Archive for May, 2011
What is going on in Britain?
A few weeks ago this blog noted the underperformance of the UK equity market, and drew attention to falls in consumer confidence which set the country apart from its developed world peers. Was it possible that something about the UK economy was causing us to lag the recovery in the rest of the world?
Data released yesterday offered completely contradictory answers to that question. On the one hand, the Nationwide measure of consumer confidence failed to recover and remains at levels last seen in the teeth of the recent contraction. On the other hand, the monthly CBI survey showed rising optimism and buoyant order books in the manufacturing sector, and retail sales figures got a boost last month from the weather and the royal wedding.
So which data is right? Is Britain a country that will recover along with the rest of the world, or stagnate?
There is a way of reconciling the apparent contradiction between these different pieces of information – and it’s not hopeful. In a world where economic data largely tells us what happened weeks or months ago, confidence surveys are an exception in that they afford a glimpse of what might lie ahead (“leading indicators” in the textbook jargon). So while the CBI series and the retail sales data give grounds for hope today, weak consumer sentiment suggests a more difficult tomorrow.
Of course, recoveries are patchy things. In 1984, for example, confidence and growth both took a knock on the back of the miners’ strike, but recovery from the rather severe recession of 1980-81 soon picked up speed again to become the famous late 80s boom. Consumer nervousness could always turn round and see us “recover the recovery” in a similar way.
Today, however, a major strain on confidence is the squeeze on real incomes arising from modest wage growth in the face of relatively high inflation. There is no way of telling for certain how long this squeeze may last, though it has already proved far more persistent than the pickets of a generation ago and is expected to last a while longer.
Growth forecasts for the UK have already been revised down. Absent that turnaround in confidence, there is a chance that our growth blip could become a double dip.
There have been a few days recently where asset classes have behaved in an unequivocally bearish way: equities down, bonds up, commodities soft. Such movements remind us that this remains a reasonably fearful market.
There is, of course, much to be afraid of. The travails of the peripheral euro countries continue to make headlines. There have been signs that the pace of the recovery has slowed. Emerging economies have continued to pursue a programme of monetary tightening. Inflation is on the rise. And all this in the context of a year which has seen major exogenous upheaval: literally, earthquakes and revolutions. No wonder markets are anxious.
Not all of the concerns add up, however. How, for example, do fears over inflation and interest rates square with alarm over falls in the price of commodities? And is it not a little schizophrenic to blanch at the prospect of higher prices while dreading slacker demand?
Furthermore, some of these fears are demonstrably overblown. Yes, there are signs that growth has come off the boil in some economies, but that is absolutely not the same thing as renewed contraction. A “slowdown” in China, for instance, means growth of six instead of ten percent. And while some countries have raised interest rates, they remain historically low at a global level. Most developed countries still have negative real interest rates, and even in places where post-recessionary tightening began early, such as Australia or Brazil, policy rates remain low by historic standards.
Finally, some market prices are bucking valuation dynamics too. By all means fear inflation – but then why buy bonds? And while earnings growth has slowed from the breakneck pace associated with post-crisis recoveries, Bloomberg data for developed and emerging stock markets shows that reported EPS rose by over 6% during the first four months of this year – a creditable annualized rate of 19%.
Fears, of course, can turn out to be justified. But against the fundamentals as they stand, these recent bouts of funk do look rather overdone.
If you are reading this by the window, take a look outside. That object hurtling towards the ground at breakneck speed is the silver price. Six days ago, it peaked at $48 an ounce; at the time of writing an ounce is worth $34, a fall of about 30% (it has fallen 2.5% this afternoon alone).
The trigger seems to have been an increase in margin requirements for futures trading in America. This evidently led to an unaffordable drain on available cash for many participants who were forced to close out positions. It must also have deterred new entrants from putting in extra money.
There has been a knock on effect in oil markets (Brent crude is down about 12% since silver peaked), and to a lesser extent in equity markets and other commodities. Comment has accordingly focused on supposed investor nerves about the economic recovery.
On a longer term view the story is less concerning. Silver remains up on the year, as does oil. In the latter case, the fall in price has merely seen it return to levels consistent with the upward trend established during the second half of 2010 (i.e. before the “Arab spring”). And investors should expect high short term volatility in the commodity space as a matter of course. Precious metals may well be in a bubble at the moment, but we should be cautious about interpreting these events as a popping sound.
However, this blog cannot help but wonder if there might be someone standing underneath the silver price waiting to be squashed as it lands. Readers may recall that in the autumn of 2006 a $9bn hedge fund called Amaranth collapsed after losing $6.5bn in a month purely by betting on the price of natural gas. The fall in silver may end up amounting to nothing. But it may be a cause – and effect – of similar distress right now.
Amaranth’s demise had little external significance, and if there are similar casualties over the coming days and weeks they may well be similarly manageable. That said, being long of silver (and gold) is a crowded trade. Some investors have taken physical delivery of their futures positions for extra security: if everyone tried that, physical supplies of precious metals would soon run out as the face value of futures contracts is a multiple of what is available. And Glencore’s IPO prices in 13 days.
These are, as ever, interesting times …