How UK banks went from Big Bang to universal failure

It all started with the Big Bang in 1986. That was Margaret Thatcher’s attempt to shake up the cosy relationships in the City of London and build a globally competitive financial services industry of which the country could be proud. The old separation between brokers and jobbers (market makers), and between retail and investment banking, were dismantled and cleared away – without much consideration of whether there were sound reasons for these divisions to exist, like Chesterton’s Fences.

Retail banks such as Lloyds, Barclays and Midland were allowed, if not encouraged, to own stockbroking firms. The likes of de Zoete Wedd, Hill Samuel and Samuel Montagu were bought by UK retail banks. Other brokers such as Phillips & Drew, Warburg’s and Smith New Court were bought by large investment banks from overseas. UK banks expanded into new territories and built empires where the sun never set. Banks attracted a new breed of rocket scientists and physicists to help them price complex derivatives. A new model emerged: “universal banking”, implying a bank could do everything under one roof. London became a centre of global financial competition. 

The Big Bang was good for London as a financial centre, but there were two questions no one thought to ask: was it good for customers, and was it good for shareholders? The answer to both questions is an uncontroversial “no”.

Few benefits for customers

Barclays’ fixed-income division may have risen up the corporate-bond underwriting league tables, but it is hard to see how this brought any benefits to a Barclays current-account customer, for example. Even for retail banking products, having a current-account relationship with one bank doesn’t mean a better mortgage deal or cheaper home insurance. It is almost always true that customers do better to look at the best-buy tables than trust their bank to cross-sell to them. This is especially true of mortgages, where high house prices mean a large mortgage over 30 years is very sensitive to the interest rate offered, and hence customers would be mad not to go to a mortgage broker to find the best deals on offer. The same logic applies to credit-card customers, driven by eye-catching balance transfer rates. So using current accounts to cross-sell additional banking products has proved more difficult than universal bank management would like to admit.

It is even harder to see how a customer of what was once Midland and is now part of HSBC benefits from the parent company’s high market share in Hong Kong, let alone the ill-advised expansion into Mexico, Brazil, Argentina, or risky US subprime mortgages. It is patently ridiculous to claim that HBOS, the UK’s biggest mortgage lender, was somehow helping local borrowers in Halifax by also lending money to fund the buy-out of M Resort Spa Casino in Las Vegas in the run-up to the global financial crisis in 2007-2009. Indeed, HBOS’s management were securitising their high-quality UK mortgages and selling them in financial markets, and replacing these assets with collateralised debt obligations (CDOs) sold to them by US investment banks, which contained packaged up lower-quality US subprime mortgages.

No economies of scale

Aside from customers, the universal banking model has not been kind to shareholders either. The UK banks have underperformed the FTSE All Share index since 2002. Yes, even before the financial crisis banks were unloved by fund managers, who worried about overleveraged balance sheets, and how sustainable returns on equity would turn out to be. As it happened, the fund managers were right to be wary.  

As the pull of size and consolidation worked on UK banks like gravity, this was justified in the name of efficiency. The trouble is that there is very little evidence that big banks are more efficient. Instead, they became in danger of collapsing under their own weight, like financial black holes. The cost/income ratios for large UK banks such as Barclays, HSBC, Lloyds and NatWest were all above the 60% level in the 2020 financial year – not much improvement from cost/income ratios seen ten, 20 or even 30 years ago. The smaller UK mortgage banks such as Northern Rock (before it failed) operated a more efficient model, with a cost/income ratio close to 30%.

My own experience of banking efficiency as an employee supports this. Over the years I have worked at both large banks (Credit Suisse, Societe Generale) and smaller brokers (none of which have survived to the present day.) Arriving at any small broker on my first day of work, my IT systems were set up, my Financial Services Authority registration had been transferred over and my new colleagues were pleased to see me. At large banks the first day tended to be shambolic. Most conversations with HR and IT started with the sentence: “Oh, hello! We didn’t know you were starting today”.

That’s because bringing all the banking activities under one roof created more complexity than any efficiency savings. Banks still needed to spend lots of money on technology systems. And any savings from streamlining the back office were lost, because they needed to employ an army of legal and compliance staff to manage conflicts of interest, for instance building “Chinese walls” to keep employees with inside information separate from market-facing roles and prevent the bank being fined by the regulator. The huge increases in computing processing power and decline in the cost of computer hardware hasn’t benefited shareholders in banks at all. By December 2014, Antony Jenkins, the then-chief executive of Barclays, was admitting that the universal banking business model was dead. Diversifing by business, customer and geography hadn’t worked.

Banks have many challenges

In recent years, low interest rates have made life even harder for banks. Most of the time, banks make a margin on their retail deposit funding, because their average interest costs are below central bank rates. But when base rates drop below 1%, margins shrink because the banks can’t charge customers enough for looking after their savings (notwithstanding the efforts of some European banks to levy negative rates on retail deposits). As interest rates rise, analysts expect banks to increase revenue. Still, while margins are set to improve, technology spending is likely to rise even faster and bad debts are hard to predict. 

Setting aside the barrage of regulatory fines, the other reason that banks have struggled to generate the return on equity (ROE) that the market wants (10%) is that the regulator has demanded that they fund their balance sheets with less debt and more equity. Larger banks that are judged “systemically important” have to fund with even more equity, because of the serious consequences of failure. In very simple terms, that even bankers can understand, if the “R” of ROE stays the same but the denominator “E” increases, then it is a mathematical inevitability that ROE will fall. 

A further problem is that banks tend to reward their loyal customers with worse deals than the new customers they are trying to tempt away from other banks. In the short term, this strategy works. Customers have better things to do than check they’re still getting a good deal every couple of months. But over time, the strategy is bad news for shareholders. It’s terrible for banks’ brands to use inertia from loyal customers to generate high returns. Thus the last few years have seen disruptive new entrants, such as Atom, Monzo, Starling and Funding Circle. 

