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Watch out for a return to fundamentals

Watch out for a return to fundamentals

Joshua Roberts Weekly bulletin April 2019
For a significant proportion of the last few years, it has been possible to discuss UK market movements without much recourse to fundamentals. As we begin another week in which the turmoil in Parliament is set to dominate headlines, the reason for this is pretty clear. Market participants are not ignoring the underlying economic reality. But the consensus view seems to be that monthly data releases matter less than the day to day noises emerging from Westminster on how the Brexit impasse might be broken.

There is a case to be made for this being a rational position. It is true that any given day’s headlines are unlikely to be particularly helpful for forecasting the UK’s future relationship with the EU (blame the interminable U-turns of relevant MPs as appropriate to your political persuasion). Nevertheless, that future relationship will of course have a huge impact on how the economic fundamentals develop, so arguably this should be weighted more highly than the most recent data release when making trading decisions.

It’s a persuasive argument, but one that is starting to outlive its usefulness. And for one key reason: while the form that Brexit will ultimately take may still be uncertain, its economic impact has already started to materialise in concrete, measurable ways. Last week, the IHS Markit/CIPS Purchasing Managers’ Index (PMI) showed the services sector as a whole contracting for the first time since July 2016, while new orders fell at their fastest rate since the peak of the financial crisis. With services making up around 80% of the UK economy, PMI data is one of the better indicators of how GDP is likely to develop in the coming months. On a more prosaic level, it is also a good barometer of demand for sterling: services are a significant contributor to total UK exports, and are also strongly linked to the level of foreign investment. When orders for services firms decrease, sterling exchange rates start to look more vulnerable.

If this appears to paint a fairly grim picture, it is because the dysfunctional behaviour of our elected representatives has also managed to obscure much of the good news in the UK economy. At 3.9%, the unemployment rate is currently at its lowest level since 1975. Wage growth stands at 3.4%, just off its highest level since the financial crisis and comfortably above the current CPI inflation rate of 1.9% – which, incidentally, is almost exactly on target. Meanwhile, the ever-present worry that robust figures represent a boon only to those at the top is, in this case, misplaced: last summer, income inequality in the UK fell to a 30-year low.

More importantly, there is good reason to believe that the stall in services and investment will turn out to have been a temporary blip, whatever the eventual outcome of Brexit. The Markit/CIPS survey highlighted that a key reason for the fall in orders was a reluctance by firms to commit capital while the future regulatory and trading environment in the UK is still so unclear. Crucially, though, a significant part of that reluctance appears to be due to uncertainty in how best to deploy investment, rather than whether or not to deploy it in the UK. As soon as there is some clarity over what a post-Brexit UK will look like, it would be reasonable to expect a boost resulting from the release of pent-up capital.

The point is that, however exceptional the circumstances, markets cannot stay unpegged from economic fundamentals forever. In all likelihood, the UK’s political crisis still has a long way to run. But despite (or, indeed, because of) the sheer intractability of the current impasse, we are at last nearing the point where the range of potential Brexit outcomes will be narrowed down. Whatever your view on the options that remain, a significant source of uncertainty will be removed. In turn, that reduction in political uncertainty should reassert the importance of concrete data over the latest Downing Street briefing. To misquote Churchill, we may not be at the end, nor even the beginning of the end – but we are, perhaps, at the end of the beginning.

For more information, please contact Joshua Roberts, Associate Director at Chatham, at jroberts1@chathamfinancial.com.


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