Ian Stewart is Deloitte’s Chief Economist in the UK. This is his Monday Briefing, a succinct and eclectic weekly take on economics and finance.
Predictions of cataclysm proved wide of the mark
The performance of financial markets provides signals about the state of the global economy. Market movements in part reflect shifting expectations about growth, inflation and risk. The messages from markets are fallible. But unlike economists’ forecasts, the positions investors take are backed by real money.
So who made money in financial markets in 2016 and what does it imply for the global economy?
It’s worth recalling that 2016 opened on a wave of pessimism about the global economy and about equities. A hard landing for the Chinese economy was seen as the number one risk, an outcome that could have dragged the global economy close to recession. One City of London analyst advised clients to “sell everything except bonds”, advice that was widely repeated in the media. Clients were told to brace for a “cataclysmic year” and a global deflationary crisis. It was an extreme statement of a prevalent view that 2016 would be a risky year.
Happily, predictions of cataclysm proved wide of the mark. The global economy continued to grow, and at a similar rate to 2016. The much-feared Chinese hard landing failed to materialise and growth in other emerging markets accelerated. At the start of 2016 a Brexit vote and the election of Donald Trump were seen as major risks to the outlook. Both, of course, materialised and yet equities have rallied in seven of the ten major developed economies we track.
UK equities have been the best performers, returning 16% in 2016. Large UK corporates, which tend to earn a significant chunk of their revenues abroad, in dollars, have benefited from the sharp drop in the pound, and have returned 19% over the year. But the rise in UK equities is not just about a weaker pound. The UK economy has proved unexpectedly resilient since the referendum and this has supported smaller, UK-focussed companies. They have done quite well, returning 14% over the same period.
Mining and oil and gas were the best performing sectors in the UK. They staged a spectacular recovery as commodity prices rose, returning 108% and 59% respectively. Miner Anglo-American was the biggest gainer in the FTSE 100, with its shares rising almost 277% over the year.
UK equity investors may be bullish but this sentiment has not spilled over to the corporate sector. Corporate risk appetite, as measured by the Deloitte CFO Survey, is running at low levels, with 80% of CFOs saying now is a bad time to take risk. Sentiment among economists has partially recovered from the Brexit vote. Economists swiftly slashed their forecasts for UK growth in 2017 on the Brexit vote, from 2.1% to 0.6%, a massive downgrade and greater than anything I have seen in 20 years. But from a low of 0.6% in August growth forecasts have risen every month and in January reached 1.4%.
After a rotten first half to 2016 US growth reaccelerated in the second half with the unemployment rate falling close to at eight year low and wages, at last, rising. Forecasts for US growth in 2017 are now drifting higher. Despite what, overall, was a lacklustre year for US growth, US equities returned 12% in 2016.
Markets have responded positively to Donald Trump’s election victory, with expectations of tax cuts and more government spending eclipsing worries about protectionism and geopolitics. US equities have returned 5% since the election. Telecoms and financials have been the best performing sectors, returning 11% and 9% respectively, since November. Mining and pharmaceuticals and biotech have been the worst performers.
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Another sign of confidence in the US economy comes from the Federal Reserve which has suggested it is on track to raise interest rates by 75bp, or three-quarters of a percent, this year. Many US investors and analysts are speculating that interest rates and bond yields, could, at last, be heading back up to pre-crisis levels. With investors pricing in a less bond-friendly world of higher inflation, higher growth and higher interest rates the value of US Treasuries has fallen. I was in the US last week and was struck by the widespread view that the 30-year bull-run in US bonds could be drawing to a close.
Among major equity markets Italy’s had the poorest performance in 2016. Against a backdrop of weak growth, banking and housing crises and political uncertainty investors in Italian equities lost 5% last year. The worst performing sector was real estate with investors losing 28%.
Other major euro area equity markets made gains, with French, German and Spanish stocks returning 9%, 5% and 5% respectively.
2016 was a good year for commodities, with prices up 28%. Crude oil ended the year up 59%. This has boosted growth prospects for commodity-producing emerging markets such as Russia and Brazil and has helped fuel a 13% return in emerging market equities.
Chinese equities lost investors 25% in the first 5 weeks of 2016 on fears of a hard landing. Since then sentiment revived, and Chinese equities returned 14% by the end of 2016.
In the currency world the big news is the rise of the dollar, which has risen 10% on a trade-weighted basis from its trough in April, driven by a rebound in US growth and growing expectations of higher US interest rates. This is part of a long uptrend. Since reaching an all- time low in 2011 the dollar has risen in value by 39%.
The dollar’s rise has been so vertiginous that it is starting to look overvalued. The Economist’s Big Mac Index provides a light hearted gauge of currency valuations by comparing the price of a Big Mac around the world. The Big Mac index rates the dollar as being overvalued in 37 of the 42 countries it tracks (the exceptions are Switzerland, Norway, Sweden, Venezuela and Brazil).
Last year the euro rose by 2% on a trade-weighted basis, with 16% gains against the pound helping offset a 3% loss against the dollar. The pound was the worst performing major currency in 2016. It has fallen significantly since the Brexit vote and is down by 14% from its peak last May.
Gold is often seen as a safe haven in uncertain times. Greater optimism about the global economy, and in particular the US economy, has hit the gold price. It has fallen 5% since the US election.
So what do investors expect for 2017?
