In this report, we focus on the big stories,
which have unfolded over the past 3 months or so and what implications they
have on future economic prospects for both the UK and the global economies. Firstly,
we ask why commodity prices keep falling and what it really means; then, we analyse
the implications of how Athens capitulated to its
creditors in the Eurozone crisis; and we also look
at political confidence tricks in the context of the shock General Election
result and George Osborne’s Budget, which turns out
to be massively less austere than the one forged with the Lib Dems in March,
just before the election. In the meantime…
Steady as she goes…
Monetary expansion in Europe, America
and China all point to stronger growth this year, signaling another leg to the
global expansion. With hindsight, it is clear that the world economy came
within a whisker of recession earlier this year but this episode is now behind
us. Leading indicators and monetary data in the US, Europe and China point to
an accelerating rebound over coming months. The triple effects of quantitative
easing by the European Central Bank, a 12pc fall in the trade-weighted index of
the euro in 15 months and the fall in Brent crude prices from $110 to $50, have
together boosted the global economy and, in particular, lifted Euroland out of
its six-year depression.
But why are Commodity
prices falling?
Newspaper headlines and financial markets may have shifted their focus from events like
the Eurozone and its Greek woes and the dramatic stories associated with the General
Election and the Budget but the major global economic
event, which continues to unfold, is tumbling commodity prices. It is, in reality, the
really big event that continues to impact the wider economy day in, day out. It
is the tail-end of China’s hard landing, compounded by Saudi Arabia’s political
decision to flood the global crude market and strike a blow against Russia,
Iran and the US shale industry. Yet commodity crashes are double-edged. They
act as a stimulus for the world economy and are a main reason why the global
recovery is building. The consuming nations are effectively enjoying a $500bn "tax cut" from the
OPEC cartel.
A
combination of factors continues to knock gold, crude oil and industrial metals
such as copper at the moment. What commodities are on the move and what are
they used for? Here is a little reminder:
- Gold
- Brent crude
There is a risk that this could go too far and lead to a
second leg of global deflation. This would play havoc with debt dynamics in a
world where debt ratios have risen by 30 percentage points of GDP since 2008,
reaching unprecedented levels but for now it is the stimulus for the world
economy, which is key.
Greece Capitulates to Creditors
Not for the first time
over the five years of Greece's euro crisis - or the Eurozone’s Greece crisis –
some of us are a little confused. Pretty much everything
wanted by the creditors is there in the latest so-called deal - with the odd
tweak, but nothing which looks as though it ought to be toxic to them. So,
there is a pledge for budget surpluses rising in steps to 3.5% of GDP or
national income by 2018; VAT would be raised to three rates of 23% (the
standard rate), 13% (for food, energy, hotels and water) and 6% (for medicine
and books) - increases that would raise revenue equivalent to 1% of GDP; and
Athens is eating the dust of comprehensive reforms of pensions to make them
more affordable; and so on.
So here's why I am a bit baffled.
In the run up to the deal, the Greek Prime
Minister Alexi Tsipras won an overwhelming mandate from the Greek people, in a
referendum, to reject more-or-less these bailout terms and, on the back of that
popular vote, he signs up to the supposedly hated bailout. This is big politics,
I suppose. Does that mean the Eurozone can go back to life as normal, of
inadequate economic performance but Greek Armageddon deferred (again)? Is a
rescue done and dusted?
Not yet.
Greece and the Eurozone aren’t yet fixed, not even close.
We simply haven't seen since the 1930s
a rich developed country collapse as Greece is doing - millions of people
threatened with losing their life savings, companies on the point of collapse,
cancer sufferers unsure what treatments, if any, will be available to them.
Now to most outsiders, this nightmare
is in part the consequence of the incompetence and greed of a succession of
Greek governments, and the negligence, incompetence and political insensitivity
of the rest of the Eurozone and the International Monetary Fund.
In other words, debtor and creditors
are both to blame, arguably in equal measure.
So what is particularly shocking to outside
observers is the perception that most of the Eurozone, and especially Germany, seems
hell-bent on making an example of Athens, humiliating the government of Alexis
Tsipras, as the price of a financial rescue that - in a best case - will
continue to make Greeks poorer.
The
widespread perception that Berlin and Brussels have put fiscal rectitude, the
importance of a country paying its debts, above humanitarian concern for a
nation's plight, or even the long-term sustainability of the euro itself, will
reap a bitter future harvest for the Eurozone and the wider EU.
