Market Bulletin (07/03/2016)
Tale of two economies
It might not yet be the best of times for the US economy, but data released last week persuaded markets that there was no longer any need to expect the worst.
One of the most common prefaces to a recession is a tidal outflow of investment from high-yield bonds; last week, the asset class attracted its largest weekly inflow on record ($5.8 billion), according to Bank of America Merrill Lynch. Friday’s non-farm payrolls data showed 242,000 new jobs added in February, far above the 190,000 expected. Unemployment held steady at a respectable 4.9%.
Yet if the US economy is gaining momentum, it is not yet running at full tilt. The Friday report showed a slight dip in hourly wage inflation. Corporate earnings continue to trouble markets, too, although some sectoral headwinds may be finally lifting. Strip out the energy and commodities sectors and the decline in corporate earnings through the third and fourth quarters slips from dramatic to marginal. Consumer profits continued to rise through both quarters, and commodity prices are now improving: Brent crude opened this week above $39, while copper and zinc are at multi-month highs.
For investors, the S&P 500 plays the dual role of both reflecting the mood and helping to drive it. Last week, it rose 2.3% and is now not far from its 2016 opening. US growth and commodities prices lifted other indices last week, too: the FTSEurofirst 300 rose 3%; the Nikkei 225 was up by 5.1%.
There will be plenty to unnerve markets in the year ahead, notably the ongoing political crescendo of US primary season, culminating in November’s presidential election. But the economic pillars of American growth look increasingly robust.
Despite its higher growth rate, the developing world’s leading economy looks less secure. In February, factory activity in China reached its lowest level since the financial crisis. Moreover, unlike in recent months, services failed to soften the blow; in February, services expansion recorded its weakest reading since 2008.
There are significant structural headwinds for the Chinese economy too. Moody’s, one of the three leading financial ratings agencies, warned last week that Chinese officials may not be up to the policy challenges they face. Although the government’s fiscal accounts and reserve levels remain solid, debt is growing rapidly, and capital flight remains a challenge.
On Friday last week, senior members of the governing Chinese Communist Party (CCP) gathered in Beijing for the annual National People’s Congress, and to announce its five-year plan for 2016–20 (inclusive). In a speech delivered on Saturday, Premier Li Keqiang set a 2016 growth target of 6.5–7%. He also emphasised the importance of currency stability (allowing for interventions), decisive fiscal policy (allowing for social spending) and prudent monetary policy.
Over the next few days, state-owned enterprises (SOEs) can hardly fail to be a focus. China faces a problem of ‘zombie’ industries in which large SOEs have been allowed (or encouraged) to continue with old industrial practices, management techniques, and employment targets. The result has been a slew of large companies largely divorced from market forces, which hoover up government funding, stymie market reforms, and create excess risk for the banks obliged to lend to them. Inevitably, remedial action means significant job losses, and social funding increases. The first major round of SOE reforms took place in the 1990s, but the job remains unfinished. A no-holds-barred reform push is unlikely, but markets will be watching closely. Last week, the Shanghai Composite index rose 3.9%.
Reviewing the situation
Since the date for Britain’s referendum on membership of the European Union was slated for 23 June, the debate about the impact of a British exit has begun to draw in senior voices from across both business and politics. Last week a few new heavyweights were added to their number. The director general of the British Chambers of Commerce, John Longworth, told Sky News on Thursday that the UK could have a “brighter economic future for itself” outside the EU. On Sunday, he resigned his post.
François Hollande, the French President, offered the warning – all the more loaded for not being specific – that in the event of a British exit from the EU, “there will be consequences”. Emmanuel Macron, Hollande’s finance minister, was not content with presidential generalities, and warned: “The day this relationship unravels, migrants will no longer be in Calais.” Wolfgang Schaüble, the German finance minister, said the UK would face trade restrictions in the event of the exit but also tried a more surprising tack. Germany, he said, would “cry” if Britain left.
Areas of the UK economy appear to be stuttering slightly. Services suffered their sharpest slowdown for almost three years in February, and economists have marked down their forecasts for UK growth in the first quarter of 2016 as a result. The ‘in’ camp sees the spectre of a British exit from the EU as contributing to these trends – and likely to worsen them if Britain leaves. A BlackRock report published last week warned that a British exit would offer “risk with little reward… lower UK growth and investment and potentially higher unemployment and inflation”. Services, the currency and London property would all suffer, the report argued.
In London, a rush of initial public offerings set the tone for the New Year, but a pre-referendum lull is expected. The FTSE 100 enjoyed a strong week, rising 1.7%; but volatility is likely in the weeks running up to the referendum, particularly for companies with strong exposure to the UK.
It was a less good week for Barclays, which announced pre-tax losses of £1.9 billion for the fourth quarter. (The figure includes a £1.45 billion fine for mis-selling.) The leading bank has since announced that it will cut its dividend payment and divest itself of its African subsidiaries. There followed a surprise announcement by Bob Diamond, the bank’s former CEO, that he would head a consortium to acquire the African businesses; Diamond’s inside knowledge may make it harder for the bank to negotiate a good price. Nevertheless, the Barclays share price had recovered by the end of the week.
Pick a pocket
If Cameron is winning plenty of support for his pro-EU campaign, his Chancellor faces a tougher time over his own agenda for pensions – indeed, the Prime Minister is wary of radical policy shifts before the referendum. At the weekend, Osborne reportedly relented, postponing the biggest reforms.
How long it will be before the Chancellor starts picking pensioner pockets remains unclear. Yet however long the grace period, the UK pension savings rate remains a major structural weakness – since savings rates across Britain remain far below what they should be, individuals can ill-afford to pass up the tax-efficient savings opportunities that still exist. It is significant, too, that the Chancellor’s retreat came only a day after the media had announced that the pension ISA was a certainty. In this environment, little should be taken for granted.
As the countdown continues on the opportunity to utilise your ISA allowance before the end of the tax year, it seems there is little cause for optimism for those saving into a Cash ISA. In January, Moneyfacts recorded 139 rate cuts on savings accounts compared to 21 rises, and in February there were a further 169 cuts to just 11 rate rises. This was supported by figures from the Bank of England which revealed that the average Cash ISA rate fell from 0.85% at the end of 2015 to 0.81% today.
Indeed, last week David Blanchflower, former member of the Bank of England’s Monetary Policy Committee, suggested that interest rates could fall further and are likely to remain at near-record lows until 2021. Those looking to make the most of their ISA tax breaks might want to think again about whether cash is the right solution.
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