Stock Market & Economic Commentary - September 2024

“If you never want to be criticized, for goodness’ sake don’t do anything new.” – Jeff Bezos Founder and Executive Chairman of Amazon.

Economic Update

One of the long-running criticisms of the UK economy is that it is too dependent on consumer spending. Britons, so the argument goes, are too eager to borrow and spend and don’t save enough. For most of the last half century, consumer spending has indeed outpaced wider growth in the economy. No longer!

Ever since the pandemic, consumer spending has grown more slowly than the wider economy. Despite a strong recovery in activity this year, consumer spending remains lacklustre. In the first six months of the year, GDP expanded at twice the rate of consumer spending.

Britons seem to have acquired the savings habit. Households saved 11.3% of their income in the first six months of this year, according to the latest data. Outside of the pandemic, when lockdowns restricted people’s spending and enforced high levels of saving, this is a level of saving more normally associated with recessions or big squeezes on consumer spending. The old characterisation of spendthrift Britons looks out of date.

A move to a more sober UK consumer has been a long time in the making. In the wake of the financial crisis of 2008-10, regulators tightened criteria for mortgage lending which accounts for roughly 90% of all consumer borrowing. With mortgages harder to come by, consumer borrowing slowed, reversing the seemingly inexorable rise in the burden of debt. The ratio of consumer debt to GDP hit a peak of 110% in 2010, since then it has dropped to 80%, a 20-year low.

The pandemic added another major dampener to consumer spirits. Consumer spending dropped at record rates and savings surged. Consumer activity recovered from mid-2020 but at a slower rate than the rest of the economy. While GDP today is 2.3% higher than on the eve of the pandemic, household expenditure is 1.3% lower. In the last four and a half years British growth has been driven by government spending and investment, not by consumers. Unlike the US, where consumers seem to have spent their pandemic-era savings, Britons are hanging onto them. How can we explain the difference in behaviour?

Most of the pandemic-era surge in savings in the US was a product of the federal government handouts and increased welfare payments. In the UK, savings rates rose because consumers made big reductions in their spending. (British consumers cut spending by 25% in the first six months of the pandemic; over the same period US consumers reduced spending by just 10%.) The Office for National Statistics (ONS) suggests that US consumers saw excess savings as a windfall gain to be spent in an economy that had seen a strong recovery. In the UK, higher savings were harder earned and, against a backdrop of a lacklustre recovery, consumers held onto them.

Not only are consumers hanging onto past savings, but they are also continuing to save an unusually high proportion of what they earn. More than three years after the ending of all pandemic restrictions, levels of savings are, according to the ONS, running at 11.3%, more than three times US levels.

It is indicative of the change in mood that homeowners are paying down mortgage debt. Through the 1980s, 1990s and early 2000s, homeowners tended to borrow against their property, using their homes as security for low-cost credit which was often used for home improvements or major purchases such as buying cars or holidays. Twenty years ago, in the first quarter of 2004, households borrowed the equivalent of 6.9% of their total post-tax income, a huge amount, through so-called mortgage equity withdrawal. For years this form of borrowing functioned as a major factor in driving consumer spending and growth. Since the financial crisis, mortgage equity withdrawal has gone into reverse. Consumers are using their savings to pay down mortgages. In the fourth quarter of last year, repayments of mortgages hit an all-time high, equivalent to 5.3% of GDP.

What conclusions can we draw from all this?

First, the UK household sector balance sheet is now in better shape than it has been for years. Debt levels are down, savings rates are up, and consumers seem to have held onto much of the money they saved in the pandemic. This strengthening of balance sheets means that the UK is likely to be less prone to boom-bust cycles.

Second, despite a stronger overall position significant numbers of households are in a fragile state. Lower-income households have few, if any, savings, or assets. Rising house and equity prices don’t help them. Soaring prices, especially for food and energy, have hit low-income households hard. Meanwhile, mortgage payers face a continued feed-through of past interest rate rises to their monthly bills. Earlier this year the Resolution Foundation noted that levels of food poverty and material deprivation have risen in recent years. There are a record 2,900 food banks in the UK.

Third, a period of sustained growth in consumption is in prospect. The economy is on a recovery path and lower inflation is boosting real incomes. With the economy growing and interest rates heading down, consumers are likely to cut back on saving and spend more. Yet, UK consumers are unlikely to give up on the more sober habits of recent years. A return to the sort of consumer booms of old seems unlikely.

Stock markets, and other matters of interest!

“Both optimists and pessimists contribute to society. The optimist invents the aeroplane, the pessimist the parachute.” George Bernard Shaw 1856-1950. Irish critic and playwright.

The cooler days and longer nights of Autumn bring a time for reflection and for taking stock of the major developments over the summer months.