In theory, these financial technology (fintech) firms can offer more competitive services because they don’t have legacy IT system costs or a branch network. That said, given that the disrupters tend to be loss-making, it could just be that their services are being funded by deep-pocketed venture capitalists. 

Last year the UK saw $11bn of investment into fintech. There were 713 deals, with Revolut, Monzo, and Starling in the top five amounts raised. Zopa, the peer-to-peer lender founded almost 20 years ago, still managed to raise $220m from SoftBank’s Vision Fund 2. The UK fintech sector seems particularly good at attracting capital, because that $11bn is more than double the next largest in Europe: Germany ($4.4bn), followed by France ($2.3bn) and Sweden ($1.7bn). Overall, $24.3bn was invested across the continent in 2021, with the UK representing nearly half (45%).

Most disrupters aren’t disrupting

That sounds impressive, yet the pandemic has not been the boon for fintech that it has been for tech firms, as Marc Rubinstein points on Net Interest, his financial sector blog. Monzo’s fund raise in May 2020 was at a 40% discount to its previous funding round. German digital bank N26, funded by Peter Thiel, pulled out of the UK after finding the competition too strong.

Meanwhile, branch-based challenger bank Metro Bank has fallen 95% since its initial public offering (IPO), while peer-to-peer lender Funding Circle is down 75% since its IPO at the end of 2018. These have not been anyone’s idea of a successful investment.The problem is that UK banks’ core business of taking customer deposits and lending out money is highly competitive. Thus the fintech winners are not the ones trying to re-invent universal banks. Revolut and Wise (formerly TransferWise) show that fintech isn’t just about technology, it’s also about finding the areas of greatest risk-adjusted return. They have focused on cross-border payments, attacking the huge difference between the currency rates available to large corporate clients in wholesale markets and the price that retail banking customers pay. 

Ten years ago there was a complaint to the Office of Fair Trading by consumer groups because banks were charging 3% on foreign currency transactions. Some debit cards also added a further fee of £1.50 per transaction, while using a bank card to withdraw cash abroad could cost up to £4.50 a time. At the time a spokesman for the British Bankers’ Association (BBA) blamed the high fees on foreign payment systems, saying “transaction costs abroad are driven by the costs of overseas payment systems, often in countries where free banking does not exist”. 

Of course, this was nonsense. And hence both Revolut and Wise were founded by eastern Europeans who were appalled at the price gouging from banks when they wanted to send money home. 

Wise and Revolut: the two winners

Wise was originally a way to send money to bank accounts overseas (see below). It unbundled a specific financial product and offered better value than the competition, with no cross-subsidisation. 

Revolut began as a pre-paid card and an app for spending money abroad. It planned to levy a small fee every time a customer used the card, but realised that there wasn’t enough money in this to support the cost and started charging subscriptions. It is remarkable that an app can charge customers up to £13 a month, while UK retail banks with higher-cost branches and legacy systems struggle to convince customers to pay anything. Rather than lower costs, Revolut is able to make money by charging customers to access services they value, such as crypto trading, which has done well over the pandemic. That said, Revolut’s subscriptions made it £222m of revenue in 2020, but direct costs and administration expenses meant that the business made a loss of £207m the same year. 

Wise and Revolut attracted millions of customers, despite not having a banking licence. They had an e-money payments institution licence, which means that they weren’t able to lend out money to borrowers and take credit risk. Instead, they have to keep customer funds in cash or other low-risk alternatives. (Revolut was granted an EU banking licence last year.) 

So the great irony of fintech is that technology has not meant bigger, more efficient banks. Nor has it allowed new entrants using technology to disrupt saving and lending. The real success story is built on the fact that wholesale customers who deal in large size receive a better price than individuals. That’s true in any industry and financial services is no different. That was the original reason for brokers (who bought and sold on behalf of retail clients) and jobbers (who made a market and dealt wholesale). Wise and Revolut have used technology to reduce the size of the retail versus wholesale price difference. That outcome is light years away from anything foreseen at Big Bang.

Is Wise worth 90 times earnings?

Wise (LSE: WISE), which has a March year end, put out a third-quarter trading update in mid-January. It’s enjoying strong growth, transferring over £20bn in the three months to December, up by 38% from a year ago. So far this strong transaction growth has meant reducing costs, the benefit of which it shares with customers by driving down fees, while generating cash for reinvestment. 

The firm says that over the last year it dropped prices across 50 currencies and fees are now 0.60% of transaction value on average, nine basis points lower than a year ago. It was profitable in the first half of the year, to September 2021, making £19m, and analysts are forecasting profits to reach £150m in the 2024 financial year, according to data from SharePad. 

Analysts covering Wise are forecasting around 24% revenue growth in 2023 and 2024, and the total addressable market for cross-border transactions is huge. There were around £2trn of global cross-border payments made by individual consumers in 2020. Around two-thirds of that is done by banks – Wise estimates that it has a market share of around 2.5%. That £2trn pool is also growing. 

Like many fast-growing tech stocks, the shares look expensive. The forecast price/earnings (p/e) ratio is 90 and price/sales (p/s) ratio is 15, according to SharePad.

This approach to growing fast and sharing efficiencies with users is similar to Amazon’s. Even after 25 years of growth, the “Everything Store” now has revenue of half a trillion dollars, but shows no signs of going ex-growth. It trades on a forecast p/e of 70. In his 2005 letter to shareholders, Jeff Bezos described Amazon’s strategy in this way: “Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long-term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon”.

Wise, like Amazon, intends to expand its product offering. It recently launched a service called “Assets” for UK customers. They can now transfer balances to an index fund, while still being able to spend or transfer money overseas as though the balance were still held in cash.

There are risks to Wise. One concern is the co-founder, Taavet Hinrikus, selling 11 million shares last year, and entering a loan agreement with Goldman Sachs where up to 49.6 million shares would be pledged as security. There’s also a dual share structure common to many tech stocks. The founders hold B shares that have nine times more votes than the A shares. That lets them keep control even if they decide to cash out their A shares. 

