News

Please see the below article from Tatton Investment Management detailing their views on global economic news from the past week.

Overview: Summer markets lukewarm on good news

On the face of it, last week contained many of the positive headlines  market optimists had been waiting for, but the response to those headlines received was tepid at best. On Thursday, the US Bureau of Labor Statistics released its consumer price index (CPI) inflation data for July, and it was relatively benign. In particular, the core CPI measure (with food and energy taken out) was +0.16% for the month, the same as in June. For the two months, annualised core CPI is now running below 2%, at +1.92%. Commentators reiterated the June narrative: that the US Federal Reserve (Fed) will be able to stop raising rates and then begin cutting next year. In the bond market, the 10-year yield went from 3.95% as the CPI data was published to 4.10% by the close on Thursday. Meanwhile, the S&P500 was pretty much unchanged. So, for equities and bonds, what was once a bullish driver has become less so now, and corroborative data is not new information.

Back at home, the Royal Institute of Chartered Surveyor’s report on the housing market continued to flag the prospect of further house price falls which, in earlier years, would be a harbinger of very difficult economic times. Yet the UK economy put in yet another quarter of growth, albeit anaemic, at +0.2%. The really surprising aspect was that July manufacturing and construction output was very strong at +2.4% and +1.6% month-on-month, respectively. That echoed the construction purchasing managers’ index (PMI) from last week, which showed a totally surprising shift into growth territory at 51.7 (50 marks the divide between contraction and expansion). Perhaps unsurprisingly, bond yields shifted sharply higher on Friday after the data, with the 10-year testing 4.5% and the two-year back at 5%. Neither has yet broken beyond the highs of the past month, however.

August is generally a quiet month, with holidays the priority for many. In recent years, it has felt more like business-as-usual, but market liquidity can still be somewhat reduced and, if news is really important, can lead to sharp dislocations. So far this month, the stories are not unimportant, but neither are they earth shattering, and while volatility has picked up, remains way down from last year and even the first half of this year.

China’s growing pains continue

China’s economy has sputtered again. CPI inflation fell 0.3% year-on-year in July. Producer prices were even lower, falling 4.4%. That might sound like a strange thing to complain about, given the West’s ongoing battle with high inflation; but China did not experience the same wave of post-pandemic inflation, and now deflation is a bad sign for the world’s second-largest economy. It shows weakness in consumer demand, which will likely mean slower growth down the line. Moreover, businesses competing with Chinese exporters are losing pricing power, while suppliers of commodities to China are experiencing a sharp slackening in demand. Thus, weak growth in China may be transferring to the rest of the world.

As we wrote recently about China, its economic problems have never been about lacking potential. The question is whether the government is willing or able to unlock it, and as yet that question remains unanswered. At the end of July, Beijing called for strong countercyclical measures to arrest a recent decline, but as (by now) usual, the details on what this means are lacking. Policymakers want to boost short-term growth, but are unwilling to loosen their grip on the private sector to do so.

China still has potential for a near-term rebound. But for foreign investors, the longer term returns on Chinese assets are hard to assess. Even though economic growth will come through, there is no guarantee this will translate into enough profit to justify investment, thanks to the unpredictability of central government. There are growth opportunities in China; Beijing only needs to decide if they are in its interest.

Is US earnings supremacy on the wane?

American companies are leading the way again this year, with 12.8% year-to-date returns as of the end of July. With the benefit of hindsight going back a decade, there are few better bets any international investor could have made than the US and its tech giants. Over the 20 years from 1989 to 2019, the S&P delivered an average real (inflation-adjusted) return of 5.5% a year excluding dividends.

However, a June discussion paper written by US central bank staff for the Federal Reserve Board of Governors in Washington argues that much of the growth in the value of US investments is explainable by different, more straightforward factors. The paper posits that exceptional US stock market performance over the last three decades was a consequence of changes to tax and interest rates. Moreover, it is very hard to see either of these trends continuing into the next decade or beyond. Short-term government interest rates have already increased from around 0% at the start of 2022 to above 5%, and markets expect these to come down over the next year or so. But as we have noted before, the economic environment – and particularly labour relations – mean we should not expect a quick return to the pre-pandemic norm of low inflation and growth.

Tax rates are a similar story. Effective taxation is already as low as it has been since corporate taxes were introduced, and the historically high levels of government debt are coinciding with an historically small tax base.

Equity prices change because of earnings growth and the rate investors are willing to pay for those expected earnings. Essentially, long-term US performance from here could be capped given that valuations are no lower than the average, an average based on net income growth which has had exceptional factors since 1989. It is possible that investors could show an even stronger bias for American assets, and accept a lower return because they feel US equities are less risky than other countries. This is not unthinkable but, in the current environment, it is hard to see the US outperforming to the level it has before.

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

Alex Clare

14/08/2023

Please see below, the ‘Daily Investment Bulletin’ from Brooks Macdonald providing a brief summary of the key factors currently affecting global markets and economies. Received this morning – 11/08/2023

What has happened

US equities were unmoved yesterday after US CPI came in line with market expectations but the US 30-year Treasury auction struggled. Over in Europe, equities rose more than three-quarters of a percent as the market closed before the later US sell-off. Travel and luxury goods companies did particularly well after China announced that it would be ending its ban on outbound international group tours.

US CPI

The monthly July US CPI print came in line with market expectations but taking the readings to two decimal places there was even better news. Headline CPI expanded by just 0.17% month-on-month with core CPI expanding by just 0.16% over the same period. These very low monthly figures brought headline annual inflation to 3.2% whereas core stayed at 4.7%, reflecting the stickiness of monthly core CPI earlier in the year. The monthly numbers will receive the most attention with both the core and headline readings now near the 2% Fed target for a second month in a row. In terms of contributors to this, airfares were down 8% over the month, building on a similarly sized decline the month prior.