The latest forecasts from the International Monetary Fund (IMF), published in July, are reassuring, showing the global economy in a holding pattern with year-on-year growth running around the 3.0% mark seen last year. The IMF’s forecasts assume this ‘steady as she goes’ pattern of activity will continue through 2025. However, this serene characterisation of the state of the global economy belies the more messy and turbulent stock market moves over the summer months.

Global equity markets went into a brief meltdown in early August with the Japanese market down a remarkable 23% from its July high. The damage in the US was on a lesser scale, but significant, with the US S&P 500 having its worst day since 2022. The panic was motivated by worries about the US falling into recession and reinforced by a sharp sell-off in semiconductor stocks as investors cooled on the prospects for AI.

Those worries eased through August, and by the end of the month, global equities had largely made up their earlier losses. However, with a touch of déjà vu, bouts of panic returned in early September, with stock market volatility hitting the high notes once again.

September is historically a challenging month for stock markets often dubbed the “September Effect.” It’s as if the market takes a page from nature, shedding some of its exuberance like trees shedding leaves in autumn. True to form, September 2024 was no exception, though it added an extra dose of drama with the US S&P 500 index having, in rapid succession, its worst and best weeks of the year.

Fears about the state of the US economy are fuelling this extreme volatility. Recent data highlights that the biggest risk to a soft landing is a weakening in consumer spending, triggered by rising unemployment. Over the summer months a raft of consumer-facing companies, including Disney, Hilton Hotels, Airbnb, and Proctor & Gamble reported a slowing of US consumer demand. The question on investors’ minds is whether this slowdown will turn into something much worse.

Lower US interest rates will help reduce the risk of a hard landing. And, with wage pressures easing faster than expected, Jay Powell, Chairman of the Federal Reserve, scored a big win on 18 September when the US central bank started its rate-cutting cycle with a bang, chopping half a percentage point off the interest rate benchmark.

Typically, a cut of that magnitude is a distress signal to markets – a flag that the economy is in dire shape or that the central bank knows it is cutting rates too late in the economic cycle. Powell, however, convinced investors that this was a luxury decision. The bank cut hard because it can. This piece of deft central bank speak succeeded in not spooking the horses. Equities and bonds held their cool, and the day following the decision, the S&P 500 index hit a new all-time high for the 34th time this year.

Now, the common assumption is that this rate cut, the start of a long series of cuts judging from the Feds messaging, will prompt a huge wave of cash to spill onto the shores of risky markets, particularly the equity market.

For the past two years asset managers have been saying it makes no sense to hold high levels of cash in the immediate run-up to the rate-cutting cycle. When cash piles kept building up anyway, they said that outflows would start as soon as rates started to fall. Well, the day has finally arrived, so if the pundits are correct, all that cash sitting on the sidelines is about to find its way into stock markets. The Bank of America estimates that $6 trillion is held in money market funds waiting to be invested, but nowadays that is less than the market capitalisation of two Apples. So, even if we do see a tsunami of cash flood the equity market, it might not make that much difference anyway.

A note from past Commentaries.

“Central banking, in the final analysis, isn’t usually very interesting. If central bankers are doing their job well and all else is well, then nobody should notice the largely technical decisions they take. Big surprises and battles between hawks and doves are often over-hyped narratives produced by the financial press.

But in recent years, more and more people have taken ever closer notice of what central bankers are up to. Their role and their power within the economy, and their accountability, has provoked anger both from the progressive left and the libertarian right. That in turn is because all is not well, for the reasons we know about, and monetary authorities have been delegated to act as firefighters. So, the job is more exciting than it used to be.”

I wrote this piece in November 2021 when investors were worried that central banks would be forced to increase interest rates to dampen inflationary pressures. It’s rather funny that now we have gone full circle and interest rates are heading down, investors are still focused on how central bank decisions will be influenced by the ongoing stream of economic data.

Some things never change; investors worry when interest rates are going up and they worry when interest rates are coming down. Stock markets, as they say, climb a wall of worry so as always it is better to ignore short-term noise and focus on the long term.

Trump or Harris

The ups and downs of stock markets are nothing compared to the shifts in US political fortunes. Donald Trump’s 3.0% lead in the average of national polls in late June has swung to a 1.9% lead for Kamala Harris. The Economist’s model, based on national polls and economic indicators, places a marginally greater chance of the Democrats securing the presidency. Betting on the outcome of the presidential election is not legal in the United States, but non-US betting markets show Trump marginally ahead among punters. The vote, on 5 November, will hinge on the outcomes in a handful of swing states and is likely to be close. Perhaps the second assassination attempt on Mr Trump will influence the more fickle voters.

