled again to Rmb17.3tr in the last two years. Indications are that 2024 will show a similar number.

The flip side of this is, of course, household debt. Chinese household debt (as a % of GDP) has also risen steadily over the past two decades:19% in 2004, 29.8% in 2012, 55.8% in 2019 and 66.5% in 2023 according to Bloomberg economics. This is low by comparison with the United States and the United Kingdom where household debt (as a % of GDI) stands at 97.7% and 137.6% respectively according to OECD data, but it does make the point that Chinese households are willing to take on debt, primarily for property purchases.

For the statistical geeks, GDI (gross domestic income) is comparable to GDP (gross domestic product). 

Surveys of Chinese household intentions over the last ten years have consistently suggested that circa 75% of households want to save or invest more and only circa 25% want to increase consumption. This is a cultural issue, and it is difficult to change long held intentions or preferences. ‘Get rich before you get old’ seems an appropriate adage.

The collapse in the residential property sector is not the cause of excessive savings but it has aggravated a pre-existing ‘condition’. Outstanding individual residential mortgages have declined 3% from their 1Q 2023 high.

We are reminded of the long-held view of our old friend Doctor Jim Walker that trade surpluses are a sign of economic weakness and not a sign of strength. China last posted a (tiny – $1.7bn) trade deficit in 1996. The trade surplus in the first half of 2024 reached $156bn, completely blowing away the previously record annual trade surplus of $98bn in 2021.

Recent policy announcements are cyclical in nature, not structural. China needs inflation not deflation and a trade deficit not a trade surplus. Can the authorities ever get their heads around this proposition?

Please continue to check our blog content for the latest advice and planning issues from leading investment management firms.

Alex Kitteringham

10^th October 2024

Please see the below article from Brewin Dolphin detailing their analysis of the U.S. job data and the impact on financial markets. Received yesterday 08/10/2024.

While there was some reassuring news on the economy last week, there was some concerning news on the geopolitical front. It’s worth considering how these trends can become intertwined.

It’s been a year since Hamas launched its unprecedented attacks on Israel from Gaza. Since then, Israel has conducted an extensive ground operation in the region. Conflict has also continued between Israel and the Houthis in Yemen and Hezbollah in Lebanon.

In recent weeks, the conflict has intensified significantly around the Lebanese border, with some ground operations by Israeli forces in Lebanon. Last week, Iran launched 180 ballistic missiles against Israeli targets. The two sides differed in their reports of the operation’s success but thankfully, casualties were low.

Nevertheless, speculation has risen that Israel could attack Iran’s oil infrastructure in retaliation, as predicted by former Israeli Prime Minister Ehud Barak. This speculation was fanned by comments from U.S. President Joe Biden. When asked whether the U.S. would support such a move by Israel, Biden responded: “we’re discussing it”.

What’s at Risk?

The events in the Middle East are very troubling from a human perspective, but we know that markets and to a large extent economies, are dispassionate about such things. If the conflict were to impact energy production, markets and economies would begin to react quickly. Indeed, following Biden’s comments on Thursday, oil rose around 4% and ended the week 9% higher.

In previous notes, we have discussed the benefits of an energy position within portfolios. The bull case here is that energy stocks stand to benefit from a reluctance to invest in new energy supply. Constraints on energy investment are more politically acceptable than taxes on energy consumption, which have the same effect of driving energy prices higher. The difference between the two is that taxes would create revenue for governments, whereas supply constraints increase profits for suppliers.

This capital cycle argument has in recent months been overwhelmed by a gloomy outlook for energy demand. In the U.S., the change in consumer behaviour over the summer months has raised fears that gasoline demand could be weak. Across the U.S. and Europe, evidence last week continued to suggest that the manufacturing sector is suffering from an ongoing recession. But the main factor weighing on energy demand has been China.

We discussed a couple of weeks ago how the China situation has changed significantly, with a forceful monetary and fiscal stimulus unveiled over a few days the week before last. While the Chinese mainland market was closed for most of last week due to the country’s Golden Week national day celebrations, Hong Kong shares rallied, meeting the threshold for a bull market (a 20% gain). Prior to this, Hong Kong-listed Chinese shares had seen a decline of 50% since early 2021.

Historic worries over oil prices

Anxiety over the energy supply has haunted investors since the 1970s. Why? Well, oil price increases can act as a tax on consumers and cause them to reduce other forms of spending.

