Financial Update from Brewin Dolphin - 24 February 2023

February 2023

The Weekly Round-up

Friday 24 February 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, discusses the one-year anniversary of Russia’s invasion of Ukraine and stronger-than-expected purchasing managers’ indices.

Russia and Ukraine: a year on…

This week, China’s relationship with Russia was in the news. China’s top diplomat told the secretary of Russia’s Security Council that “Chinese-Russian relations are mature in character: they are rock solid and will withstand any test in a changing international situation.” China later issued a 12-point plan to achieve a ceasefire that would leave Russian troops in their currently occupied Ukrainian territory. China also abstained from a UN resolution calling for an end to the war.

Russia is in focus because today marks the one-year anniversary of its ‘special military operation’ in Ukraine. The conflict has been a tragic negative sum game, and has contributed to high inflation both inside and outside Russia. There will be plenty written about the ineffectiveness of the sanctions taken against Russia, although its economy contracted significantly in 2022 and inflation touched a painful 15%.

What has remained solid, though, is Russian employment. There were misgivings about the hardship that sanctions might impose on the Russian people at the beginning of the war. The absence of a surge in unemployment should address some of those misgivings, even if it also limits the scope for sanctions to bring about an end to the conflict.

However, Russia’s service sector spent a fourth month in contraction, according to January’s purchasing managers’ indices (PMIs). We will have to wait until next week to see how it has fared during February.

Making a change…

The PMIs for several countries are released in provisional form, giving a generally accurate steer on how they are performing. The news was good from an economic perspective. In manufacturing, PMIs worsened in France, Germany and the broader euro area (as well as Japan). All those countries remained below 50 which theoretically implies economic contraction at an accelerating pace. In reality, I don’t think the indices are precise enough to make the distinction between expansion and contraction, so the direction of change matters most – and that was lower.

By contrast, PMIs improved in the UK, the US and Australia (which was the only one above the magic 50 level that implies expansion).

The indices are constructed from a range of questions. We would place greatest importance on whether companies are experiencing increasing or decreasing new orders as a guide to the strength of demand in the economy. Here the news was better, with most of the above markets seeing an improvement in new orders, albeit from a low level.

Hot on the high street…

There was also better news from the services sector PMIs, which represent a larger share of most developed economies. Of the handful of provisional PMI reports that are issued, all but Australia saw accelerating expansions of the services sector.

Also within the detail was data relevant to the outlook for inflation. The good news is that the implied pace of input cost inflation fell, although it remained above the nadir at the end of 2022. Prices charged, however, rose. Theoretically, this should be good news for equities as it suggests that margins are being protected better than feared, something which I think has also been evident during earnings season. In the text accompanying the US report, the author noted that raw material costs are easing but wages drove costs higher.

As the report stated:

“Although input costs rose at a softer pace, February data signalled a sharper rise in output charges across the private sector. The pace of increase in selling prices was the quickest since last October and steep overall. Firms reportedly passed through hikes in costs to their clients.”

Just a minute…

That would be good news for investors if it wasn’t worrying news for policymakers. Minutes of the Federal Reserve’s last meeting showed that almost all participants supported a downshifting of rate hikes to 25 basis points. They observed that:

“Participants observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2%, which was likely to take some time.”

But these minutes relate to a meeting which took place before January’s US employment report, which saw jobs growth reaccelerate and massively exceed expectations. Since then, the consumer price index (CPI) has fallen less than forecast, retail sales have expanded unexpectedly and, as we discussed above, the PMIs signalled an acceleration of activity in the US service sector.

Spending time…

The most complete assessment of US consumption during January only came out this afternoon. Personal consumption expenditure includes services as well as goods. It also accelerated during January (even accounting for December being revised higher). Because this is the more complete measure of consumer expenditure, changes in the prices of these goods are the Federal Reserve’s preferred measure of consumer inflation suffered. Perhaps most worryingly for markets, this measure of consumer prices actually accelerated; again, this was despite upgrades to previous readings.

The silver lining from a policymaker’s perspective has been that wages have been slowing. In fact, today’s release showed that personal spending has been outpacing personal income. We know that this has been possible because consumers still have quite high levels of excess savings on aggregate, although lower-income cohorts will inevitably turn to debt in order to maintain their post-Covid living standards.

Britain’s back…

For the last few months, the UK has been the laggard among developing economies, stagnating if not collapsing. But the UK PMIs jumped, suggesting that the economy may have found its stride.

That vibe was repeated this morning as the GfK UK consumer confidence index improved more than expected in February. The headline index rose to the highest level since April 2022, although it is at a level which has consistently coincided with recessions going back to the 1970s. For now, though, it is recovering, and although respondents are apparently less keen on making major purchases (according to the survey) they do expect that the economy and their personal financial situations will be getting better in the future, albeit from very depressed levels.

In other good news for the UK, the government recorded a surprise budget surplus for the month of January, while Rightmove house prices were unchanged in February. Given the severity of the change in mortgage rates, it does seem like house prices are due to fall, but the extent of the fall should not be very severe as there is a lot of pent-up housing demand ready to capitalise on improvements in affordability. Even the recent normalisation of mortgage rates after the drama of the mini-budget has prompted some improvement in activity. House (asking) prices in London rose more than 2% in February, reflecting increased demand for property in the capital from people seeking to capitalise on the strong jobs market.

The stronger economy is not always what investors want. Monetary policy operates with long and variable lags, but if demand continues to accelerate then there will be growing pressure to raise interest rates further.

Finally, it is worth remembering that the week began with hopes that the Northern Ireland Protocol could be sealed after talks between the government and the EU. Those lofty ambitions, however, soon dissipated as it became clear that the government was disunited once more on its position with Europe. Resolving this issue seems as hard as ever, and yet it holds the key to unlocking business investment which, given that it has stalled since 2016, seems likely to have been inhibited by the uncertainty created by the Brexit referendum and the failure to establish working trading arrangements with the EU.

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. The Weekly Round-up