I think the bull case is relatively easy to make, but the high valuation multiples mean that if the company disappoints, then it’s likely to be punished severely. For every Amazon-style investment, there are plenty of Groupons and Pelotons that don’t receive much attention – once hyped stocks that failed to deliver.  

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Three long-term growth stocks to profit from a world that’s getting wealthier

When I think about Finsbury Growth & Income Trust’s 2021, I think with chagrin and euphoria respectively about the shares of two of its biggest holdings. I also think about the mediocre showing of the shares of a third, middling-sized holding, where that lacklustre performance presented an opportunity to buy a lot more.

It strikes me that in expanding on this teasing introduction I can convey something of how we invest shareholders’ capital and the types of companies that we hope will do well for them.

The London Stock Exchange’s ambitious data deal

Our problem stock in 2021 was London Stock Exchange Group (LSE: LSEG), which we have held for the best part of 20 years. It has been a great investment. For instance, over the five years to the end of 2020, its shares more than trebled. However, disappointingly, in 2021 they fell by over 20%. This can be ascribed to some investors worrying that LSE has recently been too ambitious – last year it closed the biggest acquisition in its history, Refinitiv. 

This deal makes LSE, on some measures, the world’s top provider of market data and analytics. It is a leap into the big league. We can understand why some have decided to wait and see whether LSE has bitten off more than it can chew. But we remain long-term supporters. The transaction is consistent with LSE’s clearly articulated and hugely successful strategy, and market data is the gold dust of the 21st century. So we not only held, but we also bought more.

Diageo: profiting from wealthier drinkers

The winner was another long-term holding – Diageo (LSE: DGE). As a career-long UK equity investor I am always so grateful that Diageo is a UK quoted company – it has been a reliable cornerstone for us forever. Diageo is evidently the best spirits company in the world and spirits are a highly profitable and growing sector. 

It is a long-established trend that as the world gets wealthier people drink less alcohol. Is that bad news for Diageo? Not really, because, crucially, richer people drink more better-quality products. And this phenomenon is helpful for Diageo and helps explain why its shares rose by more than 40% in 2021. 

By and large, over my career it has been right to be optimistic about the global economy and today is no different, with digital technology accelerating wealth creation. Owning Diageo’s shares is still a great way to participate in things getting steadily better.

Fever-Tree: creating cachet

We think the same is true, as a corollary, for the third holding – Fever-Tree (LSE: FEVR). Fever-Tree has brilliantly created a new beverage category that did not exist 15 years ago – premium mixers for the growing premium spirits industry. As such it is not really competing against mass-market brands. Customers love the taste and luxury cachet the Fever-Tree brand conveys. Its success is manifest in the UK. 

Now the question is whether Fever-Tree can replicate that domestic success in the US and continental Europe. If it can, then there is little doubt its shares have enormous potential. Of course, by the time you know for sure, it will be too late. So, we must take a view. The early signs for Fever-Tree abroad, particularly in the US, look thrilling. Accordingly, we bought more in 2021 – both the shares and the product.

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Bank of England raises interest rates to 0.5% and stops money-printing programme

Today, the Bank of England raised the key UK interest rate by a quarter of a percentage point to 0.5%. That’s exactly what it was expected to do. It did so by five votes to four – in other words, five members of the nine-member rate-setting Monetary Policy Committee voted in line with market expectations.

However, what has rather taken markets aback is the fact that the other four – as you might assume – did not vote to keep rates at 0.25%. No, they voted to raise rates by a full half a percentage point, to 0.75%.

For perspective, obviously, this is still very near an all-time low. But from a different perspective, the UK bank rate is now five times higher than it was a scant two months ago (rates went up from 0.1% to 0.25% on 16 December last year).

Quantitative easing programme to be unwound

Moreover, the Bank is going to unwind quantitative easing (QE). QE involves printing money to buy assets. Those assets – mostly government bonds – sit on the Bank’s balance sheet. One key point about bonds is that they eventually mature; thus far, the Bank has been maintaining QE by reinvesting the proceeds of maturing bonds as they do so.

The Bank is now going to stop doing that. So, in effect, when government bonds held by the Bank of England reach their payback date, the government will need to find a new borrower to lend them the money to repay that loan (whereas previously it would just have “rolled over”). That’ll amount to just over £70bn bonds during 2022 and 2023, and another £130bn over 2024 and 2025.

On top of that, the Bank is also going to sell off the corporate bonds that it has purchased.

Most importantly, the Bank’s attitude has changed drastically. In November, markets were also shocked, but back then, it was because Andrew Bailey, head of the Bank, had led them to believe that a rate rise was a dead cert, then switched tack at the last minute.

Now, inflation is public enemy number one again. It’s expected to peak at 7.25% in April – remember, this is the CPI measure, so RPI could easily be just under double-digits by that point (here’s what the difference between CPI and RPI inflation is, and why it matters).

That’s even while the Bank is warning consumers that there are tough times ahead. It reckons that the squeeze on spending created mostly by higher energy prices (though it nods to the increase in National Insurance scheduled for April too), along with excess supply building up as supply chain bottlenecks ease off, is going to drive the unemployment rate up to 5% by the middle of next year.

Meanwhile, energy prices might stop contributing to higher inflation rates but only because they “are assumed to remain constant after six months”. How realistic that assumption is is hard to judge, but even if energy prices remain where they are, that is quite the squeeze on consumer spending.

Get ready for stagflation

• SEE MORE Too embarrassed to ask: what is stagflation?

None of these things is inflationary in the sense of making the economy overheat. They are stagflationary, in the sense that prices rise but the price rises themselves choke off growth. If your energy bill goes up by 50%, that’s money you can’t spend on anything else; it does not boost demand in the economy.

The Bank even acknowledges this. “The sharp rises in prices of global energy and tradable goods of which the UK is a net importer will necessarily weigh on UK real aggregate income and spending. This is something monetary policy is unable to prevent.”

So why is the Bank raising rates then? “The role of monetary policy is to ensure that, as such a real economic adjustment occurs, it does so consistent with achieving the 2% inflation target sustainably in the medium term, while minimising undesirable volatility in output.”