Here’s a brief recap of the major incidents since the ‘70s:

• The 1973 oil embargo by the Organization of the Petroleum Exporting Countries (OPEC+) in protest of the Arab Israeli war caused prices to quadruple and triggered a global recession
• A second oil price shock at the end of the 70’s was triggered by production disruption caused by the Iranian revolution
• The Gulf War precipitated an oil price spike and led to the early 1990s recession
• Sharp energy price increases were also present when the tech bubble burst in early 2000 and at the outset of the global financial crisis in 2007

It can be a little unclear how a central bank would react to a price spike. If it happens when the labour market is healthy, there’s a higher chance of workers demanding their wages keep pace with inflation. If unemployment has been increasing, they may cut back on discretionary spending instead. This will determine the extent to which the central bank feels it needs to increase interest rates, given that a rise in oil prices can be destructive to demand on its own.

What’s happening now?

That brings us on to the current state of the U.S. economy.

We have talked a bit about management commentary, which has suggested things are stable, and that the summer slowdown was a seasonal lull rather than a terminal decline. Last week’s labour market data backs that up.

Early last week, the U.S. Bureau of Labor Statistic (BLS)’s Job Openings and Labor Turnover Survey showed fewer people are quitting their jobs. This suggests less need for high interest rates because the rate of job quitters is a good leading indicator of wage growth. Encouragingly, the number of job openings increased, suggesting that labour demand remains robust.

The non-farm payrolls employment report seemed to confirm this on Friday, as it showed an acceleration in jobs growth to the fastest rate since March.

This followed the purchasing managers indices, which suggested that U.S. services sector activity remained very robust – however manufacturing remains very weak.

Meanwhile, continental Europe is suffering a slowdown that seems to be leaking from manufacturing into services. Some U.S. services sector anecdotes seemed to suggest this was happening there too, while others expressed concerns over the forthcoming election in early November.

What’s Next?

It was a surprising week even for those of us who believe the economy will buck the historical trend and avoid recession. From an investment perspective, we’ve seen a lot of liquidity added to markets. This will continue with the large-scale Chinese stimulus announced the week before last. Further action is expected, particularly from the European Central Bank. Even Bank of England Governor Andrew Bailey talked about being more aggressive with rate cuts if the inflation data remains under control.

That should provide a decent environment for assets like equities, but we find diversifiers like gold have a role to play as well. Bonds saw some selling because of the good news on the economy, and gold was certainly caught up with that to an extent. But the risks that remain from high oil prices and fiscal largesse from the U.S. electoral candidates are factors that would encourage investors to flock to gold.

The current environment is one that seems well suited to real assets like gold and oil, not least because of the uncertainty that prevails at the moment. While the soft-landing scenario got a boost last week, we have long felt it was the most likely scenario in the absence of an economic shock. The most obvious source of such a shock would be the oil price, and Middle Eastern tensions serve as a reminder of how fragile a solid economy can quickly become.

This week will see further evidence of the inflation moderating in the U.S. before earnings season starts on Friday. A number of banks, including JP Morgan, will announce their results, but they will also be asked about the state of the American consumer, and with sight of household bank balances and spending patterns, what they say will go a long way to setting the tone for earnings season as a whole.

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

Alex Clare

09/10/2024

Please see the below daily update article from EPIC Investment Partners received this morning 08/10/2024:

A recent report by the non-partisan Committee for a Responsible Federal Budget (CRFB) indicates that Donald Trump’s economic proposals would more than double the increase in US debt compared to Kamala Harris’s plans. Both presidential candidates have put forward new tax and spending initiatives aimed at attracting voters. However, budget analysts are struggling to keep up with these rapidly evolving proposals, and further details may emerge before the November 5th election. According to CRFB estimates, Trump’s plans could raise the national debt by USD 7.5tn by 2035, compared to a USD 3.2tn rise under Harris. 

Trump’s proposals include sweeping tax cuts for individuals and businesses, higher tariffs on imports, increased military spending, and the deportation of millions of immigrants, all of which are expected to greatly inflate the national debt. Harris’s approach, on the other hand, focuses on expanding tax credits for small businesses and families, paired with higher corporate taxes.  

