In this week’s bulletin:
- European bankers make a surprise cut in interest rates to 0.25%
- Investors gain confidence in Europe amid early signs of recovery.
- UK economic growth outpaces Bank of England forecasts.
- Markets anticipate an early increase in UK interest rates.
Through the Looking-Glass
A world awash with easy money and debt as it takes its tentative steps towards meaningful economic recovery is bound to throw up conundrums for investors and fund managers, governments, markets and business. In this looking-glass world, things can sometimes seem back to front as good economic news becomes bad – and the seemingly bad can appear good. Amid this uncertainty, one reflection on quantitative easing (QE) remains a matter of fact: QE is an unprecedented experiment in monetary policy by the advanced economies. And, for now, the evidence and arguments remain in its favour, even if a sense of unease can set in as assets appear to grow and shrink in value. Despite these ups and downs, fits and starts, the global economic recovery has begun to look like a recovery. And if it looks like a recovery then, perhaps, it is really one, too.
Monday 11 November 2013
So, in America, the markets closed on Friday on a positive note, after a better-than-expected jobs report helped offset losses earlier in the week. US Department of Labor figures indicated that more than 200,000 extra jobs were added to the American economy in October despite the shutdown of US government and clash over the debt ceiling during the month. The world’s largest economy is also surging faster than anticipated with an annualised growth of 2.8% in the third quarter. The positive economic data has stirred markets to again guess when the Federal Reserve will opt for an early tapering of its $85 billion-a-month bond repurchase scheme. However, the Fed’s stimulus programme has induced the historic highs and the intraday volatility of the major equity markets this year. The welcome news of sustained economic growth poses a set of challenges for equity markets – not least in the awkward experience of transition. Consequently, the positive US jobs data has brought a bit more market wariness towards equities.
Although the ramification of last week’s economic data on Wall Street had a mixed effect on sectors, overall the news pushed the S&P 500 index up 0.9% to 1,762 points on Friday, ending the week up marginally. US house builder shares fell on the last day of the week on the unemployment data and expectations that the Fed will reduce QE, increase mortgage rates and potentially reduce demand for loans and new homes. Financials on Wall Street, however, gained 1.6% on the news as markets expect that any increase in interest rates would translate into stronger earnings for America’s banking sector (US banks Wells Fargo, Bank of America and Citigroup all gained more than 2 %). But US consumer-orientated businesses that are focused and benefit from economic growth, rather than the nuance Fed tapering policy, made big gains, with clothing retailer Gap and entertainment group Disney making 8% and 3% advances respectively on Friday.
Asian equity markets slipped as investors interpreted the strong US growth figures as paving the way for the Fed retreat from QE. As outgoing Fed chairman Ben Bernanke’s hint in May that tapering was under consideration precipitated outflows from the emerging markets, so last week’s data set in motion losses across the region’s equity markets. The main indices in India and Thailand, as well as China’s main centres in Shanghai and Hong Kong, all lost around 1% on Friday. In Asia’s pre-eminent financial centre, Tokyo, the region-wide dip on news from across the Pacific was reflected on the Nikkei 225 Average index and its 0.8% five-day slide.
Bond markets also gave the outward signs of pricing in the prospect of the beginning the end of QE at the Federal Open Market Committee’s next meeting in December. Fund manager AXA Framlington believes that tapering of QE is likely in early 2014. Stronger economic growth and the prospect of the Fed action, however, bolstered the dollar, which had an impact on US sovereign debt and put upward pressure on interest rates. The benchmark ten-year Treasury yield rose 15 basis points to 2.75%, with UK gilts and German bunds following a similar trajectory.
The ECB’s tea party
Europe also poses markets and investors with a series of conundrums and paradoxes. The region has some of the world’s leading corporates, but economic growth remains behind the other developed economies. The European Central Bank (ECB) has voiced muscular support for the euro, but not a single bond purchase has yet to be made under its Outright Monetary Transactions scheme – the commitment to buy government bonds of crisis-hit countries in unlimited quantity. Many fund managers are singing the praises of the eurozone, but, despite a flow back of funds, wider investor perception is of a region yet to step clear of the mire of the sovereign debt crisis.
The ECB pulled off another of its surprise moves last Thursday with its decision to cut interest rates to a record low of 0.25% from 0.5%. ECB president Mario Draghi’s decision follows the European Union’s flash estimate of an October inflation rate of 0.7% for the eurozone, compared to an ECB target of 2%. This is the lowest reading since November 2009 and the same level as Japan, which fanned concerns over deflation. The European Commission also cut its forecast for eurozone growth in 2013 to 1.1% down from 1.2%.
This week brings further insight into whether the eurozone economic recovery has substance or is a mirage with the publication of a slew of eurozone and member state preliminary third-quarter growth figures. The eurozone secured an exit out of recession in the second quarter, but economists expect only weak growth for the June to September period. There are positive signs with Spain out of recession and an upturn, if slight, among peripheral eurozone countries; but eurozone industrial production figures this week are expected to show a slight decline. Growth figures from Germany, France and Italy will make clear the challenges ahead for Draghi and the member states’ individual governments. France’s economic outlook looks difficult as François Hollande’s government battles with public sector and economic reform, and after ratings agency Standard & Poor’s cut its sovereign credit rating by one notch to AA.
