We moved through May with concerns of the possibility of a global recession as well as talk of stagflation and whilst neither may happen, I thought it might be useful to at least give you an idea of what both are.
Historically, a recession is typically when there is a significant decline in economic activity, which is generally determined by two consecutive quarters of economic decline reflected by a fall in the gross domestic product (GDP) of a particular country or region, in conjunction with monthly indicators such as rising unemployment and falls in retail sales and manufacturing output. GDP, if you recall from previous newsletters, is the value of all finished goods and services within a particular timescale and is a broad measure of a country’s economic health.
There’s no doubt that the current economic crisis, with inflation impacting in a big way on food and energy prices, is going to have a global impact and therefore recession has become possibility and this uncertainty is just what investment markets don’t like.
Taking stock markets out of the equation for a moment, the US Federal Reserve attempting to rein back inflation could ultimately result in a recession, although they are hoping for a soft landing, i.e. a period of monetary tightening not concluding in a recession. However, in 12 major tightening cycles since 1954, the Fed has managed to raise interest rates significantly without leading to recession on only three occasions.
One of the ways out of a recession is through governments adopting expansionary policies such as quantitative easing (increasing the money supply), government spending and decreasing taxation, most of which are heading in the wrong direction at the moment!
As to stagflation, this is a combination of stagnant growth and rising inflation and usually includes rising unemployment, however the unemployment rate for the majority of developed world remains low on an historic basis and in the UK it dropped to 3.7% for the first three months of this year, its lowest level since 1974, with job vacancies at record highs.
It would also be helpful if UK business investment could grow as this should help stimulate growth, however that fell by 0.5% in the first quarter, suggesting companies had held back from spending on new projects, this leaving business investment 9.1% below its pre-pandemic level.
The short-term outlook, therefore, is not too rosy and this has clearly been hitting investment markets which remain fickle and volatile and where very little is performing well at the moment. For those invested, it’s a case of holding your nerve and doing nothing, remembering you are investing for the long term . If you are taking an income, then you are already holding cash within your investments so don’t need to disinvest.
For those thinking of investing, whilst we don’t know where we are in relation to the bottom of this current market cycle, nor how long we will be experiencing this current volatility, there are some very good fund managers whose portfolios are currently undervalued and despite them holding shares in companies with good management teams, exceptional products and services in their particular market, with strong cash flows and strong balance sheets, these share prices are similarly undervalued, so this could well represent a good time to invest.
To paraphrase a saying of one the world’s richest men, the investor Warren Buffett, he recommended investors be fearful when others are greedy and greedy when others are fearful.
You will no doubt be aware that the Bank of England raised its interest rate for the fourth time in succession, with the Bank base rate now standing at 1% and their highest level since February 2009. The Bank is also forecasting that UK GDP could fall by nearly 1% in the final quarter of this year when the energy price cap is lifted again and where inflation could hit 10% by this autumn.
You will know from previous newsletters that I find the purchasing managers index (PMI) a useful measure of activity in particular market sectors and the UK services PMI dipped from 58.9 in April to a 15 month low of 51.8, while the manufacturing index slipped from 55.8 to 54.6, its weakest since January 2021, so whilst the UK private sector remains in positive territory, where a reading above 50 suggests growth, this growth has clearly slowed.
In the US, the Federal Reserve benchmark interest rate was raised by 0.5% to a target rate between 0.75% and 1%, the largest hike in rates since 2000.
In Europe, demand for German goods dropped 4.7% from February to March, driven by a decline in overseas orders and with Germany being the largest economic power in the Eurozone, it’s not surprising that the economic outlook for the region has weakened. It also showed retail sales falling in March by more than was expected as record high inflation and the war in Ukraine hit consumer confidence. Inflation in Germany hit a new record high of 7.4% in April, put down to food and energy prices.
In China, where as you may know they have a zero tolerance for dealing with covid, the expected one-week lockdown in Shanghai eventually ended after nine weeks and this has had a big hit on the region where export growth fell to 3.9% year-on-year, its weakest reading since June 2020, whilst the purchasing managers index survey for China’s service sector fell from 42 in March to 36.2 in April, its second steepest drop in activity on record, whilst retail sales fell by 11.1%, though none of these figures are surprising when you factor in the impact of their covid restrictions.
As many of the world central banks are tightening financial packages, China is to roll out a broad package of support measures to help businesses and stimulate their economy as it seeks to offset the damage done by the recent outbreaks and subsequent lockdowns. In all, there are 33 measures being introduced. This could help stave off global recession.
UK inflation hit 9% in April, helped by the removal of the energy price cap and was further stoked by the inflationary aspect of the war in Ukraine and other supply chain disruptions caused by Brexit and the covid lockdowns in China. Thankfully, the UK Chancellor has announced a £15 billion package of fiscal measures to help curb the cost of living crisis, whilst also announcing an “energy profits levy”, with oil and gas companies facing an additional 25% tax on profits.
The UK now has the highest consumer price index inflation (CPI) rate in the G7. Why is this? Well, the UK is a large net importer of goods and is much more reliant on them than our counterparts across the pond and on the continent and this means the economy is susceptible to exchange rate swings and thus inflation. Moreover, as the economic outlook turns bleaker, the pound isn’t as attractive for investors as the dollar, though ours is not the only currency this is happening to. The dollar is considered a safe haven in times of economic crisis and its value has been buoyed further by the hawkish stance of the US Fed where it has suggested that interest rates could increase several times this year, making dollars more attractive to buy.
US inflation dipped slightly to 8.3% and whilst being close to a 40 year high, they did have a month on month rise in retail sales of 0.9%.
Unsurprisingly, Ukraine’s finance minister suggested the country’s economy would shrink by 45% this year, though said that his government is committed to servicing its debts in full. As one of the world’s major wheat suppliers, it’ll be interesting to see how much of their crop they can export this year, which in turn should give farmers incentives to plant again for next year, hopefully helping to ease some of the global food problems and other inflationary pressures.
Let me finish with the UK housing market which remained strong in May and whilst prices were rising again, the Nationwide Building Society suggested there may be the first signs of cooling off, this because the annual rate of price growth dropped to 11.2% in May from 12.1% in April and this modest slowdown was seen as evidence that steam could be coming out of the housing market. Robert Gardner, the Nationwide Chief Executive, said that they expect the housing market to continue to slow as the year progresses with household finances remaining under pressure.