Will the Eurozone’s marginalisation of
Greece make it harder or easier for David Cameron to sell continued membership
of the EU to the people of the UK? It
remains to be seen.
The Eurozone crisis began in Greece in
2010. The day of reckoning has been postponed but the threat remains that the
Greece debacle has degenerated into an existential crisis for the wider EU.
Election 2015: Dramatic General Election which Reshapes U.K
The next big event was back in May -
three months later what have we learnt?
The first thing to note is that England
and Scotland voted for diametrically opposed economic policies. If there was
one policy associated with the Tories, it was further deep spending and welfare
cuts to generate a budget surplus; if there was one policy associated with the
Scottish National Party it was an end to deep spending and welfare cuts. This means
that if the integrity of the United Kingdom is to be sustained, somehow a way
has to be found - and presumably fairly fast - to reconcile the English vote
for more austerity and the Scottish vote for an end to austerity. Also, this
would have to be done in a way that doesn't reinforce the view of millions of
English citizens that they are subsidising feather-bedded Scottish public
services. The transfer of more economic decision-making powers to Edinburgh
also has to be done in a way that doesn't split the ruling Conservative party.
Which takes us to the second important
uncertainty of this apparently certain result - which is whether Tory MPs will
be more or less united going forward.
Strikingly, the Eurosceptic,
nationalist and more socially conservative right of the Tory party has been
remarkably loyal to David Cameron over the past few years - partly because they
could see that in a coalition party discipline was vital to governing and
staying in office. But the trouncing of the Liberal Democrats means that Tory
MPs no longer have to be on their best behaviour - they no longer have to be
careful not to alienate coalition partners with their words and deeds.
The result was a personal triumph for
the Prime Minister David Cameron and the future belongs to the man who defied
all those - including at times, perhaps, himself - who doubted that he could
ever increase his party's support. Nevertheless, it is only a slim overall majority in the Commons or to put it another
way, the new Conservative government may not turn out to be a unified, strong
government, of the sort that investors prefer and that is partly because the
Fixed Term Parliament Act means there can be endless backbench rebellions that
do not come anywhere near to tipping the government out of office.
Apart from anything else, David Cameron
will now be under enormous pressure from many of his MPs, alarmed by UKIP's
success in taking votes - if not seats - to claw back much more sovereignty
from Brussels than is realistic, as a precursor to the much heralded U.K referendum
on EU membership. Or to put it another way, the UK's continued membership of
the EU is today more uncertain than it has ever been - and many investors and
those who run big multinationals never like uncertainty.
Opposition in Disarray
Politics seems to involve confidence tricks at every turn,
yet it will be fascinating to see how the political drama will unfold from here.
The Labour Opposition is in total disarray, amidst its leadership election.
Who are the candidates? Andy Burnham, Yvette Cooper, Jeremy
Corbyn, Liz Kendall.
Ballot papers will be sent out on 14 August; they must be
returned by 10 September. The result is on 12 September.
The Labour leadership front runner appears to be the left winger,
Corbyn with big-spending plans that may doom his party to irrelevancy. Jeremy
Corbyn says he wants a "fundamental shift" in economic policy and for
Labour to be a "credible alternative" rather than "Tory
light". To those who say he wants to take the party back to the 1980s, he
has said he'd go back a decade further, to the 1970s Wilson/Callaghan Labour
government.
According to his critics, the Islington North MP's vision
for Britain is so left-wing it would make the Labour Party unelectable. Britain's
railway network would be renationalised. He is opposed to the HS2 scheme
linking London with the north of England, claiming it would turn northern
cities into "dormitories for London businesses". Labour should not
shy away from putting "necessary things" in public ownership he says
as it establishes its future direction.
Osborne’s Big Budget
It was indeed a "big" Budget
- just as the chancellor said it would be, delivered by a
politician with "big ambitions". George Osborne's stated aim was to
create what he called a "new settlement".
So it is that he did something rather
surprising - slowing and softening spending and welfare cuts now having
promised faster and deeper cuts in the run up to the election. So it is that he
adopted a series of Labour policies - a higher re-badged minimum wage, a levy
on firms to pay for apprentices, an assault on the tax privilege of so-called
non-doms.
This in addition to delivering
Conservative promises to cut income tax, corporation tax and inheritance tax.
