deVere Group: Global Market Review

Investment Outlook

Tom Elliott

A fortnightly look at global financial markets

• Central banks delay tightening monetary policy as economic data begins to weaken
• This fuels investor uncertainty?
• Asia ex India looks interesting: Japan stocks at 30yr high, India at all-time high
• U.K government re-introduces fiscal conservatism in a mini-budget?
• U.K taxes to rise to 35.5% of GDP, highest level since 1950

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Market sentiment:?Investors are waiting for the Fed and other major central banks to tighten monetary policy, through raising interest rates and/or tapering (ie, reducing) their bond buying programmes. Central banks appear poised to act, but recent weaker global economic data, together with rising cases of the Delta variant, make them cautious. On Thursday we will, hopefully, get more guidance from the ECB on its attempt to normalise policy.

In practical terms, the uncertainty of central banks means that stock market investors are unsure whether to chase value ‘recovery’ stocks higher, which makes sense if central banks favour growth over price stability (ie, they go easy on inflation). But tech, and other ‘jam tomorrow’ growth sectors, could be a better investment option if central banks act to curb inflationary pressures and so ensure low interest rates in the longer term.?

Meanwhile, fixed income investors have to consider not only the difficult-to-foresee macroeconomic factors, such inflation and interest rates, but the direction of travel for central bank asset purchase programmes, which have made central banks key players in the bond market. What will the mix be between interest rate hikes and reductions of bond purchases??

Amidst this uncertainty, a multi-asset portfolio that invests across assets classes and geographic regions is probably the optimal investment approach.?

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What’s delaying the central banks??The Fed’s chair Jay Powell made it clear in his Jackson Hole speech a fortnight ago that the U.S central bank expects to begin to taper its asset purchase programme later this year. But it, along with other central banks, is waiting to see what the impact of the withdrawal of various economic support measures over the coming months will have on labour, property and other markets. Until then, much economic data is hard to interpret, let alone rely on for policy decision making.?

The U.S and euro zone are experiencing their highest inflation in more than a decade, which would normally cause central banks to raise interest rates. But recent weakness in leading global economic indicators (such as purchasing managers indices – known as PMIs) suggests that ‘peak growth’ may already have passed in the U.S, China and U.K economies, and be taking place right now in the euro zone. If so, inflation may start to weaken in line with decelerating demand growth, and tighter monetary policy could push economies into recession.?

Meanwhile, U.S labour market is in a fog. Unemployment remains above pre-pandemic levels at 5.4%, and August new payroll numbers came in at well below market expectations of just 235,000 new jobs created. Yet labour shortages and are pushing up wages in many of the recovery sectors. Some blame the anomaly in the U.S labour market on the enhanced unemployment benefits that were available until just recently. But a study by?The Economist?magazine found little empirical evidence of high U.S unemployment benefit hindering employment growth. In the U.K, we wait to see what will the impact be on the labour market, as furlough comes to an end in a month’s time?

Covid-19 continues to threaten new lockdowns, and shocks to goods and labour markets. Vaccine programmes are acceleration across the world, reducing hospitalisation rates, but the predominant Delta variant is more transmissible than previous variants. Northern hemisphere schoolchildren, relatively few of whom will have been vaccinated, are returning to school. And so long as there are large pools of unvaccinated people in the world, more contagious variants may yet emerge. The ‘zero-Covid’ policies of some Pacific countries, such as Australia and New Zealand, which introduced strong lock down measures to prevent the virus spreading (and thereby prevented large numbers of deaths), now look unsustainable. In the absence of large vaccination take-up rates, they require persistent new lockdowns to enforce.

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Asia ex China.?Investors in Chinese stocks have been surprised by new regulations from Beijing, concerning the governance and the behaviour of companies, particularly in the tech sector. The practical implication of President Xi Jinping’s stated goal of ‘common prosperity’ are unclear. This has contributed to underperformance from Chinese stock market indices this year.

In contrast, the Indian stock market has been on a roll over the last three months, that has lately been driven by foreign investors. The BSE Sensex index reached an intra-day high on the 6th?September. Confidence comes from a number of factors: the mass vaccination programme is helping to curtail incidents of Covid-19, while loose monetary and fiscal conditions are combining with the global economic recovery to generate strong domestic economic growth. Goldman Sachs (GS) forecast 7.1% GDP growth this year, compared with 5.7% in China, 5.5% for the U.K and 4.5% for the U.S.?

The TOPIX stock market index in Japan reached a new high last week. While 2021 GDP forecasts from GS are at a relatively modest 2.1%, investors see support from a number of directions. The resignation of prime minister Yoshihde Suga is expected to herald more fiscal stimulus, which will support already strong levels of capital spending by Japanese companies. Recent corporate earnings statements have been optimistic on future earnings growth, with less mention of input cost pressures on margin than in U.S and European corporate statements. A relatively weak yen helps exports, and finally the Japanese stock market has lagged other major stock markets in the recovery phase and offers value.

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U.K social care.?Yesterday the U.K Conservative government announced two policies which together suggest that the Treasury’s fiscal conservativism may be gaining the upper hand over the populist wing of the party, epitomized by prime minister Boris Johnson. First, the triple lock state pension guarantee -by which the pension will rise by the higher of average wages, inflation, or 2.5%- was suspended for a year. This has long looked unaffordable, and this year in particular given that a statistical quirk will record wage growth of 8%, while the country is running a budget deficit of around 10.5% of GDP.?

But the main news was on the funding of social care (ie, the non-hospital treatment of the elderly and the severely disabled). From 2022, ￡12bn a year will be raised through a mix of an increase in National Insurance (which will be shown separately on workers’ pay slips as the ‘Health and social care levy’, and an increase in the tax paid on dividend income on shares held outside of ISAs and pensions. The money raised will enable the state, from 2023, to fund care costs after ￡86,000 of care has been used by an individual. This initial ￡86,000 will be paid for by the local authority, or the individual themselves, depending on the findings of a means test.?

The increase in National Insurance, as opposed to a rise in the broader income tax, has been criticised as an unfair tax on the young and less well-off (ie, those less likely to vote Conservative). The increase in tax on dividend income is an attempt to weaken this accusation.?

Credit should be given to the government for taking on the vexing issue of social care funding, which previous governments have dodged due to the political sensitivities concerning who should pay. It is to be hopped that by next spring the economy will be in a robust enough state to be able to absorb the new taxes, along with those announced at the spring budget. Together they will raise the U.K tax burden to 35.5% of GDP, the highest level since 1950.?

The government has come under fire for breaking election manifesto promises to preserve the triple lock and not to raise taxes. Johnson’s response is to blame the pressure on public finances arising from the pandemic. In reality, the pandemic has proved a useful fig leaf by which fiscal conservatism can be re-introduced to U.K government.