A key distinction between the two candidates is their stance on the 2025 expiration of Trump’s individual tax cuts. Trump has vowed to make these cuts permanent, including for high earners, which could reduce federal revenues by USD 3.3tn to USD 4tn over ten years. Harris would extend the 2017 cuts only for those earning less than USD 400,000, potentially adding USD 2.5tn (from the currently estimated USD 2tn) to the deficit over a decade, according to the CRFB report. 

Trump has suggested using tariffs and economic growth to mitigate some of the debt increase, but we remain doubtful. His proposed 10% global tariff and 60% tariff on Chinese imports could generate up to USD 3.8tn over a decade, but these tariffs would harm the economy and fail to fully offset the debt increase. 

Harris’s platform includes revenue-raising measures, such as lifting the corporate tax rate to 28%, to help finance her plans. Overall, her approach is viewed as more fiscally responsible than Trump’s, although both candidates’ policies are expected to contribute to significant rising national debt in the long term. 

The CRFB report, published just weeks ahead of the election, underscores the substantial fiscal challenges awaiting the next president. The Committee cautions that national debt could climb to as high as 133% under Harris, while Trump’s plans could push it to a substantial 142%, by 2035.  

The CRFB warns that: “Our large and growing national debt threatens to slow economic growth, boost interest rates and payments, weaken national security, constrain policy choices, and increase the risk of an eventual fiscal crisis.” 

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

Charlotte Clarke

08/10/2024

Please see the below article from EPIC Investment Partners detailing their discussions on France’s significant fiscal policy shift. Received this morning 04/10/2024.

Earlier this week, France announced a significant fiscal policy shift, unveiling plans to implement €60 billion in spending cuts and tax increases in 2025. This move, spearheaded by Prime Minister Michel Barnier, aims to address the country’s widening budget deficit, and restore investor confidence.

As of 2024, France’s debt-to-GDP ratio stands at approximately 112%, significantly above the Maastricht threshold. This high level of debt is a result of increased public spending to support the economy during the pandemic and subsequent recovery efforts. The government’s plan to slice spending and hike taxes is a direct response to this fiscal imbalance, aiming to bring the deficit down to 5% of GDP from an estimate of over 6% this year.

Getting the right balance of measures in next year’s budget is a delicate challenge for Barnier, whose premiership is tenuous given his centrist coalition does not have the numbers to ward off a concerted opposition attempt to topple the government. Adding to the pressure, investors have been dumping French assets in recent months on concerns over slippage from deficit reduction goals and political stability after snap elections delivered a deeply divided lower house.

The budget will be submitted to cabinet and parliament on October 10 for debate and amendments. It is likely that Barnier will resort to a constitutional tool to bypass a vote as he has no majority and there is a convention in France for opposition lawmakers to oppose budget bills. However, if he does use that option, it gives lawmakers another chance of tabling a no-confidence motion to try to bring down the administration. 

Current parliamentary math means the greatest threat to his government’s survival would come from Marine Le Pen’s National Rally backing a censure motion from the left. For now, she has said her far-right party would refrain from such a move to avoid being responsible for plunging the country into political “chaos” again.

Still, Barnier must also manage criticism within his own camp. Some lawmakers in the narrow group backing the minority government have warned they would not support tax increases that risk undoing seven years of pro-business policies during Emmanuel Macron’s presidency.

It appears Mr Barnier could be caught between a rock and a hard place, and this could just be the opening act of what becomes a drawn-out saga, or worse.

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

Alex Clare

04/10/2024

Please see below, today’s Daily Investment Bulletin Brooks Macdonald providing a brief analysis of the key factors currently affecting global investment markets:

What has happened

Equities struggled to make headway on Wednesday – in the end, the US S&P500 equity index was effectively flat, up just +0.01%, while the pan-European STOXX600 equity index finished up just +0.05% (both in local currency price return terms). There was a little more direction in currency markets meanwhile, with the US dollar up as markets dialled down US interest rate cut hopes a little on the back of stronger US private jobs data – the US dollar currency index (DXY), which is an index of the US dollar against a selection of major developed currencies globally, yesterday rose to its highest level in around 3 weeks. The better US private jobs data also pushed US 10-year government bond yields higher, with bond prices lower.

 Middle East

Middle East news continues to dominate newspaper headlines even if the broader market impact is proving to be relatively measured for now. While Israel’s prime minister Benjamin Netanyahu has warned that Iran “will pay” for its latest missile attack on Israel, the US is putting pressure on all sides to avoid further escalation. The oil price (for Brent crude oil) is still hovering around US$75 per barrel – it is off recent lows, but for context it is still towards the lower end of its past 2-year range.