But hold on - below those headlines are
some potentially eye-watering cuts to benefits - the cuts to tax credits for
families despite the pay rise some will get. There are cuts too to Whitehall
budgets on the same scale as seen over the past five years – details are
emerging.
And there are tax rises - on buying
insurance, on buying a car, on pensions - which dwarf the headline tax cuts.
So, yes, it was a "big
Budget" that paves the economic way.
Whether it is another example of a Gordon
Brown style confidence trick to the nation, is a judgement for you.
What of the Deficit?
- The budget deficit will fall to 2.2pc of GDP in 2016-17, 1.2pc in 2017-18, and 0.3pc in 2018-19, the OBR predicts
- The government will run a surplus of 0.4pc of GDP in 2019-20, and 0.5pc in 2020-21, according to the forecasts
- In cash terms, that means the deficit will fall from £69.5bn in 2015-16 to a surplus of £11.6bn in 2020-21
- Mr. Osborne says that is the biggest structural budget surplus in 40 years
- Total government spending is rising from £735.5bn in 2014-15 to £844.5bn in 2020-21. Over the same time period total government receipts are set to rise from £672.7bn to £856.1bn, the OBR predicts.
MARKET OUTLOOK: MAINTAINING GOOD MOMENTUM
US: MODERATELY POSITIVE
- The first Fed hike cycle is moving closer – we bet on a first increase this Autumn
- Quantitative easing (QE) ended earlier in the year
- US growth will remain solid in 2015.
UK: A POSITION OF RELATIVE STRENGTH
- Generally positive economic news – inflation and unemployment low; GDP growth picking up again
- Political uncertainties removed
- The minutes of Monetary Policy Committee revealed that members are concerned that “domestic cost pressures had increased”, supporting the view that the recovery in prices and wages is on track.
EURO-AREA: CAUTIOUS; PROSPECTS IMPROVING
- Economic momentum in the second quarter should help to push yields higher, now that Grexit has been averted in the last minute
- The ECB continues to provide ample liquidity which gets placed in equity markets given that relative valuation of stocks is attractive. Yet, the market looks currently overbought and we would not exclude a temporary correction.
JAPAN
- The Nikkei was negatively impacted by the equity meltdown in China recently, however…
- The Nikkei rose almost by 20% since the start of the year
- Continued weak yen (and exports) and continuing quantitative easing suggest the rally may endue a little longer, but potentially at a lesser pace.
The
imminent Fed hike cycle plays a central role in our assessment for fixed income
and foreign exchange markets, we also evaluate its potential impact on equity
markets: A study of all Fed tightening cycles since 1964 reveals that the US
stock market delivered an average return of around 5% over the twelve months
after the initial rate hike. Since we expect a gradual tightening by perhaps
just 150 basis points until end of 2016, the stock market is not at risk for a
major correction caused by central bank policy.
We
continue to focus on the traditional asset classes and always choose a balanced
approach to managing those assets. Within equities, we consider a value
approach. Within and across asset
classes, we also consider using trend following methods to reduce risk and
exposure to catastrophic loss. Geopolitical
tensions, any disappointment on corporate earnings and the UK political
situation will create market fluctuations. We regard any such dips as an
opportunity for selective buying opportunities.
Sources
- Invesco Perpetual Investor Magazine April 2015
- BBC News Politics, Economics, Business, reports May-July 2015
- CNBC Highlights – Market Outlook, July 2015
- Financial Times – Global Economy comment and review, Background Research July 2015
- Daily Telegraph – Politics Aug. 2015
- The Guardian – Budget Highlights July 2015
The above is our opinion but
it is no guarantee of future performance.
The above information should also not be solely relied upon for
investment purposes. We seek a balanced portfolio and
reiterate the preference for putting in
place a balanced portfolio of investments,
made up of collective investments. As you are aware, there are many ways
to invest in equities. Each has its own practical and taxation considerations
and, for this purpose, collective investments, such as unit trusts, are an
appropriate means by which a good spread of investments may be achieved. Such
pooled funds put the fund in a position to hold a good spread of company
shares. The funds are managed on a day-to-day basis by professional investment
managers to try and achieve the best possible returns. They represent the best
means of managing the risks by asset allocation. The value of investments and
any income will fluctuate (this may partly be the result of exchange rate
fluctuations) and investors may not get back the full amount invested. Past
performance is not a guide to future returns. Current tax levels and reliefs
may change. Depending on individual circumstances, this may affect investment
returns.
SJK 09.08.15
