Stock market and economic commentary May 2023

“The world is full of foolish gamblers, and they will not do as well as the patient investor”. Charlie Munger of Berkshire Hathaway in the 2022 Annual Report to Investors.

Economic Update

Reasons to be cheerful Part 1… the UK consumer

In the last 18 months, UK consumers have faced the worst energy crisis in 60 years, double-digit inflation and rapid interest rate rises. Last autumn consumer confidence hit the lowest level since 1974. No wonder turnover in the housing market has stalled and retail sales are falling.

High inflation has hit spending power, with household disposable income falling 1.3% last year. This is a significant hit by the standards of the last 60 years. Yet along with the headwinds, the UK consumer is also seeing some tailwinds.

Thus far, high inflation and rising interest rates have had surprisingly little impact on the labour market. Unemployment is low, job vacancies are abundant, and employment keeps growing. Consumers have been able to dip into savings built up in the Covid pandemic to support spending. Increased borrowing, with consumer credit growth running at the fastest rate in four years, has bolstered consumption. Meanwhile rising interest rates, up from 0.15% to 4.5% in less than 18 months, have not fully fed through to fixed-rate mortgages.

These factors have enabled consumers to keep spending even as real disposable incomes decline. In the first quarter of 2023, household expenditure was 1.6% higher than a year earlier.

Consumers have had to adapt to higher energy and food prices. An Office for National Statistics survey carried out in early April found that 67% of adults were spending less on non-essentials, 55% were using less energy in their homes and 42% were spending less on food shopping and essentials. Spending on durables and furnishings has taken much of the strain with sales volumes falling in the last year. The boom in internet sales is over, with sales down about 20% from their 2020 highs.

There is also a compositional question. Official data captures averages or aggregates, which are skewed to higher-income households. In the UK the top 50% of households account for almost 70% of all spending. At the other end of the income spectrum, official data shows that almost 20% of UK households live on less than 60% of median income, the threshold for absolute poverty.

Measuring overall consumer spending does not fully capture the pressure felt by lower-income households because so much spending is accounted for by higher earners. It is also why, at a time of falling real incomes, some parts of discretionary spending remain strong. Demand for airline travel has continued to recover with flights to, from and within the UK up by more than 10% in the last year. Shares in BA parent IAG, Ryanair and EasyJet have risen sharply since last September. Ryanair CEO Michael O’Leary has predicted that an expected increase in airfares this summer of up to 15% will have no impact on bookings.

Overall, the consumer is in a marginally better place now than seemed likely six months ago. Consumer confidence is weak, but it has risen from last year’s lows. Inflation should moderate in coming months driven by ebbing pressures from food and energy prices. By the end of this year, inflation, which is currently running at 10%, is likely to be below 5%.

On average economists expect household spending to contract by 0.4% this year before returning to growth in 2024. Given the scale of the likely contraction in real incomes – on the Office for Budget Responsibility’s forecast it is likely to be the most severe in over 60 years – this would constitute a reasonably soft landing for the UK consumer. A decline of 0.4% in household spending compares with a 3.0% fall in the financial crisis in 2009, and a 1.0% fall in the previous recession in 1991.

Reasons to be cheerful Part 2… the global economy

In parallel with the UK, the global economy in 2023 has also performed much better than feared only a few months ago. Here then are five important reasons to be cheerful.

1) Looking at the world’s largest economies, China, the US, the EU, India, Japan, the UK and South Korea, contrary to predictions, not one country is in recession at a time when the US Federal Reserve has raised US interest rates by five percentage points in the space of a little more than 12 months. This is unusual and positive. This resilience in almost 70% of the global economy, alongside the absence of any financial distress in large emerging economies, makes a systemwide financial crisis unlikely. Why then is there so much gloom and doom? Perhaps it’s because we are all scared of sounding arrogant and overconfident about the future.

2) The second reason stems from the oft-repeated weakness that the world is suffering from a series of adverse supply chain shocks. That is true, but shocks come and go and the global difficulties in moving goods are fast disappearing. The Federal Reserve Bank of New York’s supply chain pressure index is now well below its historical average. In a separate indicator, a Kiel Institute tracker of the proportion of freight on stationary container ships waiting to go into ports is now back to normal levels.

3) Europe specifically can welcome a positive shock in lower natural gas prices. The speed and solidarity of its response to Putin’s natural gas blackmail over the winter ensured that energy consumption fell significantly. All of this came without a recession.

Compared with previous forecasts from the European Central Bank, the market price of gas over the next three years is predicted to be 30% cheaper than at the start of the Ukraine war. Lower gas prices allow Europe to have higher disposable incomes, higher consumption and lower inflation.

4) No one should be naive about the economic risks of the strained political relationship between China and the US. Mutual antagonism has the potential to split the world into separate trading blocs and for nations to take sides and duplicate production with huge inefficiencies. But recent moves, notably speeches by Janet Yellen, US Treasury Secretary, and Ursula von der Leyen, European Commission President, have sought to reassure China that neither is trying to decouple their economies from the world’s largest manufacturer and slow China’s path to prosperity. Yellen’s remarks were also echoed by Jake Sullivan, Joe Biden’s national security adviser. This is positive progress and lowers what could otherwise be a big political risk.

5) China’s emergence from its zero Covid policy provides the fifth reason to look at 2023 with some optimism. China’s economy grew at an annual rate of 4.5% in the first quarter which was faster than expected with household consumption and domestic services leading the way. Although IMF officials chose to stress the negative aspects of this rebalancing, higher Chinese domestic consumption is exactly what the global community has asked of Beijing for decades. It raises living standards, reduces the chances of an over investment crunch and gives Chinese people more to lose if their government decides on a path of military aggression.