I have to admit that this mostly sounds to me like pure self-justifying gobbledegook. The Bank will be told off for not meeting the 2% inflation target. By raising rates a bit, it can at least say “but we’re trying”.

Anyway – if you have a variable-rate mortgage, you’ll notice the difference quite quickly, so maybe consider switching. If you have savings, you’ll notice the difference rather more slowly I suspect, so it might be worth starting to shop around there too – though I wouldn’t lock in any rates yet, given that more rises are apparently set to come.

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BoE hikes, ECB steady; wants to see inflation “durably” at target

GBPUSD rallied to 2-week highs of 1.3628 from near 1.3560 following the as-expected 25 basis point BoE rate hike, and generally more hawkish statement from the Bank. The US Dollar was mixed following the mix of data, which saw productivity rise more than expected, labor costs rise less than expected, and jobless claims drop more than forecast. USDJPY idles at 114.90, while EURUSD popped up to 1.1310 from 1.1290, though this was likely a fallout from the ECB announcement.

BoE hiked rates by 25 bp to 0.50%, with four dissenters actually arguing for a 50 bp rise as inflation continues to spike. The BoE plans to fully unwind its stock of corporate bond purchases by 2023, which means quantitative tightening is underway.

The ECB confirmed rates and guidance, with no commitment to an end to net asset purchases yet. The initial press release wasn’t much changed from December, but the central bank’s focus on trying to bring inflation “up” to target is starting to sound increasingly out of touch with reality. Vowing to keep rates at current or lower levels until “realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at 2% over the medium term” when inflation is running at 5.1% and set to once again exceed the ECB’s projections is difficult to follow, as is calling the record highs “moderately above target”.

Click here to access our Economic Calendar

Stuart Cowell

Head Market Analyst

Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in Leveraged Products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distribution.

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A wage-price spiral is stirring in the UK – what does that mean for your money?

I’ve long said that 5% on the consumer price index would make inflation a headline issue in the UK.

Well, the cost of living crisis is certainly filling the headlines right now.

Later today (or maybe even by the time you read this email), the energy regulator will have told us that the price cap on energy bills is going up by about 50%.

It’s all quite reminiscent of the 1970s: energy shocks, inflation – and we’re starting to see strike action picking up too.

Inflation will drive more unionisation and strike action – not the other way around

The cost of living is rising. Currently, it’s outpacing wage growth. In other words, if you are the average worker (no one is, but some of us must be close to it), you’re getting paid more than you were last year, and in fact, you’ve probably had a bigger rise than you’ve had in years – but unfortunately your living costs have gone up by more, so your standard of living has in fact declined.

In other words, you’ve taken a pay cut in “real” terms.

The thing is, right now, the labour market is extraordinarily imbalanced. There are loads of job vacancies, and just not that many people available to fill them. So workers have more power than they’ve had in a long time, plus more motivation to use it.

And that’s what we’re starting to see play out. Baggage handlers and refuelling staff at Heathrow have voted to go on strike during the February half-term holiday. Refuse collectors in Eastbourne have already won a big pay rise after striking last month.

Even the Financial Conduct Authority (FCA) – the UK’s financial regulator – is facing “unrest”, as the FT puts it, after the Unite union “secured the backing of some of the regulator’s 4,000 employees for industrial action if management refused to engage with the trade union” (note though that Unite hasn’t revealed how many FCA staff are actually members of the union).

This isn’t just a UK issue. Over in the US, companies such as Starbucks are seeing increasing attempts to unionise. This is often presented as “grass roots movements” by the socially-conscious “generation whichever one is the current one”. But I’d put it down to simple economics rather than a different type of political consciousness.

As financial historian Russell Napier pointed out in an interview with The Market last July, the direction of causality between unionisation and wage inflation is not at all clearly understood.

“People always say unionisation caused inflation. The statistical evidence suggests that it was the other way around, that inflation caused unionisation. People banded together and joined unions to protect themselves from inflation. When there is no inflation, you don’t need to be in a union. I think we will see more unionisation again.”

If this is indeed the case, then all the people who argue that we can’t have a repeat of the 1970s have got it precisely wrong.

And that’s the thing that worries central banks more than anything else.

Inflation isn’t transitory anymore

Until very recently, central banks had been saying that inflation is “transitory”. It’s a one-off bump higher, created by supply chain disruption which was caused by the big covid shutdown.

We’ve never agreed with that view here at MoneyWeek but we can see why central banks stuck to the line for a while.

That’s because the thing that really freaks central banks out is “inflation expectations”. If people think inflation will be higher in the future, then it creates a self-fulfilling prophecy. Here’s the rough outline of the theory:

“I think inflation will rise, so I ask for higher wages if I’m an employee, or I raise prices if I’m a business to compensate for said expected inflation. If everyone does this, then rising wages beget higher prices which beget higher wages which beget higher prices and so on until no one can remember which day of the week it is and the economy collapses as a result.”

This is mostly nonsense like a lot of macroeconomic theories, in that it’s not about expectations, it’s about reality. The reality right now is that there are fewer people to do jobs, those people are seeing their energy bills rocket, and quite rightly they feel empowered to ask for more to compensate. Meanwhile companies see that business is fine so they feel empowered to pass those costs on.

What can central banks do about this? The reality is that their tools are pretty blunt. If you really want to stop this kind of inflation, you basically need to punch the economy in the face with significantly higher interest rates, so that everything slows down again. However, the desirability and purpose of such actions is questionable. Why would you want to trigger a recession right now?

The ideal solution would in fact be for the state to shift the tax burden away from incomes and onto assets, particularly property (or rather, land). That way workers get a pay rise, and you make some progress towards closing the wealth gap (and more importantly, the house price gap) which is at the heart of most of the current frustration.

But that’s unlikely to happen because income tax is easy to collect and politically non-toxic as long as you can pretend the burden is mostly falling on the “rich” (whereas in reality it’s mostly falling on those in mid-to-late career).

