Source: AmendmentGazette.com
A few weeks ago I published Chart 1 not entirely mischievously, and now it seems a good a way to explain actual and potential power struggles…
Brexit opinion polls finally affecting markets
Figure 1: Alle Menschen werden Brüder (‘Ode to Joy‘words by Schiller music by Beethoven)
Markets have taken quite a long time to have a serious attack of nerves over Brexit, not least because so many traders appear to support Leave personally or at least say they do. A big swing to give Leave a 10% lead in an ORB Opinion Poll in the Independent was enough on Friday for UK equities to tumble, albeit after a fairly precarious week. The FTSE 250 fell by 1.68% on the day and the FTSE 100 by 1.86% while Sterling dropped 1.39% vs the dollar. However, these moves are not huge by historical standards and it is was noticeable that EZ equities were hit even harder on the day while the euro also lost ground. This points to more weakness on both sides of the Channel, as evidenced by futures prices, even if other opinion polls do still show Remain in the lead.
In contrast, the gilt market continues to stay remarkably calm. This may at first have been due to the widespread view that Remain would prevail but it could well be that gilts are now more seen as a safe haven for sterling-based investors, notably pension funds. However, price movements in other higher-rated markets, especially US Treasuries suggest that expectations amongst bond investors for global growth and inflation are softening even more. Accordingly, gilts are unlikely to face disaster if Leave does end up winning the referendum.
Chart 2: yields plunge as bond investors sink ever deeper in the slough of despond
In fact, last Friday was probably as good an indicator as any as to what might happen if Leave prevails in the end. The pound would be the most immediate casualty and could sink rapidly towards $1.30 and €1.20 but the euro will be hit too. Equities in most major markets will be affected, less so in the US and perhaps not all in the casino that is Shanghai. The dollar would be the main beneficiary but most sovereign and other high quality bonds should also gain, led by US Treasuries.
Although they would protest otherwise, I suspect that even the most sincere Brexiteers never expected to come close to winning and that investors are increasingly aware of the looming policy void. We must just hope the Treasury and Bank of England have got plans to help them out as they would surely need it.
Chart 3: Brexit, Even the punters are wobbling a bit
Source: @neiledwardlovar
Headlines
Chart 1 The tide has turned
The Financial Times has been diligently reporting statistics that support what some of us have been sensing would happen sooner rather than later. Chart 1 shows the first quarterly outflow (about $10bn) from ETFs since 2010 and yesterday the FT ran a story revealing an even bigger outflow from all equity funds (including ETFs) of $90bn, updated to last week. There are certainly plenty of things to fret about and the latest Global Risk Survey by Oxford Economics shows that slowdown in China maintains its lead over other risks. Intriguingly, two ‘new’ risks (new to the survey anyway) are clearly troubling investors: Emerging Markets turmoil and unconventional central bank policies. I am certainly in sympathy with the sentiments depicted in Chart 2 but, without wishing to detract in any way from the survey’s usefulness, would have put stagnation in the Developed Economies up there as a risk alongside China.
Chart 2 Plenty to worry about
Last week, China published more data than even an infinite number of economists can argue over all at once but much more interesting was an interview in the official People’s Daily with an anonymous ‘authoritative figure ’, which suggested that the high command means business about structural reforms even if this means lower growth. The imagery of an ‘L’ shaped GDP chart rather than ‘V’ or ‘U’ points to acceptance of a prolonged period of constant growth. Debt is clearly now a concern to the authorities as is the slow pace of supply side reforms and this suggests at least some of them do not believe Mr Xi’s targets can be met. Of last week’s data only 10%+ year on year growth in Retail Sales and Industrial Production of 6% are compatible with the 6.5% growth target and they contrast starkly with the continuing slide in both Imports and Exports (see Chart 3) and the recent trend in PMI surveys.
Chart 3 China still on track, then?
Source: via financialorbit.com
The US did offer some better news on Friday as the Reuters Thomson/University of Michigan Consumer Sentiment Index broke a five-month sequence of lower readings to bounce back to where it was last June and well above its long-term average. This appeared to be supported by strong Retail Sales in April, up over 1% on March and 3% on April last year. However, more detailed analysis
(see Chart 4) suggests that the increases were not broad-based and were dominated by motor vehicle and gas sales. This was good enough, however, to give the Atlanta Fed Nowcast for Q2 GDP growth another leg up to a ‘hot’ 2.8% annualised. This week’s Industrial Production and CPI Inflation numbers may ‘cool’ things down again. Many investors seem to hope this ‘Goldilocks’ economy will persist, whereby there is enough growth and inflation to keep things moving but not enough to persuade the FOMC to hike interest rates. The latest minutes out this week should show that Dr Yellen et al cannot think of a better idea.
Chart 4 US Retail Sales: hitting the road?
One of the ironies of the current run of poor UK economic data is that it is so reminiscent of the dark days of the 1960s, 1950s or even the 1930s before we were swallowed up by the EU. If this is the country that so many well-heeled City folk want to have back, they are definitely not welcome to it However, they probably are hankering after a time when the French feel ashamed, the Italians humiliated and the Germans guilty. Certainly, a time when Canadians knew their place and did not politicise their role by publicising inconvenient statistics such as those shown Chart 5 from the Bank of England’s latest Quarterly Inflation Report. Last week’s reports of a record Trade deficit, falling Manufacturing Output and (from the NIESR) faltering GDP made dismal reading. This week higher inflation than most other EU countries, subdued average earnings and dismal CBI industrial orders will add to the gathering gloom. Employment and Retail Sales data may still be bright spots but Gavyn Davies and his colleagues at Fulcrum Asset Management reckon that economic activity may have seized up altogether. Uncertainty over the outcome of the referendum may be a lame excuse for businesses to postpone hiring, investing or even just purchasing regular supplies but it seems to be one they are willing to use as clouds gather globally. The hiatus will not last but in the meantime look out for all the finger-pointing!
Chart 5: lies, damn lies and statistics?
