Following a week that has seen more inflation news and talk of interest rates going up, Covid cases rise, the Earthshot winners announced, Newcastle Utd welcome new Saudi owners and tragedy with the murder of Sir David Amess MP, markets have generally risen.
Now we know we said we write these updates fortnightly going forward but we looked at the diary and realised that this timeline would clash with the budget next week and the inevitable mass circulation of instant contextless headlines. So, what we have decided to do is provide an update today and a more considered post budget reflection in 2 weeks.
This approach, completely by chance, also gives us an opportunity to mention the launch of our new website… please click on the image below to see it – we’d welcome your feedback.
Figures released by the Census Bureau last week showed US retail sales jumped by 0.7% in September, far better than the 0.2% decline expected by economists. Compared with a year ago, sales were up by 13.9%. The increase came as the government ended the enhanced benefits it had been providing during the pandemic. It was thought this would depress sales, but instead spending accelerated as workers and students returned to offices and schools.
Much of the increase was driven by higher prices, as US retail sales figures are calculated according to receipts as opposed to volume. Indeed, separate data showed inflation, as measured by the consumer price index (CPI), rose by 5.4% in September from a year ago, slightly higher than the 5.3% increase expected by analysts. On a monthly basis, prices increased by 0.4%, following a 0.3% rise in August. Core CPI, which excludes food and energy, rose by 4.0% from a year ago – well above the Federal Reserve’s 2.0% target.
Meanwhile, the University of Michigan’s consumer sentiment index slipped in early October to 71.4 from a final reading of 72.8 in September, suggesting consumers remain anxious despite spending more.
Here in the UK, figures showed GDP grew by 0.4% in August from the previous month, as the hospitality industry benefitted from the first full month of coronavirus restrictions being lifted in England. Accommodation and food service activities were the main contributor to growth in the services sector, rising by 10.3%. This was followed by arts, entertainment, and recreation, up 8.5%. Despite the increase, the Office for National Statistics (ONS) said GDP remains 0.8% below its pre-pandemic level, while consumer-facing services are 4.7% below their pre-pandemic level.
Investors were also cheered by data that showed UK employers added 207,000 staff to their payrolls last month, shortly before the end of the furlough scheme. This meant the number of payrolled employees surged to 29.2 million – the highest level since records began in 2001. However, the unemployment rate for June to August was an estimated 4.5%, higher than the 4.0% rate seen before the pandemic.
Over in Europe, Germany’s GDP forecast for 2021 was slashed last week by a group of economic research institutes. The group’s biannual report said the German economy would grow by 2.4% this year, down from its previous forecast of 3.7% growth. The researchers said the reduction was driven by the ongoing impact of Covid-19 on the service sector, and continuing supply chain issues. GDP is expected to grow by 4.8% in 2022, assuming the pandemic and supply chain disruptions are resolved.
Supply chain issues are affecting the eurozone more broadly, with industrial production falling in August by 1.6% from the previous month. Eurostat said one of the steepest declines was in Germany, where output dropped by 4.1%.
This week we bring you:
- Our latest true or false quiz
- A review of the third quarter of this year from Brewin Dolphin
True or False Quiz
As usual, which of the following statements are true and which are false? Answers and context at the bottom of this update.
- Banksy’s Love Is In The Bin – the artwork that shredded itself after being sold in 2018 – has gone for £18.5m, a record for the artist at auction.
- Wizards can earn NZ$10,000pa from the government in New Zealand.
- All Rolls-Royce Trent jet engines (representing 40% of all the world’s long-haul jet engines) are compatible with 100% sustainable aviation fuel.
Q3 2021 Review – Brewin Dolphin
Strong growth in profits provided a boost to company shares during the third quarter of 2021 but anxiety over the future tempered those gains. For most companies the worries surrounded the rise of inflation which has remained higher than policymakers expected. There are winners and losers from higher inflation, but it brings with it some concerns. Future profits, for example, might not match those of the past if companies’ costs go up but they can’t pass on those costs to customers.
Prices have been rising for several reasons but most of them stem from the outbreak of the Covid-19 pandemic. The lockdowns which were instigated to control that spread meant the closure of shops which, in turn, was assumed to mean much less demand for goods. In fact, quite the opposite happened. Goods demand moved from the high street to the internet and, confined to their homes, consumers substituted their spending on services for spending on goods.
Some of the supply shortages can therefore be blamed upon companies misjudging en masse about what lockdown would mean in terms of goods demand.
Central banks were also surprised by the strength of demand, having reached for their traditional recession fighting policy tools as lockdowns were imposed. That meant cutting interest rates to boost demand and inflation, both of which were actually in plentiful supply for the economy as a whole.
Aside from misjudging consumer demand, logistics have also played a part. Getting goods from factories has proved to be a deepening challenge. Global long-distance goods transport costs rose as ports became congested (partly through sheer volume) whilst some Chinese ports were temporarily closed to contain Covid-19 outbreaks. Every ship standing idle waiting for a berth to become free for unloading further reduces transport capacity. Passenger flights have been the willing conduits for small, valuable, or perishable goods travelling long distances. With fewer passenger flights due to travel restrictions, that capacity has been lost as well.
Typically, the most volatile form of inflation for consumers and businesses is energy prices, the most volatile component of which is normally oil. ‘Upstream’ oil prices have been rising but towards the end of the quarter oil availability became an even greater problem ‘downstream’ as a shortage of HGV drivers made it difficult to get petrol to filling stations. The world looks forward to a time when fuel price volatility will be a thing of the past due to reduced reliance on fossil fuels. However, that time is not now.