The upshot of all this is that we probably won’t see any significant action to contain wage inflation for quite some time, and so we can expect more of it.

Ah well – so what’s it all mean for investors?

From an investment point of view, in a note a couple of weeks ago, Goldman Sachs noted that FTSE 100 companies tend to outperform small cap stocks as inflation rises.

Why? They reckon it’s down to the FTSE 100 holding more banks and commodity stocks, which are among the few industries to generally benefit from inflation; bigger companies having more pricing power (so they can pass costs along, regardless of wage hikes); and also the fact that the FTSE 100 is full of multinationals (so local inflation doesn’t matter so much).

Another good reason to buy into the FTSE 100 is probably the fact that the UK is still being shunned by investors. According to the latest data from global funds network Calastone, January saw investors suck a record £795m out of UK-focused equity funds.

That was partly driven by the general market malaise, but it’s striking to see Britain still so drastically out of favour despite being both cheap and in many ways, a better bet on a more inflationary world than pretty much any other major developed market I can think of.

So there you go: buy British (or at least, UK-listed), and if you’re an employee - ask for a pay rise.

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The Crude Chronicles - Episode 122

Slight Reduction In Oil LongsThe latest CFTC COT institutional positioning report shows that oil traders cut their net-long positions last week, bringing total upside exposure back from the ten-week highs recorded over the prior week. While the market remains overwhelmingly long, some corrective action is to be expected and, at less than 10%, the reduction in upside bets has done little to dent price action in crude. The market is sitting just off the YTD highs, as of writing, and remains around 16% higher from the January open.OPEC+ Agrees Further Production HikeIn terms of the macro backdrop, the key focus for oil markets this week has been the first OPEC+ meeting of 2022. Following deliberation, the group agreed to hike oil output by a further 400k barrels-per-day in March. OPEC+ has faced huge global pressure to increase output at a quicker pace, in order to curtail soaring inflation. However, OPEC+ has remained steadfast to its plans to increase output at a gradual pace. Indeed, data shows that any of the group’s members have been struggling to fulfil the increase laid out so far. With this in mind, the latest hike agreed this week has been met with scepticism, which perhaps explains why we’ve seen little downside on the news.Russia/Ukraine Tensions Still On WatchAway from OPEC+, the Russia/Ukraine situation continues to underpin oil prices. Despite comments from Russia over the weekend, pushing back against reports of an imminent invasion of Ukraine, the situation remains very tense. The latest news this week is that the US is sending troops to the border, to help bolster the Ukrainian defence against any attack. With the threat of war still looming, oil prices remain supported for now.EIA Reports Inventories DrawdownCrude prices have also been supported this week by the latest report from the Energy information Administration. The EIA reported that commercial US crude stores fell by around 1 million barrels last week. This was in stark contrast to the 1.5 million barrel increase expected, and is solid evidence of the pickup in demand seen in the US. Crude stores are now down to their lowest levels since October 2018 despite producer ramping up output in a bid to satisfy rising demand.Technical ViewsCrudeThe rally in crude prices has seen the market trading up above the 83.75 level with price near to testing the 90.85 level and bull channel top. While price remains supported for now, we are seeing bearish divergence creeping in on momentum studies which is worth noting, as it flags reversal risks. If Russia/Ukraine tensions suddenly de-escalated, this might lead to a sharp move lower in oil. Below 83.75, the 78.49 region and bull channel low, is the next support area to watch.

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Why an ageing population need not be deflationary

• SEE MORE Why an ageing population is not necessarily the disaster many people think it is

Since the COP26 conference in Glasgow in November, the topic of demographics has been back in the news. There are many aspects of the global economy that ageing populations may (or may not) affect – but inflation is perhaps the most topical right now.

Discussions on demographics often hinge on the “dependency ratio”: the number of people who are either too young or too old to work, divided by the number of those in the working-age population (this is set at a range, say between 20 and 64 years old, and ignores those outside these thresholds who are working). In emerging markets, the dependency ratio may be high because there are a lot of very young people; by contrast, in developed economies, the ratio may be high because as people live longer, there are more retirees. But in virtually all countries, populations are ageing – thankfully, child mortality is falling, and life expectancy is increasing. So what impact will this have on the global economy and inflation?

The argument for falling prices

On one side of the inflation argument are those who feel that an ageing population will drag us into deflation, or at least low inflation. Albert Edwards of Societe Generale is perhaps the best-known proponent of this view, having been comparing the US to Japan for many years. Edwards recently shared a chart (see chart below, left) from EPB Macro Research to support his case. This shows that a rising dependency ratio (as measured by the change in the ratio over 20 years) seems to correlate with a falling inflation rate. 

This “low inflation” outcome appears to be backed by US spending data (second chart). The young and old spend less than those in work – and so, the argument goes, as the proportion of big-spending workers falls, demand will drop and prices fall. This is particularly applicable in developed economies, where it is the elderly who are driving the rising dependency ratio – much of the spending by those of working age is likely to benefit their children, but less so their parents. Another strand of the argument relates to asset prices: as baby-boomers retire, they will sell assets to raise funds, driving prices down. Of course, even if ageing demographics are deflationary, it doesn’t mean our destiny is predetermined. Other factors from energy-shocks to wage increases to supply disruptions can still cause rising prices. But in this scenario, they would face a constant headwind from the ageing population. 

What if older people are inflationary?

However, what if this is not the case? Investors – many of whom are relying on inflation to remain low, placating their bond portfolios and avoiding central banker’s rate hikes, which might unsettle the equity apple cart – ought to be aware of both sides of the argument. Subscribers to the deflationary thesis often cite Japan as an example of what we can expect – an ageing population mired in deflation – but it may be that this is a case of correlation rather than causation. It’s equally reasonable to think that increased globalisation and technological advances were significant factors contributing to Japan’s deflation, which happened to coincide with its population ageing. The idea that a rising proportion of over 65-year-olds automatically spells slower growth is not a given.