Source: Bank of England
John Bunyan definitely did not have C21st investors in mind when he wrote his stirring hymn but some must feel a bit like pilgrims seeking salvation in a world full of financial hobgoblins and foul fiends. Top line revenues, profit margins and earnings remain the problems for equities with which markets in the Developed Economies are struggling again this month. It is too simple to jump on the ‘sell in May’ bandwagon as most markets have never regained their peaks of 2015 and selling now would be to add to the pain. Spain ((political uncertainty), Italy (banks’ loan losses) and Japan (yen strength) are the worst hit but the Nasdaq Composite is down nearly 10% on its high point last July. Moreover, even some prime stocks are oversold already. Meanwhile, the hunt for yield has taken bolder investors into Emerging Markets, excluding the rigged and ruinous mainland China markets. Even this has not exactly been a raging success if one looks beyond Brazil but there has been some parallel life in Canadian and Australian equities.
Chart 6 Triple whammy
Source; via @Callum_Thomas
Bonds seem back in demand driven by a combination of resignation that interest rates will remain low indefinitely and a renewed outbreak of ‘greater fool’ punting on European sovereign bonds. US Treasuries and, more surprisingly in view of the Brexit debate, gilts fall largely into the first category as they still offer yields of over 1% on maturities over 6 years and have consolidated in May their average of around 0.5% in lower yields for longer maturities. Much scarier have been the wild swings in yields on EZ bonds, including German bunds where yields are back to negative for maturities up to 7 years. Meanwhile, the ECB hoover is revving up to buy corporate bonds.
Chart 7 US Treasury yields: settling for less
Then, of course, there is nothing like a punt on commodities and FX! Oil is the current favourite with gold and silver taking a step back. Copper seems to gained and lost favour. The dollar is making a come-back just when it was being written off. Chart 8 shows how quickly money is made and lost in commodities futures. This is not a market for the attentive…..come to think of it, it is not really a market for anyone other than the professional traders. Even the hedgies are hurting!
Chart 8 Pay attention at the back
Chart 1: Oh no, it is that time of year again!
Source: @callum_thomas
Yes, really! Chart 1 shows why the ‘Sell in May and go away’ meme remains in vogue although it is wonderfully ironic that investors in the US, especially on Wall Street, who do not really approve of holidays at any time, have latched on to the summer season of the City folk of a bygone era. In the good old days even the inside trading had to be suspended for Ascott, Wimbledon, the Lords Test, Henley, the Glorious 12th and so on until the flat racing season ended at Doncaster in Mid-September. Perhaps we wily Brits tricked foreigners into thinking St Leger was spelt with a ‘d’ in the middle and had some profound financial significance. Hey ho!
Anyway, we already know that 2016 will be different because anyone selling now will at best have made only very modest gains since January in US markets with some painful losses elsewhere (notably Japan, China and Italy). Furthermore, all major equity markets are down on their peaks in the Spring and Summer of last year. It is true that there were some ‘seasonal’ rallies in October and March but they were not sustained. The one notable exception to ‘prove the rule’ is Brazil’s Ibovespa, which has surged in seeming (seemly?) rapture over every new exposure of official corruption and I am indeed with the consensus that the time to cash in is right now (not least in view of the latest plunge in the April PMI survey).
This allows me to give a modest tootle of my own trumpet in the hope that regular readers recally my ‘witty’ exhortation last March to ‘sell in the Spring but not everything’! I coined this not to defy a hackneyed meme but because I was worried about a slowdown in the global economy and its impact on corporate earnings. This has, of course, proved prescient and is my main justification for the tootle. Again, I hope regular readers are in no doubt as to what I think will happen next: more of the same, including the prospect of further market falls.
At this point, I should make clear the distinction between investing in equity market indices and other related derivatives in contrast to trading individual stocks. A further distinction is between stockpicking to buy and hold (which is difficult even in rising markets) in contrast to trading individual stocks over relatively short periods. Here, I have to confess that I am alluding to our DAN-Trade service but will cofine myself to saying, before passing lightly on, that it has notched up quite a few hits since its launch last December.
Chart 2 Another seasonal thing?
GDP numbers command less attention these days partly because they seem no longer to reflect fully economic activity and partly because they are subject to frequent revision, while some are regrded as fabricated. Anyway, the first cut of Q1 US GDP turned out at +0.5% annualised to be worse than expected even by the Atlanta Fed Nowcast. Some commentators insist that this merely repeats the seasonal pattern of recent years and, indeed the first Atlanta Fed Nowcast for Q2 is 1.8% annualised. However, Chart 2 may well show the pattern of Q1 softness in successive years but it also shows GDP to patchy overall with a downward trend since 2014. In fact, it is already possibe to predict that US GDP in 2016 as a whole will stuggle to match last year’s 2.4%.
The outlook is even less comforting when one starts digging into other indicators. Unemployment is still very solid at 5% but average earnings at 2.3% year on year are not gaining much from it. The Manufacturing Sector is flitting in and out of contraction but the Services Sector cannot compensate in terms of pay and productivity. Consumer confidence is sliding lower according to both the Conference Board and Reuters/University of Michigan surveys, both Personal Spending and Retail Sales measures are drooping and inflation seems stuck. Business investment is also depressed but companies are still borrowing to fund M & A and unproductive share buy-backs. There is a widespread evidence that the FOMC’s policies since the Crash have resulted in money flowing to the wrong places, especially into speculation on Wall Street and overseas stock markets. It seems that the FOMC dare not go back to more QE or forward to raising interest rates to more normal l;evels. This is not yet a doomsday scenario but it suggests that the US economy will keep on slowing down this year and into next.
