Diverging Trends: On Optimism and Rates

Politics is never far from the top of investors' minds nowadays. After Brexit and Trump we are at the start of a long series of political battles in Continental Europe: now with Italy and Austria, then The Netherlands in the spring and culminating in the French and German elections next year. It fits in with my view that we are moving from the liquidity and earnings cycles based on cheap money that have dominated since the 2008 financial crisis, to a more traditional political and economic cycle. What then of the economic and policy debate?

In recent weeks, the economic data and market behaviour has fed thinking that 2017 could be a good one for global growth and, in turn, for equity markets, at least across the advanced economies.

Data in the US suggests a relatively solid growth rate in the fourth quarter. Friday's jobs data showed that the unemployment rate fell to 4.6 per cent in November. Although not all aspects of the latest US jobs data were strong - for instance, hourly earnings fell 0.1 per cent - it now seems inevitable that the Fed will raise interest rates 0.25 per cent in December. Meanwhile on the Continent, the jobs data has improved, although there is a considerable way to go.

Having discounted so much good economic news associated with President Elect Trump's policies, markets are now appreciating that they need to wait to see what actually happens in the new year. While it is always possible that fears about the implications for the US budget deficit, as well as concerns about future trade policy, could yet come to the fore, it seems more likely that the positive underlying mood in the US equity market is waiting to be justified by eventual economic data. And if that is true for the US then if may prove to be the case for the UK too.

The UK has some serious issues to address on policy. For understandable reasons, the Prime Minister is keeping her cards hidden regarding future Brexit negotiations. That, however, can create a vacuum which in turn, as we are seeing, is being filled with all manner of speculation and opinion about what should happen. This last week, too, has seen the Brexit Minister David Davis, sensibly in my opinion, suggest that the Government is considering all options. Add in the forthcoming court ruling and role of Parliament and the recent strengthening of sterling on expectations of a soft, or less than clean, Brexit may well be the prelude to a period of volatility.

In the wake of last week's Autumn Statement there is greater realisation that - while Brexit itself is the most vital issue - the economic data is highlighting some other important issues that have implications for markets and investors. Of these, much of the attention has been on the still large budget deficit and sizeable current account.

In addition, there is the position of the UK household sector. In the past it has often been the performance of the household sector that has led to growth spurts or recessions in the UK. The ratio of household debt to income went above 100 per cent for the first time in the summer of 2001. That means more household debt is higher than income. It has not looked back since, and peaked in September 2008 when the financial crisis hit, at 150 per cent, meaning household debt was one and a half times bigger than income.

Thankfully it has come down since but now it appears to have bottomed out and is edging up. It is now at 133.1 per cent. Of this 101.7 per cent is mortgages and 31.5 per cent is other credit borrowing. Exposure to the housing market is key. But so too is credit growth. Given this, and the online buying seen on Black Friday, "bricks and clicks" describes the behaviour of UK households.

Interestingly, latest data from the Bank of England shows that debt service ratios have been flat since 2009. And, as we know, house prices have edged up relative to incomes in recent years.

“So what?”, you may ask. If interest rates were to rise or if the jobs market was to deteriorate, with unemployment increasing, this would cause problems for many households and consumer spending would slow. Alternatively, and as we have highlighted before, any upward move in wages that boosts household income would make life considerably easier for consumers. In the previous words of Bank of England Governor Carney, it would be a clear sign that we have reached escape velocity.

Recent data shows the economy has remained resilient. Also there has been a succession of international firms announcing increased investment in the UK, perhaps helped by the competitive level of sterling. All this is good for growth.

Despite this, as we saw last week, consumer confidence has fallen in the latest monthly data. There is a lot of negative economic commentary and perhaps this is feeding on consumer confidence. After all, the economic outlook depends on the interaction between the fundamentals, policy and confidence. So as we end the year, economic data in the US and UK is solid. In contrast, while the markets suggest confidence about the US is high, there seems too much pessimism about prospects in the UK. While the Fed may be about to hike, it is setting a different path from that of central banks elsewhere, including the UK.

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