This time three years ago, we wrote a blog wondering if we’d seen an end to Eurozone-inspired summer volatility. This week, we’re wondering if what looks like an economic turning point and some surprise central bank moves will herald volatility’s return. Political uncertainty, contradictory data and central bank surprises might just be enough to break through this QE-assisted calm this summer.
Three years, two elections and two referendums ago…
In June 2014, Brexit was a new word, mentioned less than 300 times in the UK press compared with 100,000 last year and almost 60,000 so far in this, according to a search on Factiva. Indeed, when we asked in summer 2014, if investors would get some quiet time on the beach, it was with the Eurozone in mind. And markets did indeed wobble on a mixture of geopolitical, monetary and commodity concerns – albeit not to the same extent as previous tantrums in 2012-3.
Fast forward to 2017 and Eurozone has fallen way down the worry agenda as immediate political risks recede and the economy picks up. Instead, we’re wondering if we’ve reached a turning point in the UK economy and if developments here and in the US could shake-up markets this summer.
In political terms, I don’t have much to add to our post-election analysis. As I type, we await confirmation of a deal between the Conservative party and DUP and firm indications as to whether the UK will amend its starting position on Brexit negotiations. The Queen’s Speech, now due next Wednesday, combined with details of any political deals, could shed more light on the UK government’s intentions. But, in terms of Brexit – there are still those 27 other parties to the deal. Plus, odds currently are about 2/1 on another UK election in 2017.
…puts spotlight onto consumers…
So, there’s still a great deal that’s unknown. What we can say is that the anticipated pressure on UK consumers is starting to build and we saw plenty of evidence of that this week. Newly released figures showed that average earnings fell 0.6% in real terms in the three months to April, compared to the same period last year. This is the fastest drop since September 2014, according to EY ITEM Club, who suggest that companies may seek to limit wage growth further given cost increases elsewhere.
Thus, with inflation hitting a higher than expected 2.9% in May – and expected to go higher still – this pressure on real incomes is unlikely to relent. Indeed, official figures also showed retail volumes shrinking by 1.2% in May, compared to the previous month a bigger decline than expected.
And on Thursday, a large furniture company added to the picture citing uncertainty as one of the reason for significant declines in store footfall and consumer spending.
“The trading environment has however recently weakened beyond our expectation, with significant declines in store footfall leading to a material reduction in customer orders. We believe these demand effects are market-wide, in line with industry indicators, and are linked to customer uncertainty regarding the general election and the uncertain macroeconomic environment.”
So, we’re seeing retailers beginning to cite uncertainty amongst customers as one of the reasons for significant declines in store footfall and consumer spending. Indeed, a fairly consistent consumer picture is emerging, with big ticket and discretionary areas looking most vulnerable to the consumer squeeze and impact of uncertainty.
…especially given another surprise vote…
The picture was then further complicated later on Thursday by the surprisingly close 5-3 vote from the Bank of England to hold interest rates. UK markets were taken by surprise, with gilt yields and sterling rising quite sharply in response. I suspect that the pound’s immediate path will be twinned more tightly to political than monetary developments. It’s the EY ITEM Club’s view that UK interest rates are unlikely to rise this year. Still, market expectations for that first move have now moved up to 2018, from 2020 and that should provide the pound with some support.
…which leaves markets looking a little less certain
So, where does this leave us? With an increasing focus on consumer-facing companies as domestic demand weakens, currency hedges run off, regulated labour costs rise and companies make hard choices on price increases. Historically, lengthy uncertainty has also led to investment and contract delays, hitting software and business services companies. The UK economic surprise index has turned negative – which alongside falling consumer spending- adds to concerns that UK Q2 GDP could be weaker than expected.
Balanced against this is continued monetary support and the UK’s proven economic resilience. There is still that QE safety net, but equity markets could be set for great volatility as they adjust to changing fortunes. European leverage finance markets paused in May, but that was after a busy March-April and we don’t expect major changes. That said, there may be more push-back for high-yield issuers exposed to UK consumers. UK IPO markets – as we said last week – are pretty much on pause. Again, there will be greater scrutiny of the consumer exposed. The FTSE mid-250 had its worst day in 11 months on Thursday – largely due to a pull back in consumer discretionary stocks. We’re also seeing some pull back in the deals market.
And of course we all still need to watch the US.
The US is also keeping us on our toes…
Never a dull moment in the US at the moment and on Wednesday the Fed created a surprise of its own. The quarter point increase in interest rates had been priced in, but the potential for autumn balance sheet shrinkage had not. The actual plan would involve the Fed moving slowly; but it’s the fact that the Fed actually mentioned it at all given this week’s mixed data and low inflation that’s caused the shock.
The problem that the Fed – and all other central banks – have is that the recession and recovery have been so different to what has gone on before. Not least because of the digitisation of the last decade. So, they are all feeling their way. Inflation, unemployment and wages are not behaving as they did before. There probably isn’t a right answer – at least not an answer that returns us to what we had before.
So, to add too our areas of potential interest I’ll add automotive, where sales have been artificially boosted by cheap debt on both sides of the Atlantic – and by PPI in the UK.
…and that’s making it harder to balance
So to go back to our original question. It’s early days, but it doesn’t look like being as quiet a summer for capital as it looked – well, two weeks ago.
Is there enough to bring back widespread global volatility, probably not – unless we see more twists. But, there’s enough already to inspire behavioural change and shifts in capital flows. Our latest EY Attractiveness Survey showed investor’s still interested in the UK, but Europe is looking increasingly attractive with FDI reaching new peaks.
And if we’re looking for how quickly investors can change gear, how about last week’s two-day ‘tech tantrum’ that saw billions wiped off the value of US tech stocks? This sell off may have been largely driven by algorithms, but in a recent Bank of America Merrill Lynch poll a record number of money managers said global equities were expensive – and the NASDAQ index was named as the most “crowded trade”.