Welcome to our very first financial newsletter of a different kind, designed to keep you informed.
Here, we focus on the big economic events of today, affecting us all, as we go about our ordinary lives. And, as part of our central ethos of working with you and developing the close working relationship that we strive to deliver, we provide analysis and insight into what is going on currently in the economic and financial world, affecting you – our client.
Which ever way we look at it, 2015 has so far been one of THE most significant years for key events that have so far shaped our lives or are about to! And, we still have almost three months to go!
To understand why 2015 is such a big year, both domestically and internationally, we re-trace the significant big stories, which have unfolded this summer and discuss what implications they have on future economic prospects for both the UK and the global economies, going forward.
The news on Greece may have gone quiet all of a sudden but the implications of how Athens capitulated to its creditors in the Eurozone crisis remains highly significant, as the left-wing Syriza party, led by Alexis Tsipras, wins its second general election in less than nine months. Syriza was first elected in January on an anti-austerity mandate, but was forced to accept tough conditions for Greece’s third international bailout. The problem has not gone away.
We also look at political confidence tricks in the aftermath of the shock General Election result, 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 and the re-birth of new ‘old’ Labour!
Firstly, the story, which is arguably the biggest news story of them all but one that may not necessarily be perceived as being the more significant:
The huge collapse in commodity prices; why do they keep falling and what it does it really mean?
The great commodity price collapse: What are its long term effects?
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 are 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 is 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 continue to knock gold, crude oil and industrial metals such as copper at the moment.
Countries dependent on exports of commodities like metals or oil could face long-term growth challenges from the collapse in prices, the International Monetary Fund warned on Sept 28th.
The IMF said that the broad decline in commodity prices after the boom of the 2000s is mainly a cyclical pain for producers, their incomes soaring and now falling in tandem with prices.
But the IMF said, in its new World Economic Outlook report, that the price slump could also result in lower investment in future production in these countries, limiting their growth potential.
The Fund said many exporting countries have been better prepared for the current slump, saving more of their earnings in preparation for an industry slowdown, and letting their currencies adjust to the market, resulting in less violent swings.
They face, on average, the loss of about 1.0 percentage point of growth annually over the 2015-2017 period, with oil and gas exporters hit much harder, the IMF said.
What commodities are on the move and what are they used for? Here is a little reminder:
Primarily used in jewellery and as a financial instrument, such as in the form of bars in central bank vaults, gold is also in demand from electronics companies and for medical uses such as dentistry. Gold has hit its lowest level since early 2010 amid heavy selling. Traditionally the precious metal has served as a safe haven for investors during periods of uncertainty but investors often move money into other assets once calm returns. Gold also suffers when interest rates show signs of going up, as in the US right now where the central bank appears to be readying for a hike. Because gold does not pay interest it loses its shine compared with other assets that do. Ten years ago gold was worth around $500 an ounce only to soar above $1,800 following the first Greek crisis in 2011.
Refined into petrol and diesel, Brent crude is produced from North Sea oilfields. It is used on financial markets as a benchmark against which a large proportion of internationally traded crude oils are priced. At just under $55 a barrel, Brent crude has halved from a high of $115 hit a year ago, battered by a combination of rising supply, particularly in the US, and falling demand on the back of China’s economic slowdown and shaky confidence in Europe. Oil is falling once more further on Monday amid renewed stock market turmoil in China, the world’s biggest energy consumer.
Used for jewellery and by the car industry, for making catalytic converters, the precious metal has suffered from waning demand as the global economy loses momentum, with prices now at a six-year low.
The light metal has a wide range of uses including food and drink packaging, aeroplanes, construction and even the Rio 2016 Olympic torch – made from recycled aluminium. Prices hit a six-year low earlier this month, on the back of falling demand combined with high supply, with analysts blaming large-scale exports from its top producer, China. There has been further pressure on metals from moves in the currency market. The rise in the US currency makes dollar-priced metals more expensive for overseas buyers.
The red metal is used in everything from electrical wiring to pipework and coins (usually as a coating), and mixed with other metals to make alloys. Like aluminium, copper has fallen in price because of oversupply as well as tumbling demand in China, its biggest consumer market. Highlighting the metal’s sensitivity to Chinese economic news, it fell to a six-year low recently after weak Chinese manufacturing figures.