Draghi’s Cheshire Cat
The sudden action from Draghi last week was in line with his pronouncement in July 2012 that he would do “whatever it takes” to ensure a recovery in the eurozone. Investors responded positively to last week’s news, turning a blind eye to the inflation rate cut. European equities rose last Thursday to five-year highs with the FTSEurofirst 300 index, which had been flat prior to the decision, up 1% to 1,310 points, with the highest gainers among eurozone banks including Commerzbank (up 12%), Crédit Agricole (7%) and Natixis (6%). The European top stock index fell slightly on Friday, but gained 0.4% over the five-day period to settle at 1,295 points – with its lift from the ECB stance counteracted by news of US economic growth and a possible early rise in Stateside interest rates.
The case for European stocks remains that they offer better growth prospects – even if this looks later rather than sooner – and promising returns in sectors such as industrials, financials and technology. Fund manager S.W. Mitchell Capital, for example, has consistently argued for the quality businesses in the eurozone, their continuing value relative to other equities, such as the US, and the opportunity offered when the eurozone’s economic recovery strengthens in line with the US. “We are still in the early stages of a European upswing – with the UK slightly further along the rebound than the continent,” says fund manager Stuart Mitchell.
For fund managers and investors, Draghi last week gave proof again that the ECB is ready to guide markets. Equity analysts continue to point out that diffidence among investors towards European stock has kept their values down relative to the US. However, latest EPFR data for October shows that global investors are starting to display more interest in European equity funds, with Spain and other periphery nations attracting increased inflows. Analysts at Barclays, for example, believe the European market in 2014 could attain returns achieved from 2000 up to the financial crisis in 2007. Meanwhile, Société Générale believes that any correction in US equities when the US finally starts to wind down QE – which is again widely anticipated in 2014 if sooner – will favour European stocks.
The White Knight’s words
Meanwhile, the FTSE 100 index gained 0.4% last week, closing at 6,708 points after making a 0.2% gain on Friday on the US economic news. Strong gains at the end of the week included British Airways owner IAG up 8% on stronger-than-expected results, Rolls-Royce up 3%, Lloyds up 2% and the UK theme park operator Merlin Entertainment up 10% following its listing on the London exchange. Meanwhile, investors continue to move towards UK equities amid strong equity market gains and low interest rates. Latest figures from the Pridham Report, the fund sale monitor, show that equity funds’ net sales have exceeded £8 billion over the first nine months of 2013, which is on track to rival the £14.5 billion reached in the technology boom of 2000.
But the focus of investors and markets in Britain this week will be on the Bank of England governor Mark Carney’s inflation report and update on the economy. The signs are that the threshold 7% unemployment rate will be reached sooner than the Bank’s previously anticipated date of mid-2016. Even as the Bank last week held the base interest rate at 0.5%, where it has remained since March 2009, employment and economic growth are outpacing Carney’s initial forecasts for the speed of the UK recovery. Some former Bank officials believe the unemployment rate is more likely to hit the 7% threshold at the end of 2014. Others economists believe that a 0.1% revision down of its unemployment forecast would bring forward its forecast of hitting the threshold by a year to 2015. Whatever the debate, interpretation and Carney’s choice of action, unemployment has fallen 0.2% since August and looks set to fall further in the approach to 2014.
The Hatter’s riddle
Property prices have held Britain’s public in thrall through the recession to the nascent economic and housing recovery, but it is interest rates that have held sway over savers, mortgage borrowers, investors and consumers. And unemployment figures will determine where these will go. The accelerating economy is creating more jobs rather than merely making an existing workforce busier and is galloping faster towards the threshold for a possible rise in interest rates. Employment data is expected to show a further fall in the UK jobless from 7.7%. Latest inflation figures due out this week are expected to confirm a fall to 2.5% from the 2.7%. Consumer confidence, buoyed by the strengthening housing markets, is expected to translate into better retail figures. Official house price data will also show the government’s Buy to Let scheme is driving the housing market.
But there is an element of the Mad Hatter’s tea party about the divergence of opinion on interest rates. Many are pricing in a change in interest rates as early as 2014, and have done so since August to the chagrin of the Bank’s new Canadian governor who has pegged his change to 2016. The National Institute of Economic and Social Research (NIESR) argues that interest rates could rise in 2015 in a bid to keep a leash on Britain’s economy and prevent overheating. “There may be a sense that consumer spending and possibly house prices are rising in a way that makes an ultra-loose policy unnecessary”, NIESER director Jonathan Portes said.
In the meantime, there is much to be upbeat about in the British economy, despite talk of an over-heating housing market and a recovery driven by consumer debt. And the headline fact is that surveys, including last week’s report from the accountancy body ICAEW, are pointing to UK economic growth as the fastest among developed nations. This is despite the government’s capital spending cuts in recent years as it looked to move the economy towards exports and investment. Amid all this there is an emblem from the real economy of the UK’s ambition for trade and prosperity, and it opened for business last week downriver on the Thames at Thurrock in Essex – conglomerate DP World’s £1.5 billion London Gateway port which will handle the world’s largest merchant ships to connect Britain with global markets for the 21st century.