Quarterly Economic Review – July 2014

Welcome to the first of our Quarterly Economic Reviews.

As Harold Wilson once said, “a week is a long time in politics”, but maybe a week – or even a month – isn’t such a long time in economics. In these quarterly bulletins we want to do more than simply report on the facts: we want to give you more of an overview of what’s happened in economics and on the various world stock markets that we’ll cover.

We’ll look at events in the UK, Europe, the US, the Far East and the world’s major emerging economies. We’ll also add specific comments on some of the key issues affecting these areas and we’ll try to explain any of the technical terms that we’re forced to use.

One word of caution before we start. This review should be seen as comment only. It’s not here to provide investment or financial planning advice and it shouldn’t be read as such – if you’d like to discuss either of those issues then, as always, we’re only a phone call or an email away. The Bulletin is simply intended to be interesting and to give you some background information on the events that shaped the markets during the last quarter.

Right: to business…

The UK

It’s easy to forget that when George Osborne stood up to deliver his Budget speech in March 2013 there were real fears that the UK was heading for a triple-dip recession. A year later, the Chancellor was able to deliver a much more confident “Budget for makers, do-ers and savers” as he unveiled the most radical overhaul of the UK pensions system for a hundred years. There were also major changes to the Individual Savings Account regime, with the new rules – and higher allowances – coming into effect on 1st July.

(If you have any questions on the changes to either pensions or ISAs – and on how they might affect your own financial planning – then, as always, please don’t hesitate to contact us.)

The other big political event in the UK was the election for the European parliament in May. This was widely seen as a triumph for UKIP and a disaster for the Lib Dems, with the Conservatives and Labour desperately trying to put a positive spin on disappointing results. We’re now less than a year away from a General Election, and at the moment those fonts of all knowledge – the bookmakers – have the Conservatives as favourites to gain the most votes but Labour as favourites to gain the most seats.

This time next year we expect to be writing about the ‘new coalition Government’ – but how that coalition will be made up is currently anybody’s guess.

Traditionally, business and stock markets dislike uncertainty. At the moment, business confidence in the UK is good – as confirmed in surveys by both the CBI and the British Chambers of Commerce – and the factory output figures indicate one of the strongest periods of growth in the last 22 years. The stock market however, is stuck in the mud. The FTSE-100 index closed 2013 at 6,749 and closed June at 6,744 – down five points in six months. Contrast this with the US where the Dow Jones index has reached an all time high, going through 17,000 for the first time, despite – as you’ll see below – the economic news being far from rosy at times.

The other big story in the UK which ran through the second quarter of the year was the continuing rise in house prices, particularly in London and the South East. The latest figures show that the average house now costs 9.9% more than it did a year ago – and in London that figure leaps to 18.7%.

Bank of England Governor, Mark Carney, has recently written that the Bank will not hesitate to take “proportionate action as [it is] warranted.” You don’t need to be an economic genius to work out that this means interest rate rises, with most commentators expecting them to start moving upwards before the end of the year.


As many of you will have seen, David Cameron has managed to fall out with most of Europe over the election of Jean-Claude Juncker as the next President of the European Commission. Cameron cites the recent elections as evidence that it is no longer ‘business as usual’ and hence the need for someone new and different.

Europe’s leaders take the view that it is business as usual and Mr Juncker will do very nicely, thank you. It’s difficult not to have some sympathy with the Prime Minister when the elections for the European parliament saw the rise and rise of extremist parties all over Europe, including the spectacular success of Marine Le Pen’s Front National in France.

Maybe the ‘business as usual’ attitude was best summed up by Christian Schulz, senior economist at European equity specialists, Barenberg. “The Eurozone is on track,” he commented. “In the absence of any major geopolitical or financial stability accidents it should not require a large financial stimulus to keep going.”

As he was speaking, pro-Russian and pro-Ukrainian forces were having a little “geo-political accident” little more than 1,000 miles away. As Google maps helpfully tell us, you can drive from Berlin to Kiev in around 15 hours (in ‘current traffic conditions,’ obviously). In geo-political terms, that’s round the corner.