Bond market reaction

We have a while until the next Fed meeting therefore there were Fed speakers immediately available to comment on the CPI. President Daly welcomed the numbers but said that the monthly reading was ‘not a data point that says victory is ours’. In terms of timing of any interest rate cuts, Daly said that she expected those conversations to wait until 2024, pushing back against market hopes for a December 2023 cut. The major bond market news came with the 30-year Treasury auction however as strong demand failed to materialise, causing the bonds to be issued at 4.189%, this then catalysed further concern over the sheer size of the US deficit and its linked funding needs.

What does Brooks Macdonald think?

Stripping out some of the more volatile disinflationary contributors, such as airfares, we still see a stickier inflation backdrop in the US. That said, these volatile components can be lead indicators of wider moves within the inflation basket, just as we saw in 2021 and 2022 when inflation was on its ascendency. The overall reading will support the case for a pause in US interest rates when the Federal Reserve meet in September.

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

Alex Kitteringham

11^th August 2023

Please see below, an article from Evelyn Partners discussing the recent Monetary Policy Committee interest rate decision and the implications for markets and the economy. Received yesterday evening – 03/08/2023

What happened?

The Bank of England delivered on the expectations of economists and markets with an increase of 25bps to the base rate at their meeting today. This represents the Bank’s 14th consecutive increase and takes the base rate to 5.25%, its highest in 15 years.  The committee was split 3 ways on the vote, with 1-6-2 members voting for 0-25-50bps increases respectively. 

What does it mean?

Today’s decision by the Bank of England was always likely to be close, if markets are our guide. Prior to the meeting, Overnight Index Swap markets had priced around a 1/3 chance that the Bank would go further and increase by 50bps.  In the end the MPC’s hawks, who would have preferred such a move, were outvoted by the majority, including governor Andrew Bailey.

A key reason the bank will have decided against the larger increase will have been June’s inflation numbers, which finally revealed a downside surprise in headline inflation and, perhaps more importantly, the core (excluding volatile food and energy) print.  The core figure came in at 6.9%, which will still high, was lower than July’s figure of 7.1%.  The expectation is for inflation to continue to fall as lower energy prices continue to feed through to the bottom lines of balance sheets, both for businesses and individuals.  This was reflected in the MPC’s own inflation forecasts, which fell from 5.1% to 4.9% in the fourth quarter of this year, although this was allied with an increase in its inflation expectations over the medium term.

The monetary policy report also included growth forecasts, which continued to make for pretty bleak reading, revealing a cut to forecasts to 0.5% per year for 2023 and 2024.  On the upside, the Bank agrees with the consensus of economists in no longer forecasting a recession in the UK, but it does highlight the risk of one in 2024 and early 2025. 

Previous guidance in the minutes released today was maintained: “if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required,”. There was an Important addition about rates being “sufficiently restrictive for sufficiently long” for inflation to get back to the Bank’s 2% target.  That implies that interest rate cuts are perhaps further away than some had imagined. 

The Bank provided no clues to the market today on its plans for reducing the size of its balance sheet, saying it will lay out these plans at its next meeting in September. 

Bottom Line

Reaction to today’s 25bps increase by markets was dovish, as expectations of where rates will peak moved slightly lower, from 5.85% before the meeting to 5.75% afterwards, at the end of this year or beginning of next.  This will be welcomed by mortgage holders, in the hope that increasing rate expectations may have peaked, along with the cost of mortgage deals in the market. The yield on the 10 year government gilt remained broadly unchanged on the announcement and looks attractive in our view, at 4.4%, as the Bank gets closer to the top.

Please continue to check our blog content for advice and planning news from us and leading investment management houses.

Alex Kitteringham

4^th August 2023

Please see the below article from Brooks Macdonald providing their commentary on global markets. Received this morning – 03/08/2023.

What has happened

Equities fell sharply yesterday as concerns around the US debt downgrade focused investor attention on the funding needs of the US government. The US equity market fell by over 1%, recording its worst daily return since April of this year.

US debt financing

Concerns over the quantity of US Treasury issuance over the coming months filtered through risk assets yesterday with the near-term borrowing needs being formalised yesterday. Adding concern was the comment from the Treasury that this increase in borrowing was likely to continue, saying that ‘further gradual increases will likely be necessary in future quarters.’ Treasury issuance raises yields as the price adjusts for additional supply. At the same time, this issuance draws liquidity from other areas of the market (such as equities and corporate bonds), decreasing the prices of risk assets. All of this puts the US budget deficit back into the spotlight with the Fitch downgrade effectively just highlighting the funding concerns, recent political impasses and ongoing fiscal spending.

UK

Today the market’s focus will switch to the Bank of England which is unveiling its latest policy change at midday. The consensus expects a 25bp interest rate hike, with economists reducing the chance of a 50bp move given the downside miss to UK CPI last month. The market is only now apportioning around a quarter chance of a 50bp move after it being the most likely outcome a few weeks ago. The political pressure continues in the interim with Prime Minister Sunak saying that inflation was not falling as fast as he would like and stressing the policy importance of a further reduction in price pressure.

What does Brooks Macdonald think

The shift in market expectations towards a 25bp hike at today’s meeting does not mean that the UK will have necessarily reached its peak interest rate after the move. The market is expecting the Bank of England to need to raise interest rates further over the coming months to guide inflation lower. A strong UK labour market is a particular concern to the Bank of England, therefore one should expect the central bank to continue with their hawkish rhetoric alongside the smaller hike.

Bloomberg as at 03/08/2023. TR denotes Net Total Return

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

Alex Clare

03/08/2023