There is no doubt that 2023 will provide further economic hiccups for the banking sector and the US political impasse over its debt ceiling and persistently high core inflation are significant risks, but the year has started well and much better than thought possible a few months ago. The global economic landscape is pleasantly surprising and, along with the magnificence and mystical rituals of the Coronation of King Charles III, we all have a lot to be proud of and much to celebrate.

Stock Markets

To be a successful journalist you need to be a pessimist and to be a successful investor you need to be an optimist, but investment markets are serial monogamists, moving from one crisis to another.

In the last 15 years, since the Great Financial Crisis of 2008, we have seen multiple events, such as the eurozone crisis, Brexit, a pandemic, and more recently soaring inflation and yet investors have been handsomely rewarded for remembering that it is time in the market, not timing of the market which ultimately brings the greatest rewards. Each of these events subsequently proved to be a great buying opportunity for investors who could take a longer-term view than the next few months.

We are reminded of the need to be of a positive disposition when investing as, once again, we are surrounded by the negativity of the media and market commentators who, given the recent events in the banking sector, have a notable passion for describing what could go wrong and why the future looks worse than the past.

There is some logic in this. Pessimism always sounds wiser and more prudent than optimism. Most commentators wish to be remembered as the one who predicted the next crisis. Few remember the names of those who in March 2020 expressed optimism about the Covid vaccine developments. Or those who in the financial crisis of March 2009, highlighted that this was perhaps the best opportunity to buy equities in our lifetimes. Within investing, history remembers the pessimists, not the optimists.

Offering an optimistic view of the future in the face of the war in Ukraine, inflation at generational highs and significant uncertainty about the future path of interest rates and economic growth seems unwise. As an investor, being balanced and keeping an open mind are important characteristics to adopt. So, accepting that there are reasons to be concerned, here are some reasons for optimism that are perhaps underreported:

The global economy is proving to be resilient in the face of higher interest rates and a cost-of-living crisis. At the core of this resilience is low unemployment rates. For example, in the US, unemployment is only 3.5%, which is very low in a historical context. In the UK the unemployment rate is only 3.7%. Alongside this, major economic regions such as China (which is re-opening from Covid), and Europe (which has avoided an energy crisis – that word again), have proven to be stronger than was expected just a few months ago.
Innovation in the real economy continues apace. This comes in many forms: Space X and the James Webb telescope igniting a new generation’s interest in space exploration; Novo Nordisk providing the first medicine to fight the obesity epidemic; Microsoft developing new versions of artificial intelligence which can enhance productivity; and SSE building record amounts of renewable energy.
Across markets the message is that interest rates are nearing a peak, the damage of higher energy costs has been well contained and consumers have shown resilience. On the corporate front earnings and profitability have come in better than expected. Bond yields have fallen, and therefore bond prices have risen. The former has confounded concerns of a recession, the latter that inflation is out of control.

There is a risk that investors could miss the wood for the trees. Financial markets and the real world do ultimately correlate, but at any point in time one can overly dominate the narrative. Since January 2022, macro, negative, top-down stories have dominated micro, positive, bottom-up ones. When this changes, there may be some surprise at how much progress has been made by society, and the companies who operate within it.

Investing in the UK

Clarion follows a diversified global investment approach but just for now, we will look at the opportunities presented by investing in the UK market.

In recent years there has been something of a crisis (that word again!) of confidence in UK investing. There have been several well-written pieces discussing whether the UK is a market which will serve investors well in the coming years and decades.

The UK has some inherent benefits that have served it well for centuries. Geographically, the UK sits between the US and Asia, and next to Europe, the three big economic regions of the world. Its language is the most used in business, even if Chinese and Spanish are spoken by larger populations. Rule of law also exists to protect the rights of those who operate and live here. This trifecta of location, language and law, is a powerful one and has created, in London, one of the largest financial centres of the world. These advantages may ebb and flow, but they will continue to exist.

Let us then be optimistic about investing in the UK. Which is one of the foremost pharmaceutical and biotechnology companies and the leading cancer drug developer in the world? AstraZeneca. Which company is building the most offshore wind generation platforms in the world? SSE. Which company has bought a major US company, consolidating its world-leading position in pest control? Rentokil. Which company provided critical chemistry expertise to allow Pfizer to deliver its Covid vaccine to hundreds of millions of people? Croda.

One of the largest providers of data to the global financial sector is the London Stock Exchange. The UK is the largest net exporter of financial services in the world with a surplus of £63.7 billion in 2022, just ahead of the US with £62.5 billion. No one else comes close. Number three is Singapore with £19.4 billion followed by Switzerland on £18.6 billion.

It is puzzling that these success stories are not more acclaimed outside the City of London. The UK has so many areas of outstanding quality, including pharmaceuticals, education, the creative arts, high-tech, manufacturing, design and media that should be recognised and applauded.

Of course, there are always things that could be improved. Political instability has not helped the UK. It may also be possible to improve the attractiveness of the UK to early-stage businesses needing access to capital. We are optimistic these things will be improved and at some point, perhaps sooner rather than later, we may look back and realise that the demise of the UK investment market has been greatly exaggerated.

As we have said many times, sensible and structured diversification across a range of asset classes, sectors and geographical areas, holds the key to providing resilience and superior returns over the medium to long term. Allocating a reasonable percentage of an investment portfolio to UK equities and bonds is an increasingly important aspect of this diversification.

We thank you for your continued support and we look forward to updating you regularly throughout 2023. Please get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

May 2023

Creating better lives now and in the future for our clients, their families and those who are important to them.

Risk Warnings

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Any investment performance figures referred to relate to past performance, which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.