With the dispute in the Ukraine going to rumble on for some time – and with Russia controlling a significant percentage of Europe’s gas supply – it seems bound to impinge on ‘business as usual’ sooner or later. And contrary to Herr Schulz’s optimism, there were real fears of deflation by June as inflation in the Eurozone fell to 0.5%, meaning that yes, a large financial stimulus might indeed be needed.

The winter of 2013/2014 was unusually mild and – as if one were needed – this gave a boost to the German economy as consumer spending remained high through the winter months. The German DAX index closed June 2014 at 9,833 – up 23.5% on June 2013 as the country maintained its economic progress.

German manufacturing continues to prosper and figures for April confirmed that the country’s trade surplus had widened again – up from €16.6bn in March to a five month high of €17.4bn. Compared to the previous month, exports were up by 3% to a total of €93.8bn.

Trade Surpluses and Deficits

You’ll see us commenting a lot on trade surpluses and deficits in these Reviews. What are they? And why are they important?

A trade surplus is exactly what the name suggests – a country has exported more goods than it has imported. So in May 2014, China had a trade surplus of $35.9bn and Germany had a surplus of €17.4bn.

A trade deficit is exactly the opposite – the country has spent more on imports than it has received for exports. The most spectacular example of this is the United States, with its deficit of $44.4bn in May.

Does it matter? After all, if US consumers can afford to pay for their flat screen TVs, does it matter where they’ve come from? The economic theory used to be that trade surpluses and deficits would correct themselves in the long run – but that doesn’t now appear to be the case. China looks like it will always have a trade surplus and the US like it will always have a deficit.

Ultimately – if we just look at the China/US relationship – China is stockpiling dollars in its foreign currency reserves. This will eventually give China a measure of control over the US currency. Were it to sell the dollars it would force the value of them down, eventually making the flat screen TVs even more expensive.

Whilst the outcome of having a deficit or a surplus is far from certain, it seems a reasonable conclusion that, in the long run, you surely can’t run a trade deficit indefinitely without adverse consequences at some point.

The other major European economy, France, fared less well in the quarter, although there were encouraging signs in June as unemployment and inflation remained steady and the trade deficit narrowed slightly to €3.39bn. (To put that in perspective the most recent figures put the UK trade deficit at £2.5bn.)

Other major European news centred on Spain where King Juan Carlos abdicated in favour of his son King Felipe VI, the economy finally showed some signs of recovery and Poundland opened their first shop. Should you need some inexpensive Factor 12, the store is called ‘Dealz’ and is in Torremolinos.

United States

At the beginning of July, the Dow Jones index reached an all-time record high, going through the 17,000 barrier for the first time as good news on jobs was released, with unemployment falling to 6.1%. The market is up 14% on a 12 month basis and yet the news has been far from universally good.

At various stages over the past twelve months, President Obama and Congress have come perilously close to failing to agree on a Budget, a ‘federal shutdown’ has loomed as the Government has nearly run out of money and the country continues to have a trade deficit of around $40bn every month. Every two years, the United States adds $1tn of debt.

Is this sustainable? In the short term the answer appears to be yes – whether it is sustainable in the long term as more and more American manufacturing jobs are exported to China is very much open to question.

For now the job of guiding the US economy rests with Janet Yellen, who has replaced Ben Bernanke as Chairman of the Federal Reserve. Having taken over in February and saying that she would continue with her predecessor’s stimulus package “for as long as necessary”, Yellen is now gradually reducing the amount pumped into the economy each month as, hopefully, the US starts to recover without Government help.

What we’re gradually seeing in the US is a move from the old economy to the new economy. In the past twelve months, the city of Detroit – formerly the centre of the US automobile industry – has filed for bankruptcy, whilst a host of companies that have never manufactured so much as a single hubcap (or even made a profit) are valued in the billions. Is that sustainable in the long run?

Far East

As the US has a trade deficit every month, so China relentlessly records a surplus – the figure for May was a five-year high at $35.9bn.

At the beginning of March, the Chinese Government announced a target of 7.5% economic growth for the next 12 months. At the time, the target was seen as ambitious and there were real fears that the Chinese economy was starting to slow down – although it’s important to note that a ‘slow down’ in China is a rate of growth the West can only dream about.

