It has been a while since we covered the UK in detail in a weekly note, but with inflation data, the Spring Statement and retail sales data all being delivered this week, the UK deserves some bandwidth.
The Spring Statement took centre stage on Wednesday, and the pressure on Rishi Sunak increased with the release of inflation data on Wednesday morning, which came in at 6.2%, the highest level in 30 years and ahead of expectations of 5.9%. The Spring Statement, in truth, did not provide too many surprises and the immediate effect on UK markets was muted. At an economic level, growth was downgraded from 6% for 2022 to 3.8%. While this growth level is still above trend, the impacts of inflation and Russia-Ukraine are expected to negatively impact growth. Data on Friday highlighted that the UK consumer may already be feeling the effect of higher prices, with retail sales falling 0.3% month-on-month and consumer confidence falling to the lowest levels since November 2020. We’ve frequently highlighted that UK equities have traded on a discount to their developed peers since 2016 (Brexit) and one likely outcome of this would be increased M&A activity. After lots of corporate activity last year, we saw Brookfield, a Canadian asset manager emerge as a potential bidder for Homeserve this week. Homeserve shares rose around 15% on the speculation.
European Composite Purchasing Managers’ Index (PMI), which is seen as a useful measurement of economic health, slipped slightly from the previous month, however, was still above expectations and showed the area was still in expansion territory. Digging a little deeper into the data, it appeared that supply issues continued to deteriorate, which could impact future European growth.
The US economy delivered mixed messages this week. Services and Manufacturing PMIs rebounded from last month and came in well ahead of expectations, however this was offset by declining durable goods orders and US business investment falling for the first time in a year. The data potentially highlights that the US economy may be slowing, which could lead investors to question whether the US Fed can be as aggressive in their planned interest rate hikes.
Unfortunately, there appeared little advance in any peace talks between Russia and Ukraine this week with the conflict continuing, deepening the humanitarian crisis. US President Biden was in Europe this week for talks with allies, and said that Nato would respond if Russia escalated to using chemical weapons in Ukraine. The West also promised more aid for Ukraine and increased sanctions on Russia once again, but stopped short of sanctioning Russian gas supplies into Europe. Many European nations rely heavily on Russian gas and the Belgian Prime Minister this week summed up the difficulties they are facing by saying “We are not at war with ourselves. Sanctions must always have a much bigger impact on the Russian side than on ours”.
Equity markets have in general continued to advance this week, despite what feels like an uneasy economic backdrop. At a stock level Apple recorded its eighth consecutive day of rising on Thursday as the tech heavy Nasdaq index rose nearly 2%. The S&P 500 has advanced in six of the last eight trading days as investors have begun to buy the dip following the sharp declines in markets earlier in the year. The recent success in equities has not spilt over into bond markets however, with developed government bond yields continuing to push higher this week. Continued hawkish language from the US Fed has led the market to now price in an additional 7 rate hikes (of 0.25%) for 2022.
Despite the sell-off in government bond yields, we continue to see merits in maintaining small allocations in portfolios for diversification benefits. Our view is that if we are to enter choppy waters ahead, these assets have the potential to perform well, and would likely offset some of the volatility we would see in equity markets. At some point we may even consider adding to these positions if prices continue to fall, as we are in effect buying portfolio insurance at a cheaper price, with a higher potential future payoff.
Andy Triggs | Head of Investments, Raymond James, Barbican
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