Confusing Times

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Global equities had a wobble last week, ending down 1.4% in local currency terms. However, they finished the week on a more positive note and have also opened higher this morning. Moreover, in sterling terms, markets benefited from a weakening of the pound against a stronger dollar – it has retreated to $1.36 from a high in May of $1.42 – and were little changed last week.

More notable than the slight fall in equities was the divergence in regional performance. The US outperformed with a gain of 1.0% in sterling terms, while the UK fell 1.3% and Asia/Emerging Markets were down 3.0%.

Two main factors were behind these various moves. The first was the news that most members of the US Fed now believe QE tapering should start this year. There is still significant variation of opinion and the Fed’s plans continue to hinge on the strength of the economy over coming months. Nonetheless, tapering does now look most likely to start before year-end, rather than the start of next year as had generally been expected.

This is only a small shift in timing and does not have major implications. Indeed, the first US rate hike still looks set to come in early 2023. That said, at the margin, it is a move in a hawkish direction and the dollar benefited accordingly, boosting the relative performance of US equities in the process.

The second factor was the perception that global growth may not be as strong in the second half of the year as previously thought. In the US, retail sales fell 1.1% in July and consumer confidence posted an unexpectedly large drop in August. Meanwhile in the UK, sales were down as much as 2.5% in July.

The spread of the delta variant is very likely to blame for part of these declines. However, supply shortages will also have been a factor, as will the shift in spending away from goods to services now these areas have reopened. We do not believe too much should be read into this recent weakness. It is worth noting that retail sales volumes in the US and UK remain a hefty 10% and 5% respectively up on their pre-pandemic levels.

To add to the confusion over the strength of the UK economy, this morning saw news that UK business confidence fell more than expected in August. This followed hard on the heels of last week’s report that job vacancies hit a record 953,000 in June, rather suggesting businesses were brimming with optimism.

The truth is that while confidence is not as high as it was, it still remains strong. As for vacancies, their high level is down to the reopening of the economy and Brexit and they will undoubtedly decline significantly as the furlough scheme winds down.

Even more so than the recent data on activity, the latest news on UK inflation pressures gives a false impression of the state of play. Average earnings rose as much as 8.8% in June from a year earlier. But the gain was massively distorted by the introduction of the furlough scheme. Underlying wage growth is running at more like 3-4%.

As for UK inflation, this was unexpectedly weak in July, falling to 2.0% from 2.5%. However, this decline should prove short-lived and inflation still looks set to head up to 4% over coming months, before retreating again next year.

All in all, while recent news shows growth now slowing in the US, UK and at a global level, it still looks likely to remain well above trend over the remainder of the year. As for policy, the recent moves by the Fed and the Bank of England highlight that tightening is drawing closer but that the stimulus will be withdrawn only very slowly.

We believe this backdrop still leaves equity markets with some further moderate upside, even if the best of the gains are now well behind us.

Rupert Thompson

Chief Investment Officer