Chart 3 IMF tweaking the dragon’s tail
Source: IMF
Over the years the IMF has normally been quite placatory in response to China’s prickliness about anything that throws doubt on the success of Communist Party policies and last month China’s GDP growth forecast for 2016 was actually upgraded in the IMF’s World Economic Outlook. Needless to say, Q1 GDP was officially reported bang on target and there was other ‘good news’, some more credible than others, on Industrial Production, Exports, Retail Sales and Foreign Direct Investment. Meanwhile, PMI surveys both official and from Caixin/Markit point to a more nuanced economic outlook and a bounce-back in new loans confirms that the authorities are doing little to curb China’s debt binge. Chart 3 shows that even the IMF is now prepared to send out warning signals and one of my favourite Sino-observers, George Magnus, raised some disturbing issues on this theme in Saturday’s FT. Not least of the worries is that a combination of local government borrowing, banks’ and shadow banks’ book-keeping shenanigans and official turning of blind eyes means that credit growth is prpbably, according to Magnus, running at about 25-30% to levels that are already over 250% of GDP. This is not so much a replay of the 2008 credit stimulus that ‘saved the global economy’ (and China’s, by the way) but a continuation of it. Applying the brakes will be politically and practically almost impossible without enormous economic damage domestically and internationally and Magnus is warning us all to be prepared for it to happen within the next three years.
Japan’s official data is also viewd with widespread suspicion but over its accuracy rather than its excessive optimism. Subject to that qualification, the latest batch of dismal Industrial Production, Manufacturing PMI,Household Spending, Retail Sales and, worst of all, Deflation numbers suggest that the economy is once again in recession. Despite this, the Bank of Japan last week held whatever of its fire remains to much widespread surprise. It is not yet clear whether that was part of a central bank pact not to engage in currency wars or simply a sign that Governor Kuroda et al really have run out of ideas. It may be that the BoJ unilaterally or in concert with the FOMC and ECB is planning something drastic such as ‘helicopter money’ and it also raises the prospect that Japan’s decline is a blueprint for other debt-laden economies.
The UK also reported disappointing but not unexpectedly +0.4% quarter on quarter GDP growth for Q1. Once again the Services Sector accounted for almost all the growth but even this was not enough to avoid an increase in unemployment, albeit very modest, in the 3 months of December to February. Consumer Confidence has fallen back into more familiar negative territory and it appears consumers are reining back their spending, at least in shopping malls, from their binge in January but the mounting uncertainty over Brexit is more likely to be having more of an impact on business investment and hiring. Full year growth of 2% in 2016 now looks even more of a challenge.
Chart 4 EZ GDP 2002-16: back from the dead
Frederik Ducrozet @fwred
It would be churlish, especially in the midst of the Brexit debate, not to acknowledge that the EZ was the top performing developed economy in respect of Q1 GDP (+0.6% quarter on quarter) to the extent that the peak level in 2007-8 has at last been surpassed (red line in Chart 4). It has been, appropriately enough, a communal effort with only Italy still struggling. Germany has yet to report its Q1 data but Spain (again) and France (more surprisingly) have led the way so far while honourable mention must be made of Ireland. Unemployment is still dire at 10.2% in the EZ as a whole but is slowly getting better, even in Italy. Industrial Production remains disappointing everywhere but consumers appear to be doing their bit by spending more. The return of Deflation is, however, a major set-back and a new challenge to Mario Draghi in his de facto role as economic, if not yet political, supremo. He will, however, be relieved that Portugal has kept (just at BBB) its only investment grade rating from Canada’s DBRS, which will allow the ECB to keep propping up its debt. He has already stepped in to prop up Greece but the latest game of chicken between the Tsipras government, EU Commission, IMF, ESM bail-out fund, France, Germany and Uncle Tom Cobley and all must be another worry.
On Thursday everyone in the UK gets at least one vote in elections around the country. In Scotland the SNP seem set to reach their zenith before they start to suffer from being the party in power. The wheel of fortune may already have turned for Scots Tories if after a mere 30 years they become the second party again. Labour is also expected to fare badly in England and Wales at the hands of UKIP rather than the Tories but London still looks within its grasp. It would certainly bode ill for the referendum if the lightweight Brexiteer Zac Goldsmith pulled off a surprise.
The Brexit opinion polls continue to be finely balanced as Immigration becomes the key issue now that the Economic debate has been lost and won. It seems incredible that so many older voters, many of whom have cleaned up in the housing market, are willing to prejudice their children’s future further by voting Leave. In my family both generations have imposed three-line whips on each other to vote Remain.
So much is being written on Brexit that I will confine myself to three last charts:
Chart 5 an opinion poll from the Sun newspaper, which many readers may not have seen.
Chart 6 the latest probabilities based on betting at Betfair, showing most punters still do not believe the opinion polls
Chart 7 the GBP/USD exchange rate over the last seven months, showing that, in addition to other dollar-supportive factors, FX traders had become quite concerned about Brexit during most of March and April. They now seem to have changed their mind and, unless they do so again, the pound may not gain much from an actual Remain vote. A Leave vote would, of course, hit the pound hard at least in the short-term.
Chart 5 Brexit: the battleground revealed
Source: Sun newspaper
Chart 6 Brexit: Ordinary punters still betting on Remain
Chart 7 GBP/USD: FX punters also betting on Remain for now
Source: FXCM via ProRealTime.com/FXstreet.com
Chart 1 Contributions to year-on-year volume and value growth in the UK from the 4 main retail sectors (March 2016 compared with March 2015)
Source: ONS
A big data week lies ahead for most major economies apart from China, which as usual has already won the monthly competition to produce the quickest and most optimistic numbers.
For once, I shall give pride of place to the UK although not much good news is in prospect. The first (and incomplete) cut of Q1 GDP will hinge on the data displayed in Charts 1 and 2 from the Office of National Statistics. Consumers are still buying cheerfully but at lower prices and less so in shops while the Services sector (including retailing) is currently the only likely source of overall growth. The consensus expectation is for Q1 to be +0.4% quarter on quarter (vs. + 0.6% in Q4) but I reckon it could be as low as +0.3%. Other ‘highlights’ are likely to include another dismal CBI Survey of Industrial Orders and Gfk Consumer Confidence slipping below zero. Mortgage lending, however, will have surged in March, which is just what we do not need!