 US private jobs data pushes back on fears of labour weakness

US private payrolls data from the ADP Research Institute (ADP) for September showed job gains above forecast on Wednesday. The gain of 143,000 jobs in September was above expectations for a gain of 125,000 jobs. For context, ADP is based on payroll data covering private-sector employees only, whereas the broader US non-farm payrolls data, which is due this week on Friday and is published by the US Bureau of Labour Statistics, captures both private and public sector employees.

 What does Brooks Macdonald think

The stronger ADP US private jobs data yesterday has dampened hopes a touch for more super-sized interest rate cuts from the US Federal Reserve (Fed), with 2 more Fed meetings scheduled for the rest of this year. Following the data yesterday, as of this morning, derivative markets (US Fed Funds Futures) are currently pricing in 34.4 basis points (bps) worth of easing when the Fed next announces on interest rates in early November, implying a 37.6% chance for a 50 bps cut. Cumulatively, markets are currently seen to be pricing in 69.2 bps of interest rate cuts across the 2 Fed meetings taken together, before the end of 2024.

Please continue to check our blog content for the latest advice and planning issues from leading investment firms.

Andrew Lloyd

3^rd October 2024

Please see the below article from Brewin Dolphin detailing their thoughts on the recent Chinese stimulus measures. Received yesterday 01/10/2024.

September was the month of monetary stimulus, with the European Central Bank cutting interest rates a few weeks ago and the Federal Reserve cutting rates the week before last. But neither move has had quite the same market impact as the latest stimulus measures from China.

A banner week for Chinese stocks

Chinese equities rallied last week following a range of stimulus measures announced by the Chinese state. Economists remain sceptical that China can overcome the massive structural problems that have grown in the world’s second largest economy, but investors have embraced the move wholeheartedly.

Hong Kong-listed shares rose 12% last week, while the Shanghai and Shenzen-listed CSI 300 index rose by more than 16%. They started this week in rude health too.

What exactly was announced? Unfortunately, Chinese policy operates very differently to those in regions we’re more familiar with, so it can seem a bit confusing.

Quite commonly, monetary stimulus comes through cuts to the reserve requirement ratios (RRR) of banks. The RRR is the percentage of deposits that commercial banks are required to hold in reserve, rather than using them to make loans or invest in other assets.

For example, if the RRR is 10%, a commercial bank with ¥100 in deposits must hold ¥10 in reserve and can use the remaining ¥90 to make loans or invest in other assets. Thus, cutting the RRR means more credit can flow into the economy.

Last week was no exception, with the RRR cut by 0.5 percentage points. For context, the RRR for small banks has now been cut to 6.5%, just 0.5% above its all-time low, and the governor of the People’s Bank of China, Pan Gongsheng, seemed to suggest further cuts are coming.

That said, the RRR was 15% in 2018 and has been cut many times since. The cuts so far this year look pretty average for what we’ve seen in recent years, as policymakers have been reluctant to see big increases in borrowing as a way of arresting the growth slowdown.

Lowering the cost of borrowing

Over recent years, borrowing has slowed, because giving banks capacity to lend doesn’t help if nobody wants to borrow.

One way of encouraging borrowing is to make it cheaper by cutting interest rates. China also did that last week. They have a plethora of different interest rates directly manipulated by the central bank, as well as “effective” interest rates, which are heavily centrally influenced. This means the government influences the interest rates paid by businesses and households more directly than is the case in other countries.

Like in any economy, the policy interest rate is a factor affecting the cost of money to banks, which then determine the rates they charge customers. But in China, these lenders are often state-owned, and their lending is driven by state objectives rather than a quest for profitability.

There have been various reforms to the interest rate[1]setting environment in recent years, but the crucial one – allowing interest rates to be set by market forces rather than political dictate – remains a step the government is unwilling to take. This means that China’s perennial problem of misallocated resources will likely continue.

Will it be enough?

Even cutting interest rates may not be enough to encourage lending if potential borrowers feel over[1]leveraged or don’t expect to make a positive return on their borrowing. Here lies the central challenge for the Chinese economy.

China’s relationship with property has been a complex and variable one.

