Small steps towards a sustainable recovery

In the UK and continental Europe, economic data has been broadly consistent with the more gradual recoveries that most of the market expected

Andrew Miller
Andrew Miller

In the UK and continental Europe, economic data has been broadly consistent with the more gradual recoveries that most of the market expected. The main news from the developed world during the last month has been the marked disappointment in economic data from the US.

Two of our favourite US economic indicators – the Institute of Supply Management (ISM) manufacturing survey and retail sales – have fallen short of expectations, the former dramatically so. However, no indicator should be relied upon unthinkingly, and it looks as if the data has been affected by the severe weather that gripped much of the mid-west and eastern parts of the country.

We know that recessions do sometimes fall upon us from a clear blue sky, but, in our view, there simply hasn’t been the sort of economic excess in the current cycle to warrant a sharp slowdown yet.

As a result, the US Federal Reserve (Fed) and the Bank of England (BoE) face much the same challenge as the rate of unemployment in both regions has now reached levels at which both central banks had suggested they would consider raising interest rates.

We expect both to rethink their guidance as it is clear that neither central bank wants policy rates to rise. For us, ongoing withdrawal of economic support measures in the US confirms that this is still the most obvious phase of the business cycle to be invested in stocks. Admittedly, inflation has been soft, particularly in the UK, where inflation is back below target – and this is not a sentence I’ve written very often – but we doubt that deflation looms. GDP growth in the fourth quarter was driven by a combination of stronger investment and improved trade, while the rise in consumer consumption slowed from previous quarters. The breakdown of Q4 GDP painted an encouraging picture for the recovery as the composition of growth shifted toward a stronger contribution from investment and net trade, with less reliance on consumer spending. Household consumption growth slowed at the end of last year from the robust growth rates seen in previous quarters. If sustained, this composition of growth bodes well for the rebalancing of the economy on the domestic side as we are seeing demand supported by an acceleration of investment even as household consumption growth slows.

With the BoE recently reiterating its a bias towards continuing to support the economy, the bank also emphasised that its monetary policy stance will remain dependent on the state of the recovery. Our outlook in the UK economy and its stock market remains constructive, however, as we watch the turbulence that is taking place across the emerging markets, we are keen to remind readers that history doesn’t repeat exactly. It rhymes. Despite the parallels with the mid-1990s, we think the emerging world needn’t face crisis now.

Overall, we have preferred developed to emerging markets for quite some time tactically, but it has been a closer call of late and we doubt that such a pessimistic outlook is warranted. For one thing, the Fed is proceeding slowly, and very transparently, in marked contrast to 1994, and some relative disappointment at least is priced into emerging shares. It is noteworthy that the underperformance this time began well before the monetary normalisation, is closer to historical lows – lows that occurred after emerging market relative price performance had already begun to recover.

For sure, the current bout of emerging market nerves is not simply being driven by Fed tapering and the associated capital outflows that might accompany it. In several instances, extending beyond the so-called “fragile five” markets of Brazil, India, Indonesia, South Africa and Turkey, local political unrest and policy uncertainty has unsettled investors’ risk appetite.

:: By Andrew Miller, Barclays Wealth and Investment Management, Newcastle


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