Chart 2 UK GDP contribution to the quarter-on-quarter % change, Quarter 4 (Oct to Dec) 2015
Source: ONS
The US also reports on Q1 GDP (together with a raft of numbers for the month of March) and here too +0.3% is also very likely but with the crucial difference that this would be on an annualised basis. This is the latest reading from the Atlanta Fed Nowcast, which has become a very accurate predictor of first cuts of GDP but it has to be said that US GDP is notoriously reported lower in Q1 than in the rest of the year. The Cleveland Fed also have a Nowcast of their own and it forecasts a modest fall in March to 1.5% year on year in the FOMC’s preferred inflation gauge of the Core Personal Consumption Price Index. As in the UK, Consumption is key to future growth and the two major surveys of Consumer Confidence, the Conference Board and Thomson Reuters/University of Michigan, are also due out this week. As both have been (gently) trending in opposite directions, a dramatic improvement seems improbable with inevitable implications for overall growth in the US economy in Q2 and beyond.
It seems tactful not to dwell on expectations of the data from Japan but the numbers will include CPI, Industrial Production, Household Spending and Retail Sales. Judging by the smoke signals with regard to the Bank of Japan’s pushing interest rates into negative territory, we should expect nothing but further gloom.
Chart 3 EZ banks neither borrowers nor lenders
While listening to Mr Draghi’s press conference some lines from Macbeth did come to mind but I have since reserved them for another ‘performer’ (see below). However, as we all celebrate the anniversary of Shakespeare’s death (also his birthday, by the way) I thought an allusion to Hamlet would be appropriate in the caption for Chart 3. Essentially, EZ banks are not lending much to businesses or consumers and prefer buying sovereign bonds with what little of the ECB’s funding largesse they elect graciously to accept.
Nevertheless, Mr Draghi did manifest some ‘sound and fury’ on Thursday as clearly German politicians, not least Finance Minister Schaüble, are vexing him on at least three fronts: (1) blaming ECB policies for the rise of anti-EU protest parties (2) insisting on austerity instead of moderately expansionary fiscal policies and (3) daring to challenge ECB independence (supremacy?) just because zero interest rates do not suit the domestic German banking sector.How long will it be before Mr Draghi blames the politicians for the lack of lending that means there is little prospect of much growth in the next year and beyond? This week should bring another set of poor data headed by persistently low inflation and high unemployment. No lending means very little growth and data from the EZ this week should report more of the same: persistently low inflation and high unemployment. Spain should have the best story to tell with Germany and France lagging some way behind while Italy still struggles with high unemployment, low wages and, of course, a host of migrants from Libya.
Mr Schaüble has also been stirring up trouble in suggesting that Greece may not need debt relief, as now demanded by the IMF, if it would only try harder to meet its deficit targets. However, the latest exercise in can-kicking requires Greece to agree to an extra €3.6bn of ‘contingency savings’ to hit the 2016 deficit targets just in case the previously imposed €5.4bn is not enough. Hubble bubble, toil and trouble but probably not just yet, during the Brexit referendum campaign!
Chart 4 Brexit rises to top of concerns in April’s BAML global investor survey
Investors have been getting increasingly alarmed by the prospect that a grand alliance of romanticists, genuine reactionaries, anarchists and the merely bloody-minded might win the day on June 23rd. UK equities and the pound have been hit and Chart 4 shows how Brexit since January has overtaken a hard landing in China and a US slowdown as the chief concern of respondents to the monthly BofA Merrill Lynch survey of global investors.
The latest betting implies the probability of Remain winning has jumped to 75% after last week’s wobble and the last few days may yet prove to be the turning point. President Obama may have been at his most charming (also with flashes of ruthlessness) but the heavy lifting had already been done by economists, of all people. The fact is that it is impossible to construct a realistic case that the UK would be better off economically outside the EU. In contrast, as with the Scottish Independence referendum, a political case can be made provided one is willing to pay a short-term price and risk longer-term damage. The best one can say (as Lord Merv of Swerve did last week) is it would not make much difference but even that requires, awkwardly, some sort of new deal with the EU. The crux of the matter is that trade just cannot be ignored, no matter how loudly the Leavers complain about the three models (Norway, Canada and the World Trade Organisation) set out by the Treasury and even their own ‘Albanian’ model requires something on trade.
Here I want to make a plug for the Centre for European Reform (CER) who describe themselves as ‘an independent think-tank devoted to making the EU work better, and strengthening its role in the world. We are pro-European but not uncritical.’ Indeed, the CER regularly publishes learned papers on both EU reform and Brexit. Regular readers will know just how much I sympathise with such sentiments and that I am a proud ‘Remainian’ as Share Radio’s Simon Rose described me as I set off last Thursday to a CER-sponsored debate on the motion that ‘Leaving the UK would damage the UK economy’. The debate was preceded by Gordon Brown in as good form as I have ever heard him (and I have known him since we were undergraduates), who made a brave attempt to inject some passion into the Remain camp but, as the FT’s Janan Ganesh keeps pointing out, it is really all about economics. Proposing the motion were JP Morgan’s Stephanie Flanders and the FT’s Martin Wolf while opposing were Capital Economics’ Roger Bootle and Gerald Lyons from the Mayor of London’s office. As Mr Wolf observed with uncharacteristic generosity, Messrs Bootle and Lyons are two of the few serious economists in the Leave camp, which made their overwhelming defeat all the more significant. Chart 5 sets out the voting from the audience of academic, business and journalist economists. I might add I have rarely come across such a strong consensus amongst so many economists, despite all of them appearing to be of the two-handed variety famously reviled by President Harry Truman.
Chart 5 CER Economists debate: the Remainians have it!