However, the Central Bank introduced some stimulus measures and at the beginning of June it was confirmed that the Chinese service sector had grown at its fastest pace for 6 months, with the non-manufacturing Purchasing Managers’ Index up to 55.5 from 54.8.

The Purchasing Managers’ Index

The Purchasing Managers’ Index (PMI) is best described as a measure of confidence in future economic prospects. It’s a survey taken every month among private sector companies and, as the name suggests, it’s the purchasing managers of those companies that are surveyed for their future buying intentions.

The results are expressed as a figure: any figure above 50 represents overall positive feelings from the relevant managers about future prospects, and any figure under 50 represents negative feelings. Very broadly put, above 50 and the economy is going to expand: below 50 and it’s going to contract. So if we say, ‘May’s PMI increased to 55 from 54 in the previous month’ it means that the purchasing managers were confident in April – and they were even more confident in May.

You may also see a reference to the manufacturing or non-manufacturing PMI. The monthly survey is broken down by sector, so you may sometimes have a month where say, the purchasing managers in the manufacturing sector are feeling confident, but those in the service sector are feeling rather more pessimistic.

Later in the month, figures were released showing that manufacturing activity in China had grown at its fastest pace for the last six months – a clear indication that the stimulus measures had worked. Again, the PMI moved in the right direction, up to 51.0 from 50.8 in May as confidence increased.

As you may have seen on the news, a high powered Chinese trade delegation – led by Premier Li Keqiang – touched down at Heathrow recently. There were representatives of nuclear power, solar power, telecommunications, financial services and car manufacturing on board, all apparently keen to invest in UK plc and deliver infrastructure projects we’re now seemingly incapable of delivering ourselves.

The other big news for China was the signing of a gas deal with Russian company Gazprom. The 30 year, $400bn deal will see Gazprom deliver Russian gas to China which may in the long run mean higher prices for European consumers who are becoming increasingly dependent on Russian gas.

The other Far Eastern countries/stock markets which we’ll cover in this Quarterly Review are Japan, South Korea and Hong Kong – although China is very much the driver of economic activity in the area. Last year, the Japanese stock market enjoyed a stellar year, and was easily the best performer of the world’s major markets. This year it has lost some of those gains – down 7% since the beginning of the year – and despite their impressive trading performances, the Chinese and South Korean markets are also down slightly in 2014. The Hong Kong market has remained resolutely unchanged throughout the year and at the time of writing was 80 points down on the level at which it started the year, a fall of less than 1%.

Emerging Markets

In this section, we’ll concentrate on the world’s three major emerging economies – Brazil, Russia and India, which together with China make up the so-called BRIC nations.

Brazil’s year has so far been marked by civil unrest at the cost of the World Cup and the 2016 Olympics – but in the event the World Cup seems to have largely been a success for the nation, both on and off the pitch. Whether the tournament will provide any benefit to the millions who live in poverty is doubtful though, and it would be no surprise to see the unrest start again as the last VIP boards his plane…

The big event of the year in India was the general election as the world’s biggest democracy took to the polls, with victory going to the Hindu nationalist Narendra Modi. The country is rapidly emerging as the star performer among this year’s stock markets, and the index rose another 5% in June to 25,414 – up 20% on a year to date basis. Brazil is up by a much more modest 3%.

Russia’s interest in the Ukraine has been well documented and the invasion (or democratic decision of the Crimean people, depending on your viewpoint) initially brought forth dire warnings from the West. The threat of economic sanctions sent the stock market tumbling and the country into recession. But by June, Russia was posting a healthy trade surplus of $19.7bn – the highest for two years – with the stock market recovering all the lost ground.

The simple fact is that Russia has the gas the Ukraine and Europe needs: there may be a lot of bluster in the future as Vladimir Putin pursues his ambitions, but a cold winter will quickly bring the West to the negotiating table.

And that is that for the first of our Quarterly Economic Reviews. We hope you’ve enjoyed reading it – we should maybe have warned you to make a cup of tea or pour a glass of wine at the beginning – and it goes without saying that if you have any questions on any of the points we’ve made then don’t hesitate to get in touch with us. We’ll be back in September: see you then.