Charles Goodhart and Manoj Pradhan wrote a book in 2020 on why demographics may prove to be inflationary, not deflationary. If a smaller proportion of the workforce has to produce the goods and services the economy needs – which is what a rising dependency ratio suggests – then supply and demand basics suggest this ought to be inflationary rather than deflationary. Accordingly, wages may need to rise sharply. 

Moreover, today’s baby-boomer retirees are (on average) the wealthiest ever. Many have enjoyed growth in house prices, a 30-year bull-market in bonds, and a huge run-up in equity markets. They are now free to spend this as they wish, and hopefully have the health to do so. The idea of a 65-old-year retiring to the sofa for 25 years watching daytime television is mostly a fallacy. These retirees may spend on themselves, or disperse money to their children – but either way it gets into the economy. On top of all this, government spending on people shoots up as they age, as the third chart, breaking down healthcare costs by age in the UK, shows. It’s unclear how government will pay for these rising costs – particularly as greater demand for goods and services is traditionally inflationary.

The 60/40 portfolio may be on its last legs

• SEE MORE Too embarrassed to ask: what is a 60/40 portfolio?

The fourth chart goes global, showing the correlations between the annual inflation rate and the dependency ratio (using 20-64 as the band for working age) for a wide range of countries since 1960. The blue line uses the largest number of countries with data available at that given point, while the red line shows same 57 countries throughout. In the 1960s and 1970s the correlation was negative – suggesting that a higher dependency ratio was consistent with lower inflation – yet the correlation turns increasingly positive over time. 

Detractors may argue that the higher inflation of the 1970s make that decade an anomaly, but the trend is still upwards and positive from the 1980s onwards. They may also argue that the high dependency ratio is warped by the youth of the higher-inflation emerging markets, and not the ageing developed markets. But the constant set of countries (the red line) is skewed to developed markets (which have more consistent historical data) and it still shows a stronger trend than the full selection. The fact is that no one knows how ageing demographics will affect inflation, but it is far from certain that they are deflationary. If today’s inflation proves longer lasting, then it may be helped, rather than hindered, by demographics. 

That matters for investors. Inflation reduces the buying power of cash, and is particularly damaging to fixed-income assets. Research from Waverton Investment Management suggests that when three-year average core inflation (ie, excluding food and energy prices) is greater than 2.5% a year, then bonds and equities are more likely to move together. 

This could have a significant impact on portfolios. In recent years bond and equity returns have generally had a negative correlation, allowing bonds to hedge against falling stocks. But if the correlation turns positive, then rather than bonds providing protection, they may fall at the same time as equities. In other words, the best days for the 60/40 portfolio – the classic equity/bond split – may be behind us.                 

from Moneyweek RSS Feed https://moneyweek.com/economy/604398/why-an-ageing-population-need-not-be-deflationary
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ConocoPhillips: a bag of surprises?

The world’s largest independent exploration and production (E&P) company, ConocoPhillips, with a market capitalization of 120.737B, is expected to announce its fourth quarter 2021 financial results and business outlook on Thursday 3^rd February, 2022 before the market opens.

The report will be for the fiscal quarter ending Dec 2021. In the fiscal third quarter of 2021, which ended on 30^th September 2021 and reported on 2^nd November 2021, the company’s revenue was 11.57 billion dollars and the net income was 2.38 billion dollars, while the earnings per share stood at 1.77, surpassing analysts’ forecasts of 1.52. These figures were clearly higher than the ones for the same period in 2020 (revenue 4.42 billion dollars; net income of -450 million dollars; earnings per share 0.42). At the moment, according to a Yahoo Finance survey of 20 analysts, the forecasted earnings average estimate is 2.18 per share and average revenue is estimated to come in at 39.9 billion dollars.

Investors will be paying attention to whether ConocoPhillips will increase its capital expenditure in 2022, which was hinted at in the Q3 financial report. The fact that there has been a conflict between the Ukraine and Russia effectively pushed oil prices higher, consequently benefitting upstream oil and gas companies such as ConocoPhillips, whose stock price managed to ride the wave and is up 26.82% y/y, trading at 15.4 times the expected 2021 EPS, 10.7 times the estimated 2022 earnings of $8.49 and 11.9 times the estimated 2023 earnings of $7.63 per share. The company pays an annual dividend of $1.52 (yield of 1.70%). Total shareholder return for the past 12 months was 131.4%.

It is also important to note from the previous reports that the company has a historical record of beating earnings estimates, and according to   Zacks Earnings ESP (Expected Surprise Prediction) it is ranked number 3 among companies with a similarly  consistent history and therefore investors will watch out for a possible surprise exceeding analyst expectations.

Technically, #ConocoPhillips price action on the daily timeframe chart is trending upwards above the 50 (blue), 20 (red) and 200 (black) simple moving average having come off a low at $65.94 after consolidating in a 12-week bull flag chart pattern. The ADX is above $25.00, clearly indicating that the stock price is in a strong uptrend. Currently, the stock price is targeting the first fib expansion at the 50 period MA that is 85.17. A firmer downside target can be anticipated at 79.00 which was a key swing low in January this year.

Click here to access our Economic Calendar

Dennis Mwenga

Market analyst & Trainer –  HF Educational Office – Kenya  

Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in Leveraged Products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distribution.