The political debate will go on but it all seems so unnecessary unless one actively wishes to change the leadership of the Tory Party. At least Michael Gove is a romanticist given leave of absence from reality by his friend the Prime Minister but others have less respectable aims. For the erudite but shameless Boris Johnson and in honour of the Bard’s anniversary I address this passage from Macbeth (after I had looked for something from Comedy of Errors)
…a poor player
That struts and frets his hour upon the stage
And then is heard no more: it is a tale
Told by an idiot, full of sound and fury,
Signifying nothing.
Headlines
Chart 1 Is the price right?
A dramatic week kicked off with the OPEC meeting in Doha failing to decide on freezing output although, of course, the really important bit would have come later with an agreement that sticks if it can ever be reached in the first place. Chart 1 shows yet again the leverage of Saudi Arabia and Iran, if only they could ignore their political rivalry (Iran did not even show up in Doha). It also shows how much producers have been suffering since the golden years 2011-14, most of whom, with the major exception of the US, must be desperate for some sort of deal. Their best hope is prices’ stabilising in the range of $40-50 as the Saudis are in a hurry to get the black stuff out of the ground before world governments get serious about fossil fuels. Then, of course, there is Wall St, which having cleaned up with forecasts of a top of $150 and a bottom of $20, will want to catch everyone out again. In the immediate aftermath of this set-back, $40 looks in danger.
The Brazilian ‘House of Cards’ screenplay has reached a new melodrama with the lower house of Congress voting on the impeachment of the beleaguered (and less than competent) President Dilma Rousseff. Since February, equities and the real have been rapturously anticipating a clean-out of the bad guys but profit-taking if not disillusionment could send them into reverse if everyone concludes that there are no good guys.
On Tuesday, the New York State primary may not prove as decisive as was originally thought with both Trump and Clinton stumbling a bit. With Congress increasingly polarised into gridlock, highlighted in fascinating BBC documentaries in the Obama White House, it may not matter much who ends up winning in November. Somewhat depressingly, all four contenders are trade protectionist to varying degrees, which is, alas, one area where they definitely will be able to work with members of both parties in Congress.
Meanwhile in Europe, SuperMario has another spar first with his critics within the ECB Governing Council and afterwards with the increasingly sceptical financial press. Apart from insisting that all is going to (his) plan, he probably wants to keep his head down while the Germans squabble amongst themselves over ECB independence vs. its ‘reckless’ policies. Mr Draghi has, however, got new fans through including Greek bonds in his asset buying spree, which should help kick the Greek can down the road while the IMF and the Germans quarrel and the Tsipras government wriggles. The fact remains that the Greeks cannot meet all their targets even if they wanted to. This could end awkwardly for Mr Draghi, albeit not as much as will the European banks’ recalcitrant perversion of his asset purchase programmes through their buying ever more government bonds and cutting back on lending. Mrs Merkel faces her own uncomfortable week over her apparent kowtowing to President Erdogan of Turkey, which is threatening to overshadow the coup of securing both CSU and SDP support for her bold and enlightened approach to integrating immigrants.
Chart 2 Waiting for the Boris Bus
Source: @neiledwardlovat
Here in the UK, there also seems to be a ‘House of Cards’ building with the Brexit campaign seemingly overtaken by a struggle for the keys to Number 10. The venerable Kenneth Clarke gave the game away when he said Mr Cameron would not survive in office for 30 seconds if he lost the referendum while the less venerable Europhobe MP Bernard Jenkin reckons the Tory Party would overthrow him if he won. Who needs enemies with friends like that? (A matter to be pursued by Nick Robinson on TV on Tuesday evening, by the way). Jeremy Corbyn is in on the plot too as his ‘wholehearted’ conversion to EU membership neatly papers over the other divisions in his own party and should (coincidentally?) also help the Remain cause. However, the real drama will start with Mr Johnson’s setting off on his Boris Bus Comedy Tour bound for destination Downing Street while President Obama (also very witty on occasion) gets there next week to help out Dave, their ‘common’ mate. The publicity given to cricket legend Sir Ian Botham’s support for Brexit adds some piquancy but so far, as Chart 2 (from my mate Neil Lovatt) confirms, the punters are unmoved. Meanwhile, the Treasury is certainly not playing it for laughs in issuing a much-needed warning to those of us who are neither anarchists nor romantics.
Chart 3 China to the rescue?
Source: IMF/FT
Last week the IMF published their latest quarterly forecasts for world output and individual country GDPs, which told a familiar tale of slowing growth and further downward revisions. Economic forecasting is, of course a mug’s game but the IMF usually manages to get the direction right and, of course, provides insights into a comprehensive list of economies, albeit subject to local political sensitivities. The latest big ‘surprise’ of upward revisions to China’s GDP somehow managed to reflect the government’s official 6.5-7% target at least for 2016. Only India at 7.5% is expected to do better while no other economy of any importance is forecast to grow by more than 2.5% in either 2016 or 2017, with Japan back in recession next year.
As luck would have it, China has just published data which shows Q1 GDP to be bang on target at 6.7% annualised, albeit down from 6.8% in the previous quarter. In fact, it has to be said that almost all the official numbers from China are felicitous to a surprising extent, including not just GDP, Industrial Production, Retail Sales and Trade but also FX Reserves and even the Producer Price Index. In contrast, the US economy is not ‘doing its bit’ with a seventh consecutive month of negative changes in Industrial Production and faltering Retail Sales. Chart 4 from Jeffrey Snider of Alhambra Investment Partners shows a jagged but generally declining trend in Retail Sales excluding Autos.
Chart 4 US consumers not to the rescue!
This week attention switches to the EZ and it is all about surveys, especially from Germany and including the ZEW (Economists), IFO (Business) and the flash Manufacturing and Services PMI surveys from Markit. Not much can be expected from any of them. Meanwhile, following last week’s dire Manufacturing Output numbers, the UK puts a better foot forward in the form of Unemployment and Retail Sales. Even the Public Finance numbers should be quite favourable, albeit confirming that the Chancellor has missed his target for 2015-16.
