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Brewin Dolphin Markets in a Minute: Stock markets ease as inflation fears return

Please see below for Brewin Dolphin’s latest Markets in a Minute Article, received by us yesterday evening 14/09/2021:

US and European stocks fell last week as the prospect of higher inflation and slower economic growth weighed on investor sentiment.

The S&P 500 and the Dow ended their four-day trading week down 1.7% and 2.2%, respectively, amid a higher than-expected rise in producer prices and concerns about the Delta variant’s impact on the economic rebound.

The pan-European STOXX 600 eased 1.2% as the European Central Bank (ECB) said it would trim its emergency bond purchases. The FTSE 100 also fell 1.5% on concerns the Bank of England could start increasing short-term interest rates.

In contrast, Japan’s Nikkei 225 extended the previous week’s gains, adding 4.3% amid ongoing optimism that the new prime minister will bring further fiscal stimulus. China’s Shanghai Composite rallied 3.4% after newspapers reported ‘candid’ talks between the country’s leader Xi Jinping and US President Joe Biden.

S&P 500 ends five-day losing streak

The S&P 500 added 0.2% on Monday, ending its five-day losing streak, as rising oil prices boosted energy stocks. Airlines and cruise line operators also performed strongly, after the seven-day US Covid-19 case average fell to 144,300 from 167,600 at the start of the month.

UK and European stocks also edged higher, after a top European Central Bank official said recent gains in inflation did not yet pose a risk, and that the extremely low level of inflation seen in 2020 needed to be taken into account.

The FTSE 100 opened Tuesday’s trading session down 0.3%, after the Office for National Statistics reported that while UK company payrolls have returned to pre-pandemic levels, the recovery is uneven and labour shortages are likely to persist for the rest of the year.

US producer inflation accelerates

Last week saw the release of the latest US producer price index, which is a measure of inflation based on input costs to producers. The index rose by 0.7% in August from the previous month, which was a slowdown from July’s 1.0% increase but above estimates for a 0.6% rise.

The index rose by 8.3% on an annual basis, which was the biggest yearly increase since records began over a decade ago. This followed a 7.8% annual increase in July.

The data, which comes amid supply chain issues, a shortage of goods, and heightened demand related to the pandemic, suggests inflationary pressures are persisting despite the Federal Reserve’s insistence they will prove temporary and ease through the year.

Firms are also facing cost pressures from the tight labour market. The closely watched US Jobs Openings and Labor Turnover Survey (JOLTS), released last Wednesday, showed there were a record 10.9 million positions waiting to be filled in July, up from 10.2 million in June. It marked the seventh consecutive month of increased job openings, fuelled by factors such as enhanced unemployment benefits, school closures and virus fears.

ECB to trim bond purchases

Over in Europe, the ECB said it would move to a ‘moderately lower pace’ of pandemic emergency bond purchases following a rebound in eurozone economic growth and inflation. ECB president Christine Lagarde sought to reassure investors by stating that the shift to a slower pace of purchases was not tapering. This contrasts with the US Federal Reserve and the Bank of England, which have signalled they plan to start tapering asset purchases this year.

In comments reported by the Financial Times, Lagarde said the economic rebound was ‘increasingly advanced’, but added: “There remains some way to go before the damage done to the economy by the pandemic is undone.” She pointed out that two million more people are out of work than before the pandemic, and many more are still on furlough schemes.

Lagarde added that a fourth wave of infections could still derail the recovery, while supply chain bottlenecks could last longer and feed through into stronger-than-expected wage increases.

BoE split over rate increase

BoE governor Andrew Bailey gave a speech last week in which he revealed the central bank’s policymakers were evenly split between those who thought the minimum conditions for considering an interest rate hike had been met, and those who thought the recovery wasn’t strong enough. According to Reuters, Bailey said he was among those who thought the minimum conditions had been reached, but that they weren’t sufficient to justify a rate hike.

The comments have led to speculation that the next vote could skew towards raising the base interest rate, which currently stands at 0.1%.