Aside from logistics, the oil market has suffered from the same misjudgement of demand and supply with the expanded Organisation of Petroleum Exporting Countries (OPEC) keen to limit additional energy supply to the market for fear of causing prices to collapse. At the same time, in recent years oil companies have reduced their investment in fossil fuel reserves due to concerns over the long-term demand for this polluting fuel. This has particularly affected OPEC’s big rival, the US shale oil industry, which has been slow to respond to rising prices.
In the short term, rising energy costs meant some of the more polluting forms of energy became less expensive than cleaner alternatives. The most obvious example of this is natural gas, the cost of which rocketed during the summer, prompting a gas-to-oil switch. The confluence of additional factors all contributed to the rise. Russia is rebuilding its stockpiles; Norwegian production was lower than normal due to maintenance work. China ended the summer by instructing state-owned companies to secure supplies of energy commodities at any cost, meaning tough competition for European power producers trying to secure cargoes of liquified natural gas (LNG). Northern Europe’s great strides in building wind power generation have given a disappointingly low yield due to a lack of wind.
In short, from a supply perspective it seems like anything that can go wrong has gone wrong.
Oil price inflation often comes in bursts as higher prices prompt more supply, bringing the market back into balance or even over-supply. The same can be said for many of these other inflation categories as well. At some stage Russian gas reserves will refill; queues at ports will be cleared; air travel will resume; and consumers will prioritise services over goods. This can be compounded when consumers need to prioritise their spending on expensive fuel, thereby reducing demand for other goods.
Supply chain managers are wary of what they call the bullwhip effect whereby the cumulative effect of small changes in consumer demand can be amplified as they work their way down the supply chain, causing a market to swing from under-supply to over-supply very rapidly.
In the aftermath of the financial crisis inflation first plunged, then soared, mirroring the swooping performance of oil prices. That experience certainly prepared central banks for the fact that they might find themselves maintaining low interest rates even as reported inflation rates might be quite high. But, as we have seen, the causes of the latest wave of inflation have been much broader than that and the effects will be longer lasting, creating a conundrum for policymakers.
Having seemingly made the mistake of very loose monetary policy whilst demand was booming and inflation soared, should they now reverse course? Should they tighten monetary policy when inflation is likely returning to normal anyway? Might their actions, along with the unpredictable nature of the bullwhip, ultimately cause an undershoot of demand? But if they do nothing and inflation remains above target, could consumers come to expect higher inflation in the future? And would that mean the forfeiture of the decades of work fighting to anchor inflationary expectations among consumers?
The Bank of England seems to have decided to be proactive on this topic. Its comments conditioned the market to expect two interest rate increases in the first half of 2022 alone. Although this will leave interest rates far below the current level of inflation, this policy stance is quite aggressive by comparison with other central banks. Some way behind is America’s Federal Reserve. It will slowly reduce its asset purchases (quantitative easing) and may increase interest rates by the end of 2022.
Seemingly in no hurry to meaningfully tighten monetary policy is the European Central Bank, perhaps scarred by two misplaced rate hikes during the recovery from the last global crisis, which needed to be quickly reversed and more. Going into 2022 it seems likely that monetary policy will be tightening to some extent.
The one major central bank where there is most room for doubt is the People’s Bank of China. That’s because China faces the same inflationary challenges as the rest of the world and some other challenges besides. The most obvious of these is President Xi Jinping’s regulatory crackdowns. The president has long harboured concerns over the incompatibility of capitalism and China’s broader goals. China, for example, wants to raise its dwindling fertility rate which the high cost of private education was impeding. The government therefore announced that the sector will now be run on a not-for-profit basis with devastating effect for the companies operating in that market. Worried about children spending too much time on their screens? The Chinese Communist Party ruled that children may spend only three hours a week playing video games.
Perhaps the most significant restrictions, however, are those being implemented to address the dysfunctional Chinese property sector. Along with education and health, home ownership is one of the three mountains that Xi Jinping believes Chinese society must conquer in order to deliver a prosperous society. Reforming the real estate sector would mean less speculation in housing – houses for living in, not investing in as the president puts it. It would also reduce the accumulation of financial risk in the Chinese economy.
Collateral damage in this latest push is the former second-largest Chinese property developer: a company called Evergrande. Due to its size, leverage and breadth (across real estate development and the backing of wealth management products) Evergrande is seen as a potentially systemic risk to the financial system. Historically China has been ready to bail out companies that fail to avoid losses to creditors. However, in recent years the mood has shifted towards investors taking responsibility for their own bad decisions. The expectation is that this subtle shift means that investors may pay penance for the lending they offered to Evergrande but that those losses should not be allowed to ripple too far throughout the financial system, and most importantly consumers should be protected from the failure.
So, after a remarkable year for stocks that saw vaccinations and profit recoveries vanquishing anxiety from investors’ minds, there is a new realisation that the path from here may not be so easy. However, the reason central banks have been so reluctant to tighten policy is because unemployment is still too high. The process of bringing it down means getting people into work, allowing them to spend, and driving growth and profits. Anxiety over inflation has to be seen in that context, and in the context of the diminutive returns which can be made keeping money on deposit.
True of False Quiz Answers
- True – Sotheby’s said the decommissioned, remote controlled shredding mechanism was still in the frame. The piece was originally titled Girl With Red Balloon when it sold for just over a million in October 2018, again at Sotheby’s.
- Not True anymore – The city of Christchurch in New Zealand has laid off the only wizard in the world believed to be on a government payroll, who’d been making $10,000 a year to perform rain dances and other “wizard-like services” — mainly for tourists — since 1998.
- Not True yet – But it will be by 2023.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. For information purposes only. The views expressed are the author’s own and do not constitute investment advice.
As always, please do not hesitate to contact one of our Financial Advisers at our Leamington Spa or Coventry offices if you wish to discuss this in further detail.