Current domestic headline : Iron and steelmaking at SSI’s plant in the north-east of England is to be mothballed, with the loss of 1,700 jobs. SSI chief operating officer Cornelius Louwrens, said it was “an extremely sad day”. The company is blaming the continuing background of poor steel trading conditions across the globe, and the severe deterioration in world steel prices.
As the main ingredient in steel, iron ore is sensitive to any slowdown in larger economies and in particular to cutbacks in infrastructure projects. A slowdown in steel production in China has come as miners have raised their iron ore output and so prices have tumbled from $190 a tonne four years ago to around $50 at present.
The synchronized rout that we have seen across these commodities is certainly hair-raising and this is nowhere better visually presented than in the Reuters-Jeffrey CRB index of raw materials, which shows here the collapse by almost 60pc from its peak in 2008 to where we are today, back to levels first reached way back in 1971.
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.
World Economy: 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 India and China are slowing and preventative action is having to take place.
On Sept 29th, The Reserve Bank of India (RBI) reduced its key interest rate to 6.75% from 7.25%, with economists having forecast it would trim rates to 7%. The repo rate is the level at which the central bank lends to commercial banks. The bank has been under pressure to boost growth after inflation hit a record low of 3.6% in August due to falling commodity prices. Furthermore, China’s factory activity contracted at the fastest pace for six and a half years in September, according to a preliminary survey of the vast sector, just released.
Greece: Revolt of the Debtors
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 was there in that latest so-called deal – with the odd tweak, but nothing which looked 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, a few months on, I am still 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 and in the aftermath of September’s new election some voters say the result will not make a difference for ordinary Greek people.
Greece and the Eurozone isn’t yet fixed, it’s 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. Yet, arguably the failure of the EU in the face of the current migration crisis, would seem to play straight into Cameron’s hands, as he seeks that re-negotiation.
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.
Next we turn to politics – the triumph of David Cameron and the triumph of a different kind of Jeremy Corbyn.
Election 2015: Dramatic General Election and the Aftermath
The next big event was back in May – five 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.
The re-birth of new ‘old’ Labour
Politics seems to involve confidence tricks at every turn and the other significant event in the aftermath of the General Election, is the election of Jeremy Corbyn as new Labour leader – fascinating in the context of debate and how the political drama will unfold from here. The Labour Opposition were left in total disarray after the General Election defeat. Yet, the leadership result is absolutely clear. New ‘old’ Labour is back and some will conclude that Corbyn with big-spending plans 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.
So what are the economic policies of the long-serving Labour backbencher, Jeremy Corbyn, who – out of nowhere – became leader of Her Majesty’s Opposition?
At its heart is the precept that “Labour must create a balanced economy that ensures workers and government share fairly in the wealth creation process, that encourages and supports innovation in every sector of the economy; and that invests in skills and infrastructure to build an economy that is more sustainable and more equal” – which is the sort of statement, void of detail, that most would say sounds o.k. However, Corbyn is, famously, of the left. So his path to creating a more sustainable and equal society is what matters to many.
His opposition to this government’s planned cuts to corporation and inheritance tax, and his hatred of tax avoidance and evasion, won’t frighten the middle ground. After, all, there are plenty of political moderates who question why, at a time of scarce resources, it is a priority for Messrs Cameron and Osborne to give tax breaks to better-off dead people. But of course like many left-wingers of his generation, there is much more – for instance, he never felt comfortable with privatisations and was not persuaded by his erstwhile leader, Tony Blair, that Labour was right to end its Clause 4 commitment to pursuing public ownership of the means of production.
So Jeremy Corbyn wants the state to re-acquire ownership of the railways; he has floated a plan for the government to acquire controlling stakes in energy companies and he has talked about whether Labour should adopt a new modern version of the traditional socialist commitment for the workers to own the towering heights of the economy.
Some of you of a free-market inclination may at this juncture be spluttering into your flat whites and mojitos but it is important to remember that the hard left didn’t die in the Tony Blair era. It was marginalised. It merely went underground for a while, knowing that one day there would be a hunger for its seductive remedies for the world’s injustices.
So the underlying causes of the rise of Corbyn are driving politics throughout the rich west – and benefit the extreme populist right (the Front National in France, Trump in the US) as much as the Syrizas and Podemoses of the left.