Bailey also said there were signs that the UK’s economic bounce back from the pandemic was showing some signs of a slowdown. Indeed, data published by the Office for National Statistics on Friday showed monthly gross domestic product (GDP) grew by 0.1% in July – lower than the expected 0.5% rise and the 1.0% growth seen in June. Output in consumer-facing services fell for the first time since January, driven by a 2.5% decline in retail sales. Output from the construction industry also dropped amid a shortage of building materials and higher prices.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well

Paul Green DipFA

14/09/2021

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AJ Bell Investment Insight: The questions facing UK gilts

Please see below for AJ Bell’s latest Investment Insight article, received by us yesterday 14/03/2021:

In some ways, markets had little to digest in the immediate wake of the Budget, as so much of the chancellor of the exchequer’s speech had made its way into the newspapers the previous weekend.

Rishi Sunak did come up with a couple of surprises all the same, in the form of the superdeduction for capital investment and his plan for eight freeports, designed to boost the UK’s trade flows in a post-Brexit world. The key issues raised by the Budget, at least from an investment perspective, passed unasked:

  • Why should anyone lend the UK money (and therefore buy its government bonds, or gilts) when it does not have the means to pay them back?
  • Why should anyone lend money to someone who cannot pay them back in return for a yield of just 0.77% a year for the next ten years (assuming they buy the benchmark 10-year gilt)?
  • Why would anyone buy a 10-year gilt with a yield of 0.77% when inflation is already 0.7%, according to the consumer price index, and potentially heading higher, especially if oil prices stay firm, money supply growth remains rampant and the global economy finally begins to recover as and when the pandemic is finally beaten off?

Anyone who buys a bond with a yield of 0.77% is locking in a guaranteed real-term loss if inflation goes above that mark and stays there for the next decade.

In sum, do UK government bonds represent return-free risk? And if so, what are the implications for asset allocation strategies and investors’ portfolios?

GILT YIELDS ON THE CHARGE

The benchmark 10-year gilt yield in the UK has surged of late. It is not easy to divine whether this is due to the fixed-income market worrying about inflation or a gathering acknowledgement that the UK’s aggregate £2 trillion debt is only going one way – up. But the effect on gilt prices is clear, since bond prices go down as yields go up (as is also the case with equities).

This is inevitably filtering through to exchange-traded funds (ETFs) dedicated to the UK fixed income market. The price of two benchmark-tracking ETFs has fallen, albeit to varying degrees. The instrument which follows shorter-dated (zero-to-five year) gilts has fallen just 2% since the August low in yields.

Meanwhile, the ETF which tracks and delivers the performance of a wider basket of UK gilts (once its running costs are taken into account) has fallen 8% since yields bottomed last summer.

That 8% capital loss is at least a paper-only one, unless an investor chooses to sell now, but the yield on offer does not come even close to compensating the holder for that paper loss, which supports the view that bonds now represent return-free risk.

SAVING GRACES

However, the higher bond yields go, the greater the return they offer and that means at some point investors may decide that the rewards are sufficient compensation for the risks, especially as three arguments could still support exposure to UK gilts.

  • The market’s fears of inflation could be misplaced. Bears of bonds have been growling about record-low interest rates and record doses of quantitative easing would lead to inflation for over a decade – and it has not happened yet.

If the West does turn Japanese and tip into deflation, even bonds with small nominal yields would look good in real terms and possibly better than equities, which would do poorly into a deflationary environment, at least if the Japanese experience from 1990 until very recently is a reliable guide.

  • The UK’s financial situation may not be quite as bad as it seems. Yes, the national debt is growing but the Bank of England’s monetary policy is keeping the interest bill to manageable levels.

The Government’s interest bill as a percentage of GDP has hardly ever been lower. That buys everyone time and is also why Sunak is tinkering with taxes, to convince bond vigilantes and lenders alike that the UK can and will repay its debts, as
it has every year since 1672 under King Charles II. A big leap in bond yields (borrowing costs) would be expensive.

  • The Bank of England could move to calm bond markets with more active policy. Whether that calms inflation fears is open to question but financial repression (see a recent edition of this column) could yet come into play, supporting bond prices and reducing yields.

In sum, no-one has a crystal ball. Therefore, bonds could yet have a role to play in a well-balanced portfolio over time, but it is inflation, rather than risk of default, that looks likely to be the greatest threat to any holder of gilts.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well

Paul Green DipFA

15/03/2021