By and large most seem to be pretty optimistic that the equity rally has further to run. We tested opinion in our Year-Ahead webinar a couple of weeks ago. About half the audience, some 900 people, responded, of whom 81% said they expected equities to outperform bonds in 2017. Measures of US investor bullishness are running close to their highest levels in more than two years. Emerging market equities and US small cap stocks seem to be particular in vogue at the moment.
Investors seem to be expecting stronger global growth and inflation this year and rising interest rates. I would agree with the economic diagnosis.
As for the market conclusion – that equities will outperform bonds – well, I won’t even try to guess. The fact that the market pessimism of early 2016 was such a poor guide to subsequent events is a salutatory reminder of the fallibility of we prognosticators.
Markets & News
The FTSE 100 ended the week down 1.9%.
Here’s our take on what we think are the big economic stories of the week:
Global economics and politics
* In response to government controls on the housing market Chinese house prices fell in 12 out of 15 key cities between November and December.
* Capital outflows from China rose close to a record level in 2016.
* New claims for unemployment insurance in the US fell sharply in the week ending 14th January.
* Janet Yellen, chair of the Federal Reserve, said that the US could face a “nasty surprise” if the Fed fails to tighten monetary policy in the face of fiscal expansion.
* China has launched a direct rail freight service to London, as part of its drive to develop trade and investment ties with Europe.
* In what was seen as a counterblast to Donald Trump China’s President Xi Jinping launched a robust defence of globalisation and free trade in his address at the World Economic Forum.
* Anthony Scaramucci, Donald Trump’s newly appointed public liaison official, told the World Economic Forum that despite the Presidents recent comments Mr Trump is committed to globalisation, open trade and NATO.
* The growing cost of car insurance in the UK has helped send more customers to price comparison site Moneysupermarket, as its parent company posted a 20% rise in revenues in the final three months of 2016.
* Prime Minister Theresa May is to reveal her blueprint for Britain’s industrial strategy this week, pitching how she will “get the whole economy firing”.
* In a sign that higher inflation may be squeezing spending power UK retail sales fell by 1.9% between November and December, the biggest monthly fall for more than four and a half years.
* The International Monetary Fund has upgraded its 2017 GDP growth forecast for the UK to 1.4%.
* The FT reported that healthcare accounted for 21% of household spending in the US, three times the proportion in China, four times in Japan and five times in the EU.
* US Treasury secretary, Steven Mnuchin said that strong dollar remained important for the US economy in the long term.
* The FT reported that average day-time weekday traffic speeds in central London between June and September last year fell to 7.8mph due to clogged streets.
* Surrey county council is to hold a referendum on a 15% rise in council tax to pay for social care.
* US-based healthcare chain Cleveland Clinic is to open a 205-bed hospital in London highlighting increased demand for private healthcare, especially from self-paying foreign patients from the Middle East.
* Mondelez International is selling the Vegemite breakfast spread brand to Bega Cheese which brings it back to an Australian company after almost 100 years.
Brexit and European politics
* In a historic decision on Tuesday the UK Supreme Court will rule on whether Theresa May must hold a parliamentary vote to trigger Article 50 and begin the process of Brexit.
* Theresa May set out a 12-point plan for Brexit negotiations with the EU, ruling out membership of the single market or customs union.
* The European Central Bank has warned that it will be difficult for the UK to retain its valuable euro-clearing business after Brexit and has called for more EU oversight of the trade in London once Britain leaves the Union.
* Bank of England’s governor Mark Carney suggested that The Bank’s decision to cut interest rates by 0.25 per cent last August in the wake of the Brexit vote may have saved 250,000 British jobs.
* UK Chancellor Philip Hammond said some firms were “quite understandably… waiting for the fog of Brexit to clear” and that could weigh on investment. But Mr Hammond said for many foreign firms the UK had become a “buying opportunity”, partly due to the fall in the pound since the referendum.
* Royal Mail posted a sharp drop in letter mailing in the crucial lead up to Christmas, citing overall business uncertainty in the wake of the Brexit vote, particularly hitting volumes of advertising and business letters
* Britain is ideally placed to secure a services-based trade agreement with Australia the country’s trade minister said last week.
* London’s Mayor Sadiq Khan said that financial services jobs that leave London will likely go to Hong Kong, Singapore, and New York rather than the continent.
* Jean-Claude Juncker, President of the European Commission, said to British PM Theresa May that “we want a fair deal with Britain and a fair deal for Britain, but a fair deal means a fair deal for the European Union”, in an indication that the Commission was not in a hostile mood.
* The European Parliament’s Brexit negotiator Guy Verhofstadt said that “it is an illusion to suggest that the UK will be permitted to leave the EU, but then be free to opt back into the best parts of the European project, for example by asking for zero tariffs from the single market, without accepting the obligations that come with it”.
* German Chancellor Angela Merkel welcomed the “clarity” and “a clear impression” provided by Theresa May in her 12-point plan for Brexit.
* The prospect of losing access to the EU single market prompted HSBC’s chairman Stuart Gulliver to indicate that the bank is ready to move 1000 jobs out of London.
* Swiss bank UBS told the BBC in Davos, that it is preparing to move 1000 employees out of London to the continent as Theresa May implements her “Plan for Britain”.
* Takeshi Uchiyamada, the chairman of Toyota, which employs 3000 people in the UK, said his company is considering “how to maintain competitiveness” in its UK operations
* Elaine Mayes, 56, from Aberdeen, raised more than £2,400 for Cancer Research UK by getting her hair cut for the first time after 1994 – hair for care.
Ian Stewart is Deloitte’s Chief Economist in the UK. His Monday Briefing can be subscribed to here.