They include a palpable sense that the establishment parties have for years provided inescapable evidence that disproportionate spoils go to the very rich – tolerance of an economic model whose fruits were not available to all, having dramatically decreased after the 2008 Crash that turned lacklustre wage growth into sharply squeezed living standards.
So, Corbynism (or whatever we want to call it) is rather like a collective call, which can be heard in different accents all over the world – that it doesn’t have to be this way.
Jeremy Corbyn’s most important policy is actually his most novel and it is what he calls, alluringly, “quantitative easing for people instead of banks”.
This is how he describes it: “one option would be for the Bank of England to be given a new mandate to upgrade our economy to invest in new large scale housing, energy, transport and digital projects”.
For the avoidance of doubt, this is not same-old, same-old socialism; it is new, radical thinking.
But in a world where globalisation and the free movement of capital are inescapable realities, so-called quantitative easing for people brings considerable risks. Some will see it as stupendously dangerous. What we think of as normal quantitative easing – though it was unconventional when the Bank of England embarked on it in 2009 – involves the Bank of England creating new money to buy government debt.
But probably the most important point about quantitative easing as currently configured is that the debt bought by the Bank of England has to be repaid – eventually – by the Treasury.
In other words the £375bn of new money created by the Bank of England through quantitative easing will one day be withdrawn from the economy, through the repayment of debts by the government, when the economy is perceived to be strong enough.
Now it will be decades before all the £375bn is returned. And theoretically it could never be repaid, if the Bank of England simply decided to roll over maturing debts each time they are due for repayment (as it is doing at the moment).
But the important fact is that the debts still exist as a real liability of the Treasury – and that matters. Why? Because if the Bank of England were mandated to ‘print’ another load of money, most investors would conclude that the Bank of England’s primary objective was no longer to preserve the value of the currency but to finance politically popular projects.
In other words, you end up with the fear that if the Bank of England is forced to finance projects that the private sector – by Jeremy Corbyn’s admission – won’t finance, it would be like throwing good money after bad. In those circumstances, sterling would weaken, with inflationary consequences – and perhaps with devastatingly inflationary consequences.
It is very difficult to conceive of a way in which the perception – the confidence trick perhaps – of Bank of England independence could be preserved, while obliging it (to repeat Jeremy Corbyn’s words) “to invest in new large scale housing, energy, transport and digital projects”.
Once it had those explicit objectives, investors would see it as politician’s poodle and conclude that preserving the value of sterling would be not quite the priority it has today. That’s not to say that the UK would turn into hyperinflationary Zimbabwe or 1923 Germany but the risk of investing in sterling and the UK would be seen to have increased. Therefore the cost of finance here would rise – which would mean that there would be even less long-term productive investment here and a British malaise correctly identified by Jeremy Corbyn would be made more acute.
To understand further the means by which this policy would be implemented, it would be debt acquired by the Bank of England that would be issued by a new state-owned investment bank, whose role would be to finance housing, transport, and so on. A sort of public-sector bank, which would make viable investments that the private sector refuses to make. Yet, there would still be widespread concerns that the Bank of England would be indirectly financing white elephants via this investment bank – and would, as mentioned earlier, be throwing good money after bad.
Or to put it another way, quantitative easing for people makes good economic sense only if you believe that a state investment bank would make viable investments that the private sector refuses to make.
Osborne’s Big Budget – we can’t forget it!
Meanwhile, we must not lose sight of the next ‘big’ event. It was George Osborne’s recent “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. The big spending review announcements are also coming shortly.
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.
With our focus on you – the client – we now offer you our brief independent view of the financial markets. We like the Invesco Perpetual approach to investing that means having the courage, conviction and, yes, patience, to take the long term view.
US: MODERATELY POSITIVE
The first Fed hike cycle is moving closer – we bet on a first increase this Autumn
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
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, which appears to be happening at the time of writing.
The imminent U.S 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.
For our clients with investment interest beyond accountancy needs, 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.
Invesco Perpetual Investor Magazine April 2015
BBC News Politics, Economics, Business, reports May-September 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 expresses an economic viewpoint, which should also not be solely relied upon for investment purposes. Where investments are concerned, 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.