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Investment Bank Outlook 03-02-2022

CitiEuropean OpenSome markets reopened in Asia, following Lunar New Year Holidays. However, we note that CNY/HKD/TWD are still on holiday. In terms of moves, the plunge in equity futures late in NY session was the highlight, as sour earnings caused 2% dips. USD modestly gained in the Asian session, continuing a trend seen in NY, while UST saw modest bull steepening moves in Asia on the back of weaker equities. AUD and NZD saw slightly choppy price action, while JPY saw dovish comments from BoJ deputy governor Wakatabe (seen as more dovish among the 2 deputy governors).All eyes are on Europe today, with 2 major decisions to be made. We will start of by watching the BoE at 12:00 GMT, with Bailey’s press conference to follow at 12:30 GMT. Citi economics expects a unanimous 25bps hike, the beginning of passive QT, and potentially more hawkish near-term guidance. We will then turn our eyes to the ECB at 12:45 GMT, followed by President Lagarde at 13:30 GMT. Yesterday’s hot CPI prints have tilted the risk balance, although Citi eocnomics says the December decision to extend net asset purchases at least until September will keep the Governing Council on hold.Elsewhere, we will see USD seeing some data in the form of initial jobless and continuing claims at 13:30 GMT, and ISM services index at 15:00 GMT. We will also see Fed Nominees Raskin, Cook, and Jefferson appear before Senate at 15:00 GMT, where Citi Economics expect them to skew slightly more dovish. In other markets, HUF is likely to see no change at its one-week deposit rate decision at 08:30 GMT, TRY sees CPI at 09:30 GMT while CZK sees a rate decision at 13:30 GMT, in which a 75bps hike to 4.50% is expected.BOE PreviewThe Bank of England Bank Rate decision at 12:00 GMT, with Bailey’s press conference to follow at 12:30 GMT. Citi Economics expects a unanimous 25bps hike, the beginning of passive QT, and potentially more hawkish near-term guidance. Our bias remains towards a rapid but ultimately limited monetary tightening in H1-2022, with an easing of short-term pressures likely to mean a refocusing on a subdued medium-term outlook.–CitiFX Wire’s Rui Ding compiles the BoE expectations from Citi in Bank of England expectations: Third time’s the charm. Aside from Citi Economics’ view, Citi Rates strategy sees risk reward skewed for a dovish outcome, while CitiFX Strategy notes that the bar is high for a hawkish surprise.ECB PreviewECB rate decision at 12:45 GMT, with President Lagarde's Press Conference at 13:30 GMT. Citi Economics says the December decision to extend net asset purchases at least until September will keep the Governing Council on hold. But, high and rising inflation will keep rate setters on their toes. Many will want to send a signal that inflation is a concern. The guidance is unlikely to change, but the balance of risks can. Press conference and the minutes later may send a hawkish message.–CitiFX Strategy's Vas Gkionakis maintains his base case that it is unlikely to be a major catalyst for the euro. We do not expect any change in the ECB’s forward guidance on interest rates and see the bank staying on track to end PEPP in March and continuing with reduced asset purchases (APP), in line with the announcements made in December. However, he notes the balance of risks has shifted towards a hawkish surprise and pens 2 scenarios of note. The second scenario (hawkish surprise) would come in the form of ECB president Lagarde not ruling out a rate hike this year.

from Tickmill Expert Blog - Forex Traders Blog https://www.tickmill.com/blog/investment-bank-outlook-03-02-2022"
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Dollar Edges Higher; ECB, BOE Meetings Loom Large

from Forex News https://www.investing.com/news/forex-news/dollar-edges-higher-ecb-boe-meetings-loom-large-2755870
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Market Update – February 3 – Stocks gain, FX awaits BoE & ECB

Stock markets closed higher after a weak start (S&P500 +0.94%) Mixed PMI data, a huge miss (-301k) for ADP & record CPI (5.1%) in Europe hung on sentiment. Asia markets struggled too. Weak earnings from Meta, Spotify and a -24% decline for PayPal. USD & Yields consolidate,  Oil holds on to gains & Gold holds over  $1800. Biden ordered 3000 troops to Eastern Europe.

China, Hong Kong and other markets remained closed for the Lunar (Tiger) New Year holidays.

• USD (USDIndex 96.10) up from 95.77 low, 96.00 remains a key level
• US Yields 10-yr closed at 1.766 &  trades at 1.766%.    
• Equities – USA500 +43 (+0.94%) 4589 – (PYPL -24.59%, GOOG +7.45%) USA500 FUTS slip 4538. META lost +20% after hours,  Santander profits up 8-fold.     
• USOil – Spiked over $88.00 on OPEC+ maintaining 400k/day output. Now $86.32 after inventory drawdown 
• Gold – topped at $1810 back to $1802 now.    
• Bitcoin remains under $40,000 back to test $37,000 
• FX markets – EURUSD up to 1.1295 USDJPY up to 114.60 & Cable to 1.3550  

Overnight –  Japan Services PMI missed, Large rise in AUD Imports, & Building Approvals.

European Open – The December 10-year Bund future is up 6 ticks at 168.72, slightly outperforming versus Treasury futures, as risk aversion picks up again amid disappointing reports from tech bellwethers that weighed on stock market sentiment. DAX and FTSE 100 futures are down -0.4% and -0.3% and a -2.3% sell off in the NASDAQ is leading US futures lower.

European markets closed mixed though yesterday, after another record setting inflation report for the Eurozone put pressure on the ECB ahead of today’s announcement.

Final services PMIs for the Eurozone and the UK are likely to highlight that virus developments continued to weigh on the sector at the start of the year, but officials are increasingly optimistic that economies will bounce back quickly from the most recent virus variant. Against that background, the spike in inflation is starting to look worrying, especially as labour markets continue to tighten.

The BoE is widely expected to deliver another rate hike today, while the ECB could well sound more hawkish than some expect.

Today – EZ, UK & US Services PMI, Weekly Initial Claims, Factory Orders & ISM Services PMI, BoE & ECB Earnings Amazon, Eli Lilly, Biogen, ConocoPhillips, Penn, BT, Shell, Nokia, ING, Infineon.

 

 

Biggest FX Mover @ (07:30 GMT) NZDCAD (+0.30%) Rallied from key 1.0700 to 0.84 now. MAs aligned higher, MACD signal line & histogram rising & over 0 line, RSI 61 & rising, Stochs OB zone, H1 ATR 0.0013 Daily ATR 0.0060.