One of the tougher parts of my job is being obliged to descend from the Olympian heights of macroeconomics to mundane microeconomics. Last week took me to the Isle of Purbeck in Dorset where I was obliged to study in depth various restaurants, bars and (cream) tea rooms, all of which were full to capacity and charging prices to warm the hearts of members of the BoE’s MPC. Even the historic buildings and the local steam railway seemed full of visitors and I was assured on my my diligent enquiry that the Easter holidays had been even busier. I also should report that many of the serving staff were not……er….English. Figure 5 shows the view from my desk in Dorset, where I failed to write Economic Insights last week.
Chart 5 Daniel Stewart’s Dorset HQ last week
This awkward-sounding phrase (which may not even be original) is my attempt to look beyond the term ‘uncertainty’ (as in markets do not like it), which is being devalued by excessive repetition and becoming rather meaningless in the same way as ‘we live in times of great change’ is now a tedious cliché. It seems it is no longer enough in financial markets just to decide that not being able to judge current developments is a bad thing. It is also important to second guess how others will react to such ‘primary’ uncertainty.
Information from the ‘real world’ of consumers and businesses via official data is by definition ‘after the event’ and variable in its reliability but trends can usually help as can confidence surveys. However, that is all rather too slow for many investors, especially those who rely on algorithmic programmes for immediate responses to, and even anticipation of, the latest news. The challenge is intensified by the failure of many government and central policies and, indeed, their growing unpredictability. There now appears to a ‘secondary’ level of uncertainty that is much more unsettling and is resulting in volatility that can only be described in undignified terms as stampedes by investor herds. It ain’t easy in this uncertain uncertainty where traders and algorithmic programmers cannot themselves think of everything let alone fret over what everyone is thinking! Here I am not just alluding mischievously allusion to the warmongering Donal Rumsfeld and his ‘unknown unknowns’ but also respectfully to George Soros and his theory of reflexivity.
So, what should those involved in financial markets do about it all? Firstly, they should look more closely at the ‘real world’ where consumers and businesses make choices about enduring in difficult times, splashing out in good times and remaining on the qui vive for bargains and other opportunities. After that, they might be able to view more calmly the latest efforts of policy makers to catch up with events and also the latest gambits of other market participants.
Source: Zerohedge
US recession: this story is starting to fade as Employment, Average Earnings and (parts of) the Property sector continue to advance while consumers do their bit. However, Manufacturing and Oil are clearly part of a global recession in those sectors. GDP quarterly numbers are remarkably erratic but US growth still seems to be running at above 2%, albeit not by much. This week’s data is unlikely to settle many arguments as the Labor market in February will have been solid enough while various business surveys continued soft.
It seems unlikely, therefore, that the economy (stupid or otherwise!) will determine the Presidential Election as most non-white have-nots are always going to vote Democrat and most white have-nots Republican, irrespective of the candidates. Accordingly, it may well come down to whether enough voters in a few swing states will prefer any man from the fissiparous GOP over the experienced but nevertheless female Mrs Clinton. Perhaps surprisingly for some, a Clinton vs. Trump (no Neocon he!) is likely to keep World War III off the agenda while Wall Street can expect no new favours.
China collapse: Party control comes ahead of any economic considerations but even then officials are still struggling to keep announcing data in line with official targets. GDP growth seems easy enough to fix while the Caixin/Markit Services PMI is proving independently supportive but both imports and exports are showing signs of stress. A rigged stock market does not help dilute widespread cynicism and concern but for all that China is probably still growing much faster than any developed economy. The most recent moves by the PBoC confirm that the priority of Party control is to restrict capital outflows rather than a major currency devaluation or tightening of monetary policy, even if this inhibits inward foreign investment.
European disunion: significant economic recovery since 2009 has yet to materialise beyond Spain and Poland despite the extravagant claims of Mario Draghi. Italy seems to going backwards while Germany is losing momentum and. unlike in the US and UK, EZ consumers are not making up for the global slowdown in trade. Inflation is falling back again (flat in Germany year on year in February) as the latest falls in oil prices feed through. Then there is a scary list of political problems, including funding for Greece and for ailing banks, Russian trade sanctions and, above all, the refugee crisis.
Brexit: the whole debate is riddled with ironies of which the greatest perhaps is that any damage is likely to be self-inflicted. Meanwhile, GDP growth is being held back by the global recession in Manufacturing and slowdown in trade but the Services sector is still going well. In preparing yet another major statement Chancellor Osborne is on the receiving end of Schadenfreude as tax receipts threaten his self-imposed and unnecessarily tight fiscal targets. Any proposed tax increases will enrage even further Europhobic Tory MPs whose willingness ‘to put country before party’ seems baffling when so many of their arguments have (yes!) uncertain consequences.
Central Banks’ next moves: it is hard not to see BoJ Governor Kuroda as either desperate or dogmatic or both and it may be that Japan’s economy is in such a poor state (GDP growth negative again in Q4, Household Spending down as Inflation fizzles out) that he cannot make matters worse. Mr Draghi seems just as dogmatic but more overtly political as he schemes for further loosening of monetary policy at the ECB Governing Council’s next meeting on March 10th when Bundesbank President Weidmann by rotation does not vote. What is not clear is how far he feels he dare go with negative rates and or expanded QE purchases. By comparison the Bank of England’s MPC seem positively sane in their apparent acceptance of its inability to do much and specifically to eschew negative interest rates. Meanwhile, the FOMC also seem wary of negative rates, especially as it has to justify any sudden switch from its recent expectations of raising rates throughout 2016. A new QE programme in the US is, however, a possibility albeit not on a grand ‘Bernanke-scale’.
The mood has changed dramatically in equity markets during February. The major sell-off in 2016 (which actually began in December when the Santa rally never materialised) stopped mid-month and the stampeding herd then changed direction. By the end of last week even the stampeding had become less thunderous. It is still not clear why this happened but the main reason was a sense that some stocks had been oversold, especially in the US, UK, (some) Emerging Markets and in the Mining and Industrial Sectors. This looks like continuing into this week and March is historically a month for buying. There is also a feeling that a majority on the FOMC recognises that the US economy and, almost for first time, the global economy is simply not strong enough to withstand a serious of dollar interest rate hikes. Less healthy may a continuing correlation between equities generally and oil prices and it seems that investors remain convinced that cheaper oil is good for economic growth. The real hope has to be the signs of some differentiation between different stock markets and, whisper it soft, individual stocks. Nevertheless, earnings rightly remain the chief restraint on any rally soon.
