New article from Tatton Investment Management: So far so good

13 January 2020

Compared to last week’s ‘brink-of-war’ geopolitical shock start to the year over the US-Iran tensions, this week has brought relatively positive economic news, with not much to upset global markets, even if the general news flow was tragic from a humanitarian and environmental perspective. At the moment, no new bad news is good news in investments, with constant talk of “liquidity” (for institutional investors) and “dry-powder” (for private equity groups). Whether investors’ money is wet or dry, does not matter. The US’s NASDAQ tech stock index is above 9,000 for the first time, as we write.

Stock markets took it decidedly positively that Iran put more effort behind domestic propaganda than actual hostilities against the US and its allies. This allowed a return of the quiet with which the year originally started, even though many political observers warn that this may not be the end of the affair.

Turning back to the UK, Brexit may appear to be less of a concern for businesses, but the start of the UK-EU negotiations has done enough to take the edge off sterling, with our currency dropping back another 1% against the US dollar through the course of the week. Despite both sides being quite vocal about various positions (on fishing, the year-end deadline, not accepting EU rules, etc.), the dialogue appears to be reasonably direct and civil. We should expect lots more noise, and probably moves to expose confrontational positions quite quickly, in order to deal with the issues as soon as possible. As long as the noise is constant enough without being nasty, investors will become inured to it and things could appear to become less risky.

Meanwhile, the Chancellor announced that the budget will be on March 11th. Investment spending is highly likely to rise, and it appears Javid is intent on cutting taxes. That means debt will rise, and the Debt Management Office announced that it is raising planned gilt sales for 2019-2020 by £14bn to £136.8bn. Still, clearly, the government wants to limit debt-raising as much as possible. A swift current spending review is under way already with the clear imperative to cut costs ahead of this date. This will be a difficult trick to pull-off if the Conservatives new-found supporters are not to be upset.

Perhaps we should expect Brexit noises to increase around the time of the budget, in order to keep the electorate thinking positively about the new government and that might make sterling struggle a bit at that point.

The Bank of England Governor, Mark Carney, is soon to become Governor Andrew Bailey. Long live the governor. Bailey is an historian by training rather than an economist (Carney and his predecessor, Mervyn King were both economists). His time in charge of both the major financial regulation bodies has been not without issue. However, he is very well regarded by those he works with and beyond – a team-player.

The Monetary Policy Committee has had a hard time being seen as effective under Mark Carney, though one would be hard-pressed to come up with a more difficult set of circumstances. Carney gives way to Bailey on March 16th, just after the budget. In the meantime, he has been sounding more dovish this week, something that may be a function of the recent currency stability.

The Bank of England held a private conference yesterday (Thursday 9th) to discuss the role of inflation targeting. Invitees included Philip Lane, the ECB Chief Economist, and John Williams, the President of the Federal Reserve Bank of New York. After the August Central Banker Conference at Jackson Hole in the US, deliberations on “the effective lower bound” for interest rates have been growing. It may not be 0% but it looks like it is higher than -1%, at least for the major economies. It also seems that expectations of rates below 0% should not be maintained. This seems to be mostly because of the impact on commercial banks and their profitability, which, whether one likes them or not, remain crucial for any economy’s health. Both BoJ and the ECB have been allowing rates for longer maturity bonds to rise, so that the volume of bonds yielding below 0% has shrunk substantially. This chart from Bloomberg that shows that total volume over time:



There is a lot going on in bonds at the moment, and not just because of potential central bank policy changes.
 
If equity markets are signalling a long and decent period of revenue growth (which the high relative valuations of stocks suggest to some degree), it will be associated with expectations of stable economic growth. Despite a slightly weaker than expected US non-farm payroll figure for December (+145,000, against expectations of +160,000), labour markets are tight. Wage rises are increasing which should support consumer demand – but also revive inflationary pressures. This is also true for Europe and the UK, even for China and Japan despite a slight pull-back. Meanwhile commodities have started to rise, again despite the slight fall-back in oil prices this week.

Following last year’s very strong return picture across stock and bonds, the relative stability of global economic growth should put a solid base under equity prices, even though last year’s rises have ‘front-run’ much of the actual positives to come. This make a 2020 repeat of 2019’s return picture fairly unlikely. However, higher growth and higher inflation are not good for fixed coupon bonds, even if central banks are saying they will keep short-term interest rates at their low levels. Indeed, the act of not changing short-term interest rates could well make long-term interest rates higher, not lower – which will put downward pressure on bond values.

With relative calm returned, 2020 once again looks likely to bring a return of stable if low economic growth rates, which, because already largely priced in by stock markets, is more likely to lead to less dynamic returns and to a consolidation of government bond valuations. The more the global economy surprises to the upside the worse for bonds. Not surprising then that at the moment we are watching more and more closely the dynamics that drive bond prices.

 

News Archive

27 November 2020

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20 November 2020

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