Click here to access our Economic Calendar

Stuart Cowell

Head Market Analyst

Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in Leveraged Products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distribution.

from HF Analysis /307458/
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Rising EU Inflation Unlikely to Force ECB to Change its Mind

The rise in prices in the Eurozone once again surprised, primarily due to an increase in energy prices, but there are few qualitative positive changes. Core inflation, on the other hand, eased from 0.4% to 0.3%, indicating that a "second round" of inflationary effects, which could really make the ECB worry, has not emerged. The chances that the ECB will disappoint tomorrow appears to be rising.Headline inflation advanced to 5.1%, beating expectations:Looking at the energy component in the EU inflation report, the annual growth was 28.6%. The question is whether firms will pass these costs on to consumers. So far, judging by the data, one month is not enough: commodity inflation fell to 2.3%, while inflation in the service sector remained at the same level - 2.4%.The ECB predicts that inflation will slow down to 2% by the end of the year, and so far it cannot be said that the trend in inflation somehow threatens the realization of this forecast.Expectations for GDP and inflation in 2023 and 2024 are improving and this should be enough for the ECB to raise rates in early 2023, but the situation with EU price increases is much less tense than in the US, where a second round of inflationary effects has already played out due to strong wage pressure, which in turn arose due to the increased rotation of the workforce during the pandemic (higher layoff rates = higher labor supply and demand imbalance during the recovery period).Today the markets will be focused on the ADP report on the change in US employment. The consensus suggests a significant slowdown from 800K in December to 207K in January. ADP weakly predicts the NFP report and given that the markets do not set high expectations for the official report on the labor market, the report will not be able to influence the dollar much. Consolidation of DXY above 96.0 could likely signal a move into a dollar rally next week.

from Tickmill Expert Blog - Forex Traders Blog https://www.tickmill.com/blog/rising-eu-inflation-unlikely-to-force-ecb-to-change-its-mind"
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Midweek Market Podcast – February 2

January concluded with weak and volatile stock markets and the worst start to a year since 2009 as the USA500 lost over 5%. February starts with Central Banks and worries over inflation and geopolitical tensions, topped by NFP on Friday.

HotForex · 2022 – February 2 – Midweek Market Podcast

The Market Week – February Week 1   

The financial markets remain nervous and volatile against the background of geopolitical risk, with stocks in January 2022 posting losses more than 5%, the worst since 2009, and the Dollar and Yields gaining over 1.5%. February has kicked off with a mixed bag of PMI & Jobs data and an overall dovish RBA. Still to come are BoE & ECB tomorrow and NFP on Friday.

Central banks clearly are getting nervous about the risk of second round effects, but the IMF’s growth downgrades also highlighted the risks from slowing momentum in China. The RBA will terminate their QE purchases this month but still maintain a dovish stance on “transitory” inflation. The BoE are likely to hike by at least 25 bps tomorrow with the ECB sliding to hawkishness but staying put on rates for now.

Ukraine tensions and speculation over gas supplies to Europe in the event of an escalation of tensions with Russia continues to weigh on sentiment. The West continues to bolster Ukraine and Russia continues to claim that their security concerns are not being taken seriously. North Korea tested its biggest missile since 2009 this week too.

In FX the USDIndex was off its highs earlier in the week at 97.40 as the USD cooled. Next support is the 20-day moving average around 96.00.  EURUSD is up from 1.1121 lows to test 1.1300 once again and USDJPY has moved down from 115.50+ highs to 114.30. Cable has stalled its fall at 1.3360 this week and although the political turmoil in Westminster is far from over, with more calls for the PM’s resignation, the pair trades north of 1.3500 at 1.3540. However, Sterling remains vulnerable to bouts of risk aversion.

US stock markets had a recovery last week, but closed significantly lower to end January. The USA500 spiked down to 4,260 but has since moved to test the 100-day moving average at 4,570. The USA30 is on its 6^th consecutive day higher, testing 35,500 from 33,600 lows, and the tech heavy USA100 is back over the key 200-day moving at 15,200, having posted 7-month lows last week.

Gold sank from its 10-week high last week at $1853, to test down to as low as $1780 this week. Subsequent weakness in the USD this week and continuing geopolitical tensions has lifted the key precious metal to the $1800 pivot point area. $1780 & $1770 are support areas with $1815, $1830 and $1850 resistance zones.

USOil prices continue to be supported by very tight supply, low inventories, and geopolitical tensions on top of concerns about further disruption. The key psychological $85.00 a barrel holds this week and the 7-year high at $87.80 is the next resistance area, as markets await the outcome of today’s OPEC+ meeting which is likely to see supplies maintained at 400k barrels per day.

The yields remain the key driver of the markets once again, and the US 10-Year Treasury Note breached the key 1.80%, as markets remain extremely volatile amid conflicting dynamics, economic data and geopolitical tensions.

 

Click here to access our Economic Calendar

 

Stuart Cowell

Head Market Analyst

Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in Leveraged Products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distribution.

from HF Analysis /307201/
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Market Spotlight: First OPEC+ Meeting of 2022

OPEC In FocusThe first OPEC+ meeting of 2022 gets underway today. The group will decide on how to set its production levels for the coming months. Oil prices have been on a solid topside run recently with prices rallying over 40% since the December lows. So far, OPEC+ has stuck to its plan of maintaining a gradual increase in production levels as it continues to unwind the production cuts put in place over the pandemic, due to be completed by September this year. Recently, several major political leaders have called on OPEC+ to speed up its production in a bid to contain surging energy prices. However, OPEC+ has since refused to bow to pressure.Looking ahead to the likely outcome of this meeting, Reuters is reporting sources from the group saying that production is unlikely to be stepped up. If this is the case, oil prices should remain well supported to the topside for now. However, much will depend on the group’s outlook. If production in unexpectedly increased, this might cause some near-term downside in oil prices.Technical ViewsCrude OilOil prices continue to grind higher within the bullish channel which has framed the rally off 2021 lows. While RSI remains bullish, there is heavy bearish divergence creeping in on MACD which needs to be monitored. The 90.85 level and bull channel top will be the next big test for bulls. To the downside, 83.75 is the key support level, a break of which would open the way for a test of 78.49 next.

from Tickmill Expert Blog - Forex Traders Blog https://www.tickmill.com/blog/market-spotlight-first-opec-meeting-of-2022"
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