In the bond markets, investors had already discounted a change of pace by the FOMC and, of course, no hikes are expected from the MPC. European and Japanese sovereign yields have, however, kept falling, many far into negative territory, in anticipation of further unconventional measures from the ECB and BoJ. It is, however, not clear whether this driven by fear or opportunism to catch ‘greater fools’ as the currency markets are clearly less impressed. The yen has surged in February and the euro only recently has started to slip lower. This apparently illogical resilience seems due to hot money flows: nervous investors still unwinding carry trades and also a reaction to diminishing prospects for US interest rate hikes. Talking of fear, Gold is being talked up in many quarters but it remains hazardous for those hoping to make money trading futures as opposed to buying bullion as insurance for tough times ahead.
No surprise that the current favourite sitting duck is the pound, always a favourite for selling whatever the justification. As it happens, Brexit is as good a reason as any for a long time to give sterling a kicking and more can be expected. Until recently, however, the slide has had a variety of causes, which explains why the pound has been so weak against the euro. The more prominently Brexit features from now on the more likely it will also pull down the euro, which appeared to happen when Boris Johnson announced his ‘momentous’ decision a week ago. Hence, my suggestion in Signals that the ECB should sign up the Great Man to keep talking down EUR/USD as well.
Equity prices have hitherto in 2016 been driven by herd-like panics over earnings interspersed with hopes of succour from central banks. This has been making markets look depressingly like the Risk On /Risk Off years from 2009 to 2014. Now, however, there are signs of greater discrimination, which if they persist will surely make markets healthier. It is true that all the main indices moved higher last week but not uniformly and with some reversals of over-sold positions, including in Emerging Markets. Even better was that stocks within the various indices did not all move together. It is still too early to call a major change but I was interested to alight on Chart 2 indicating that investors may indeed be more open-minded than they have been in the last few weeks.
It is possible that many investors have finally concluded that central bankers can no longer help them much and that some members of FOMC and MPC do not even intend to try beyond keeping official rates lower for longer. Janet Yellen’s marathon testimony in Congress did nothing to persuade investors that there is any prospect of the FOMC hiking four times in 2016. Nor is there much expectation that the FOMC or MPC will venture into negative rate territory. These views are finely balanced in US Treasury and gilt yields, which have fallen significantly so far in 2016 but remain far above EZ and Japanese sovereign yields. Of course, Messrs Draghi and Kuroda are still strutting their stuff but with contrasting results. Mr Draghi, as the buyer of every resort, has managed to push sovereign bond yields ever lower, capped them for potential delinquents Italy and Spain and even hauled Portugal back from the brink. He has had less success with depreciating the euro but is planning another ‘coup’ at the next ECB meeting in March when the Bundesbank does not have a vote under the rota system. Mr Kuroda has an even bigger problem with the yen, which no matter how reckless he gets, is still seen as a safe haven by domestic and foreign investors alike. None of Mr Kuroda, Mr Draghi and their counterparts in Switzerland, Sweden and Denmark seem to consider that negative interest rates might alarm consumers and businesses sufficiently to curtail their spending: i.e. the opposite result to their aim.
Investors coming to terms with low growth and its impact on corporate earnings and interest rates is surely welcome even if some central bankers still they have unlimited ammunition left. We must hope that they continue to discriminate rather than stampede. Nevertheless, markets are likely to remain very difficult for some time, possibly for several years, and I intend to expand on the Daniel Stewart approach at the Private Client Forum on Tuesday February 23rd.
Chart 1: Armed neutrality?
Source: CNN via @Callum_Thomas
So much commentary already and we face four more months of it! I have already stuck my neck out to forecast that Britain will stay in the EU and even adding there was never much chance it would not. The negotiations have often seemed like a charade with EU leaders obliged to talk tough to their voters and Mr Cameron posturing to keep most Tory MPs at least pretending to be open-minded. However, anyone who has been involved in complex commercial negotiations will recognise the apparent surprise of EU leaders at their own generosity and the grudging caveats of moderate Tories as signs of a ‘good deal’. Time will show that Mr Cameron has achieved fundamental changes not on immigrant benefits but on future EU politics and governance. While this could well turn out to be generally beneficial there is a danger that the deal will add to the current centrifugal forces within the EU.
The economic arguments for and against Brexit remain tantalisingly unquantifiable. The pro-EU Bertelsmann Stiftung and IFO Institutes estimate the best case for the UK would be a 5% hit to GDP vs. 25% from complete (albeit highly unlikely) isolation from the EU. The main factors seem to be:
Two ironies seem likely to overshadow any economic arguments that the ‘outs’ are likely to put forward. First, the UK’s success outside the EU will depend largely on extended and extensive co-operation of those it seeks to leave behind. Second, the biggest risk to the UK economy is a messy break-up of the EU, which it may well have help to precipitate. These will prove awkward even for the eclectic and colourful prominent ‘outs’ as they seek to convince ‘conservative’ Brits of the need for a change with unquantifiable consequences. Moreover, Mr Cameron has already proved himself the doughtiest of campaigners.
The probability of Brexit apparently rose by at least 5% to 35% when Boris Johnson crossed his personal Rubicon (an allusion he would surely both recognise and deny) but I shall stick with my confident prediction of no Brexit.
Stop Press: The great BoJo (now also known as BoGo!) has managed to weaken the pound, which is really rather extraordinary for someone not in government. He is going to have a lot of explaining to do as he abandons the City of London. His tactic seems to be the classic ‘there is a problem and only I can fix it’. He has almost certainly ‘fixed it’ for Labour’s Mayoral candidate Sadiq Khan at least!