The UK and Europe

The UK economy has performed a Lazurus-like recovery, going from recession in the second half of last year to being the fastest-growing economy in the G7 in the first half of this year. So far this looks like a textbook recovery, with little sign of the excesses in the consumer sector that often bedevil previous recoveries. This momentum faltered over the summer, but a survey of Chief Financial Officers by Deloitte’s conducted in the immediate aftermath of July’s general election, showed a sharp drop in perceptions of external risk and rising levels of confidence and risk appetite. According to the Purchasing Managers’ Index, economic activity has picked up again and points to a continuation of the recovery throughout 2024 and into 2025. Inflation has fallen to just 2.2% and core inflation and wage growth have eased allowing the Bank of England to cut interest rates in August.

Despite the good economic news, the new Labour government has struck a sombre tone on the economy. Over the summer the government warned of a £22bn ‘black hole’ in public finances, with the prime minister saying the budget on 30 October would be “painful”. Mr Starmer said that those with the broadest shoulders should bear the heaviest burden, fuelling speculation that tax increases will exceed the £9bn of tax rises in Labour’s manifesto.

And with the recent announcement that public debt has reached 100% of GDP for the first time since the 1960s, the stage is set for tough decisions on welfare and spending cuts as well as “painful” tax rises. In a foretaste of the decisions that may lie ahead, the government announced that it plans to end winter fuel payments for the 10 million pensioners who are not on means-tested benefits, a measure that will save £1.4 billion this financial year.

It would not be out of character for a newly elected government in the UK to raise taxes. The Economist estimates that, since 1978, British governments have increased taxes by an average of 0.5% of GDP, equivalent to £14 billion, in their first year in office. In the 1979 general election the Conservatives denied Labour claims that it planned to raise VAT. In his first budget, just five weeks after the Conservatives had won a landslide victory, the new Conservative chancellor of the exchequer, Sir Geoffrey Howe, raised the main rate of VAT from 8% to 15% (he also, however, cut rates of Income Tax).

The EU is seeing a weaker recovery than in the UK. Germany remains in the doldrums, and its economy contracted in the second quarter. German business sentiment deteriorated over the summer, leading the IFO Institute to warn that Germany is “stuck in a crisis.” France and Italy are doing rather better, but Spain is the real outlier, with tourism driving faster growth than in both the US and the UK in the second quarter.

Inflation in the euro area eased to 2.2%, prompting the ECB to cut rates by 0.25bp in June followed by a further cut this month.

Japan

Japan has also been in the headlines in recent months. The stories have been centred around wild movements in the Japanese yen. Until the middle of July, the yen had been depreciating remorselessly, especially against the US dollar. The USD/JPY rate moved from around 141 at the beginning of the year to 162 at its peak in July (a rising USD/JPY indicates a strengthening US dollar, weakening yen and vice versa).

The weakness in the yen had been reinforced by the so-called ‘yen carry trade,’ where traders would borrow in yen at ultra-low rates, sell the yen for other currencies and invest in assets in those currencies at higher rates of return. The weakness in the yen boosted returns to this trade even more. But In July, the Bank of Japan hinted at a minor tightening shift in interest rate policy, and this caught many leveraged investors off guard. The yen rallied causing losses for these investors, who scrambled to cover their positions, exacerbating the moves. Trading was wild for a few days while this played out. Japanese equities were hit hard in yen terms, although much less so when measured in dollars or sterling. After bouncing in August, the yen has continued to strengthen into September to the extent that it has now reversed all the weakness of the first half of the year. Much of the continued momentum has come from the US side of the equation, with the Federal Reserve now cutting interest rates making the carry trade less profitable.

China

China faces a series of economic challenges and is growing only slowly. Excess industrial capacity, falling house prices, weakness in the banking system, deflation fears and the hangover from the pandemic are weighing on activity. Over the summer, Chinese consumer confidence continued to run at Covid-era lows. Foreign investors have cooled on China, and in the second quarter, foreign investment in China dropped to an all-time low. It’s hard to gauge the exact pace of growth in China – as the Economist observed recently, “the government is widely believed to be massaging data [and] suppressing sensitive facts” – but foreign economists have been trimming their forecasts for Chinese GDP growth.

Weakness in the Chinese economy is feeding back into the rest of the world, dampening demand for imports and for commodities. Iron ore and copper prices fell over the summer months and oil prices are running at 20% lower than a year ago. Manufacturing production is weak across the world, but especially in Germany.

So how can one sum up the state of the global economy?

The good news is that inflation has continued to abate and interest rates in the West are on a downward trend. The world economy is growing at a steady pace and is likely to do so through next year. But the picture varies across countries: the US economy is cooling, slowly; a weak recovery is coming through in Europe, with Germany stagnating. The UK is outperforming, and China faces a series of headwinds. Worries about whether the US can achieve a soft landing, and about China’s economic prospects, are likely to remain at the forefront of investors’ minds.

As always, we thank you for your continued support and we look forward to updating you regularly for the rest of 2024 and beyond. Please get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

September 2024

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Risk Warnings

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.

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.

Stock Market & Economic Commentary – September 2024