In the early decades of the People’s Republic, a person’s home was an asset of the state. Although private ownership of property was possible following reform in 1980, it was still very unusual. It took until 1998 before widespread commercialisation of property was possible. Since then, property has become a mainstay of economic activity and wealth accumulation, leading to a substantial property bubble.

The current status of the Chinese economy is that most consumers have the majority of their wealth tied up in housing, but property values have been declining. As a result, many households are in negative equity, while others are discouraged from buying homes because of the decline in property values. Meanwhile, developers are discouraged from embarking on new building activity.

This leaves little appetite to spend from both the household and ‘private’ commercial sectors of the economy, resulting in slowing economic activity and falling interest rates. Chinese industrial profits fell almost 18% in the 12 months to August.

What to do?

The prescription is for government demand to pick up the slack left by the lack of private sector demand. This requires a big increase in spending at a time when the Chinese government is already running a substantial budget deficit of around 5%. The main impediments to growth are a willingness to take on sufficient debt to offset private sector deleveraging, and the availability of projects to deploy government investment spending.

Perhaps the most meaningful announcement was that the Ministry of Finance is planning a significant fiscal support package. It’s expected that part of this will be used to subsidise upgrades to existing consumer goods (most notably cars), as well as an explicit payment per child for families having more than one child – a significant incentive to have more children at a time when China’s demographic woes are coming into sharp focus.

The main question is how long these fiscal stimuli will last. Without a firm commitment, the child benefit could be expected to expire at some stage, in which case it forms a temporary compensation for having had children (which would likely be saved by the households receiving it).

Alternatively, if the Chinese public can be convinced payments will continue in perpetuity, this is far more likely to bring about the kind of change in behaviour that would see them spending their windfalls.

Despite the uncertainty about what exactly the fiscal support package will look like, the stock market rallied as there were measures within the stimulus package that affected it directly. The People’s Bank of China announced a swap programme, whereby institutional holders of risky assets could swap those assets with the central bank and receive liquidity in return – if they then invested that liquidity in stocks. Unsurprisingly, this has had a catalytic effect on Chinese stocks.

Aside from these fireworks in China, last week was relatively quiet.

The U.S. economy shows some fragility

From an economic perspective, there was further evidence of a slowdown in manufacturing activity. The flash purchasing managers indices suggested the sector remained weak in most jurisdictions during September.

The U.S. saw a particularly abrupt slowdown in activity, though its services sector remained quite robust.

Other data last week continued to suggest that growth in the U.S. is running at a healthy 3% as we approach the end of the third quarter, essentially maintaining the pace of the second quarter.

In Europe, there was some evidence the manufacturing slump is continuing. The services sector seems to be losing momentum as well. The case for interest rate cuts in Europe is strong.

Is the government talking down the economy?

Although interest rates in the UK will inevitably decline as well, the need is a little less pressing than on the continent.

Economic activity levels remain high, but higher interest rates are gradually offsetting the boost from wage increases and tax cuts.

Business leaders have warned the downbeat tone from the government risks damaging the economy. This was hinted at the week before last by market research company GfK’s consumer confidence index, and partially reflected in a decline in the British Retail Consortium’s measure of consumer expectations.

In response, the tone from the Labour Party conference was one of continued tough choices, emphasising fiscal credibility to avoid spooking global bond markets. However, Chancellor Rachel Reeves’ speech hinted at a relaxation of rules that would currently restrain investment in the economy, and news at the end of last week suggested plans to end the non-domicile tax regime will be tweaked to reduce the draining effect on spending and investment that a widescale departure of influential businesspeople could have.

Japan elects a new Prime Minister

Finally, Japan’s governing Liberal Democratic Party has selected its new leader, Shigeru Ishiba. He was confirmed as prime minister this morning.

Although there were monetary policy differences between the two run-off candidates, Ishiba and Sanae Takaichi, it was unlikely there’d be much government influence on interest rates. The Bank of Japan would be too concerned about the impact on borrowing costs as a result of even a suggestion of government influence.

Despite this, speculation of a victory for the more dovish Takaichi had weighed on the yen and been supportive for Japanese stocks. The yen rallied hard on Friday after the result was announced, and stocks suffered a sharp decline when the stock market opened on Monday.

This week, China’s stock market is closed for Golden Week, its national day celebrations. We’ll also see some important speeches from policy makers, but the highlight, as ever, will be Friday’s U.S. employment report.

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

Alex Clare

02/10/2024