15 September 2016

More boom than bust

US equity markets have hit record highs despite historically stretched valuations and continued recession in US corporate profits

US equity markets have hit record highs despite historically stretched valuations and continued recession in US corporate profits. The FTSE100 did not take long to recover from the drop in the aftermath of the Brexit vote and actually has been one of the better performing European equity markets. Of course, it is the depreciation in the exchange rate which has helped and the depreciation acts as a “shock absorber” in helping the economy to avoid lapsing into recession. Certainly it seems that the “Project Fear” campaign, which predicted various economic calamities on a Brexit vote, was successful in denting business confidence, but its direst predictions have failed to materialise.

If anything, the signs are that the Europhile gloomsters have got it wrong. The fall in the exchange rate has been a gift for tourists and international investors. Tourists don’t walk round with their hands in their pockets. They spend! So it would be a surprise if the better-than-expected retail sales figures in July turned out to be just a one-month wonder. International investors are snapping up UK assets as the drop in the exchange rate acts as an attractive price discount. Weakness in the commercial property sector looks temporary and don’t be surprised to see a surge in corporate take-over activity.

The CBI’s latest industrial trends survey also reported export orders at a two year high with output growing at a “healthy pace”. Unemployment is continuing to edge lower. The housing market is holding firm and mortgage rates have not gone up as the former Chancellor, George Osborne, predicted. In the months ahead, a much clearer economic picture should emerge but the odds are that the economy looks set to improve further despite the gloomsters ignoring the facts and continuing to talk it down.

In this regard, the Bank of England’s recent cut in interest rates, corporate bond buy-backs and a re-start of its QE program looks hasty and perhaps unnecessary. Money supply growth is running at an 8% pace and the Bank of England’s own data shows that consumer credit is growing at an 11% rate. Should the new Chancellor, Phillip Hammond, come up with a fiscal stimulus in the Autumn Statement, then we might be talking about a “Brexit Boom” rather than a “Brexit Bust”. Mr Carney, the Bank of England Governor, might then have to do a rather elegant two-step and reverse course.

The idea that the City decamps to Paris, Brussels or Frankfurt is fantasy

For sure, the process of extricating ourselves from the EU is not surprisingly proving complex but there is a case for avoiding being ensnared by the Brussels bureaucracy over Article 50, single market access, Swiss models, Norwegian models, passporting rights for financial services etc. The fact is that the UK economy is the fifth biggest in the world and the City is, as it always has been, a global financial centre. The idea that the City decamps to Paris, Brussels or Frankfurt, none of which are anywhere near London as a global centre, is a fantasy. Neither do we need trade deals to trade. We do not have trade deals with China or the US but the US is our biggest trading partner and our exports to non-EU economies are at record levels.

The fact is that the EU’s share of output and world trade is on a declining trend. Monetary union has hardly proved to be an economic success story and a “one size fits all” monetary policy and strait-jacket of fiscal austerity has contributed to low growth and double-digit unemployment rates. EU voters are likely to extract revenge by voting out Francois Hollande and Angela Merkel in next year’s French and German elections, while in Italy, beset by problems with its banks and persistence of low growth, it is starting to look like the straw that could break the camel’s back.

Elsewhere, a key theme for investors through the year has been concern over the effectiveness of “unconventional” monetary policies which are now looking to have become “conventional”. Negative interest rates are a curiosity to say the least, as they are a tax on the banks and a tax on savers. More QE at a time when government bond yields in the major markets are already at record lows puts central banks in the invidious position of being virtually the only buyers in the market. This is potentially a dangerous situation as it is the road to debt monetisation. For pension funds, the reduction in bond yields only worsens fund deficits which are at a record level for UK company schemes. Ultra-easy monetary policies are now becoming the problem rather than the solution and such policies cannot deal with structural issues like adverse demographics, the effects of technological change or the overhang of debt. Should inflation return, and it can, then the 35-year bull market in bonds could spectacularly come to an end.

Neil MacKinnon is a global macro strategist at VTB Capital in London.

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