Financial Update from Brewin Dolphin - 15 September 2023

September 2023

The Weekly Round-up

Friday 15 September 2023

In his latest weekly round-up, Guy Foster, Chief Strategist, discusses encouraging Chinese consumer data, and the boost to the UK equity market from mining and energy stocks.

Cancel the obituaries – they are not needed yet.

Data released this morning confirmed a theme of the last few round-ups: that China, for all its travails, is not in terminal decline. The Chinese consumer lives on, with the rebound in retail sales being stronger than had been expected. As we have discussed in previous round-ups, around the major economies, China is a rare exception in that its services sector is expanding, even if that expansion has lost a bit of momentum. Survey data has highlighted that while services demand was weakening, it was specifically export demand rather than domestic demand that was weak.

The better-than-expected activity extended beyond retail sales to industrial production as well. It’s not enough to sway our feelings about Chinese stocks though. Several headwinds for growth remain. Fixed asset investment, which has been the historic driving force of China’s growth, continues to slow. The slump in property investment in particular continues to deepen. It may get some relief from the recent housing demand stimulus, but for the time being, house prices continue to slide. The structural underpinnings of growth often lean heavily on population growth, which has turned negative for China, and historically, the region’s equity market has failed to keep pace with its economy. Chinese Communist Party president Xi Jinping’s common prosperity ideology seems likely to be a further weight on shareholder returns.

Mining

2023 remains the year of technology earnings but more recently, energy stocks, having edged into a distant second place, have the current market momentum. Energy rallied hard during August and has continued to perform well during September, emphasising the role of our low duration position in energy as a hedge against the more interest- or inflation-sensitive secular growth exposure we hold elsewhere in portfolios. But this week has seen a sharp reversal in mining stocks, which had been among the laggards for the year. Mining seems to be following the energy stocks’ path in realisation that China’s long-term deceleration should not be confused with short-term global cyclical fluctuations.

The FTSE 100

The stronger performance from mining and energy has provided a much-needed fillip to the tired-looking UK equity market. Powered by technology, the S&P 500 left other markets in the shade this year and the FTSE 100 was no exception. For some time, the lack of new dynamic listings in the UK market has been a frustration to policymakers. Various initiatives have been considered, including revising the UK’s historic status as the gold standard of corporate governance requirements. The ambition has seemed laudable but futile, with the UK market having lost critical mass with the loss of great growth assets such as Arm plc when it was acquired by Softbank in 2016. Since then, there seems more enthusiasm for technology companies everywhere.

Sadly, the UK missed out on Arm’s return to the equity market this week, but the share sale has been very encouraging for other companies considering listing shares. A crumb of comfort for the UK would be that Arm is open to potentially having a secondary listing that might pay heed to its British heritage. A secondary listing would bring extra volume to the UK stock exchange, but if it could be demonstrated that being listed in the UK brought more investors to the shares, then perhaps other large companies might follow suit, in turn drawing in more capital and revitalising the UK’s standing as a global financial centre.

Central bank credibility

This week saw the European Central Bank (ECB) setting monetary policy a week ahead of the Federal Reserve and Bank of England. For investors, it felt like a coin flip as to whether rates would be raised, but in the end the hawks prevailed. Despite the rise in interest rates, bond yields and the euro fell. What seemed to encourage the bond market were guarded comments from ECB president Christine Lagarde suggesting that this could be the peak of the interest rate cycle. The ECB edged up near-term inflation expectations but lowered them for 2025, suggesting that it feels confident that inflation won’t be structurally higher.

That might seem a heroic judgement given the failings of inflation forecasting among the major central banks (and most private sector economists). We have seen a trend of the market accepting central bankers’ judgements where at other times bond vigilantes might put up more resistance. The National Bank of Poland recently cut interest rates by 0.75% despite double-digit inflation in what was widely seen as a politically motivated cut ahead of an election year. Polish bonds, however, rallied on this suggestion of a dovish central bank rather than selling off, as one might expect if a central bank’s inflation-fighting credibility is called into serious question.

For the time being, the markets seem to be happy to accept central banks’ assumptions about lower interest and inflation rates, perhaps because of the expectation that slowing economic activity will weigh down prices.

The UK Economy

The UK would be an economy where such expectations seem credible. Quite substantial upward revisions to UK economic growth mean that the country has wasted a huge amount of energy bemoaning its failure to surpass its pre-Covid level of economic activity, because it turned out it had surpassed that level. Ironically now though, before those revised figures have been assimilated into the official time series, the most recent GDP (gross domestic product) measures have started to decline. There is quite a realistic prospect that the UK will be determined to have entered a recession over the last couple of months. Data from the Royal Institute of Chartered Surveyors suggest that house prices will continue to decline, and jobs growth has slowed or even reversed according to some measures.

Frustratingly for policymakers, despite evidence of a softening economy, wage growth remains too high. It actually exceeds inflation at the moment, creating twin challenges. For the Treasury, it means that the triple lock ensures pension pots will grow at a faster pace. For the Bank of England, it suggests that inflationary pressures remain, and will be fuelled by the higher pension payments in the future.

The US Economy

The US economy is another complex but brighter story. Data suggests that the US is performing well at the moment and this week’s retail sales paint a consistent picture of resilient consumers. Frustratingly, inflation remains persistent, but for the time being, like other regions, the expectation of weaker activity suppressing inflationary pressure seems enough to placate the market.

It seems likely that these challenges and the lack of potential space for the economy to grow into will weigh on risk assets over the coming months, although so far, the market has proven remarkably resilient.

The value of investments can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.