It seems appropriate to bear in mind Yogi Berra’s (pun not intended) words of caution after Friday’s unexpected bounce in global equity markets. Most markets are now in bear (oops!) territory and the MSCI world equity index hit its lowest level in more than two and a half years at 20.18% below its all-time high close on May 21st 2015. Two significant exceptions are the S & P 500, which is down a ‘mere’ 12.7% from its peak on May 21st last year, and the FTSE 250, which is 15.5% below its peak on June 9th. In fact, very little has changed fundamentally over the last few months: the global economy is still slowing, oil prices are still slumping, refugees are still fleeing from Syria, EU leaders are still falling out with each other and US politics is as internecine as ever.
What has changed is market sentiment: investors seem to have given up on denial and started to face up to two developments that have been obvious for at least the last year without even the benefit of insight:
It is not yet clear, however, that investors realise that there will be no dramatic bounce-back from the current slowdown with the corollary that share prices will not bounce back either. The overnight surge in Japanese equities looks like a classic case of (speculative) hope triumphing over experience! One does not need to be a bear to expect markets to be difficult for the next several years and it will be hard to make any money until investors start to differentiate properly growth companies from the rest. Even then, there are no simple solutions but my colleagues and I intend to make a start at our Client Forum on February 23rd.
Chart 1 Reality knocks
A deal should be struck at this week’s EU Summit and apparently Our Dave is packing three shirts as a sign of his determination to negotiate to the end. We must hope so because it all seems to be getting a little contrived. There has surely never been any question of the other EU countries pushing out the UK or any UK government planning to leave. On that basis, migration, populism, Putin mischief, bank systemic risks and economic divergence are much more serious challenges. With 27 other heads of government and his Tory MPs to placate, Mr Cameron seems to have made enough fuss to allow the former to raise pseudo-objections and enough of the latter to grumble and subside (the diehards will never give up!). With so many challenges, the Single Market may be all that can be salvaged from the current ramshackle EU but only if the UK remains. Now that really would be radical and also ironical.
The great British public continues to ignore opinion polls and apoplectic newspaper articles and bet heavily against Brexit. My friend Neil Lovatt of Scottish has calculated that the probability of Brexit is around 30% and if anything is diminishing.
Chart 2 Betting against Brexit since January
Meanwhile, the fur is really beginning to fly in US politics. The significance of the New Hampshire primaries is that in boosting two anti-Washington candidates, Messrs Trump and Sanders, Wall Street and the Fed are now faced with the possibility-not more as yet-of a hostile White House. That could be a veritable Pandora’s Box if factionalism increased in Congress. The death on Saturday of the recalcitrantly reactionary Supreme Court Justice Scalia has poured petrol on the flames with the various Republican candidates urging the blocking of any Obama nominee as a replacement. It is quite something for the Grand Old Party to seek to undermine the Constitution for the sake of personal and party advantage. The unseemly GOP rows may yet hand victory to Mrs Clinton.
The FOMC this week holds a mid-quarter meeting after which there will be a Statement but no new projections published or a Press Conference. A change in official rates is theoretically possible but unlikely as the Committee now has to live with the consequences of its decision to hike in December. There appear to be four main options that could be flagged in the Statement:
Investors are surely right in expecting disingenuousness and would react strongly to either brazenness or bounty. I am often asked, reasonably enough, to say what I would do in the FOMC’s shoes and, nailing my colours to the mast, my answer is honest inaction. The US economy is just about chugging along without any signs of improvement to justify further tightening. Frankly, the only good argument for the hike in December was to warn people to assess risk more carefully.
The first cut of US Q4 GDP is due out on Friday and the FOMC will have been given a preview. While less than 1% annualised is expected in line with the Atlanta Fed’s latest GDP Nowcast, cynics have pointed out that neither are good indicators of the eventual number when all the data is collated. What seems clear is the US economy grew by less than 2% in 2015. Meanwhile, the two main January consumer surveys should show confidence holding up, even if it is not feeding through to retail sales.
China has already published its first (and only) cut of Q4 GDP and many government officials have been pointing out that growth of 6.8% in 2015 was the lowest for 20 years. Although this is too close to target to be credible it does suggest that the actual rate is still much higher than in the Advanced Economies. Japan, for example, is likely to disappoint its protagonists yet again with more dire numbers for household spending, retail sales, industrial production and inflation.
France (soft) and Spain (robust) will kick off EZ Q4 GDP reporting but the main interest will be what is happening to inflation in Germany as the month on month figures are falling while the year on year ones are rising. The ECB would prefer a mix of rising inflation in other EZ countries and more business optimism in Germany than is currently being reported.
Finally, the UK also reports its first cut of Q4 GDP and it is likely to be….er….higher unless, of course, the ONS revise Q3 up from the disappointing +0.4%. Official UK data continues to be rather confusing as last week’s batch illustrates. CPI higher because of increased fuel prices? Record employment while average earnings dive? All very odd!
It seems the more aggressive investors got tired of selling after three heady weeks (following a dismal December as the Santa Rally failed to materialise) so they bought things instead. It seems there is still insufficient discrimination between good and not so good stocks, which is the reason we have been advising our clients to hold back. The ECB and BoJ provided a handy excuse for the punters to sell the euro and yen (and buy sovereign bonds) with their wild talk of apparently unlimited further easing but it seems improbable that anybody believes that monetary policy will help economic fundamentals.
Uncomfortable as the thought may be to Messrs Draghi and Kuroda, what matters is not what they do but how investors (especially the algo programmers) think each other will react to what central bankers say. Both seem deluded: Mr Kuroda under orders from the Abe government while Mr Draghi seems to think he is the EMU government (he is getting ever closer to funding fiscal expansion by France and Italy). The FOMC is losing its sway too and once it has waffled its way through this week’s meeting without doing anything, markets may finally start to calm down, which is definitely not the same thing as marching higher again!
Alastair Winter 