SUMMER WILL BE CHOPPY FOR INVESTORS
JANE FOLEY RESEARCH DIRECTOR, FOREX.COM
THE FTSE 100 index and sterling have been trading in a similar pattern since the spring. Both the FTSE 100 and the Bank of England’s effective exchange rate – which measures movements in the pound against a basket of currencies weighted by their importance to UK trade flows – trended higher from March and both have subsequently moved lower from their June peaks.
A primary driver of both markets over the spring was the expectation that the UK could be on course to return to growth – potentially before the end of this year. Doubts over this outlook have now arrived and over the coming months evidence proving whether or not this expectation is wrong and if so by how much, will be crucial.
Talk of green shoots has become somewhat outdated over the last month or so. The markets have swallowed a heavy dose of reality and have come to terms with a scenario in which the G10 economies are faced with perhaps a long and difficult climb back to economic growth.
Counter to expectations in early June, the risk of central bank easing in the coming months is still far more likely than any unwinding of recent aggressive policy action and unemployment could reach higher peaks than had been expected. Arguably the greatest data shock suffered by the UK markets over the past few weeks was the downward revision to the first quarter GDP data.
While second quarter data has shown that the UK economy could be in the process of stabilising, the fact that the economy has troughed at a much lower point than had been previously implied suggests a much tougher crawl back to economic growth.
GLOOMY DATA
Without doubt the past few weeks have brought a lot of gloomy economic data. Adding to the depressing first quarter GDP release was last week’s unexpected 0.6 per cent month-on-month drop in UK May industrial production data. Even the June Halifax house price index fell by 0.5 per cent on the previous month, counter to market expectations for a modest rise.
US data has also been negative, particularly the US labour data release which showed that another 467,000 people in the US lost their jobs in June alone, putting the US employment rate at a shocking 9.5 per cent – it was just 4.6 per cent a year ago. In an environment characterised by risk reduction, the FTSE 100 is now down by 7.5 per cent relative to its June peak, while the BoE’s effective exchange rate is down by 2 per cent relative to its June high.
While it is correct that the markets should have given up some of the inflated optimism that fed the spring rally, the prices of assets should still reflect the fact that the global economic downturn does appear to have bottomed during the last three months. Assuming that economic data does not take a significant turn for the worse, it is likely that both sterling and the FTSE will soon meet with decent support and should end the year at higher levels.
RECOUPING GROUND
To put recent price movements in perspective, neither the FTSE nor sterling are anywhere close to recouping the ground lost over the duration of the financial crisis despite the spring rally. The FTSE 100 is still down around 35 per cent relative to its level ahead of the Northern Rock collapse in
September 2007 and the effective exchange rate is around 9 per cent lower, suggesting that there is still a lot of bad news in the price.
Hindsight may eventually prove that the current time provided a good opportunity to extend risk. However, there is a significant chance that the economy could bump along the bottom of this downturn for some months to come and the threat remains that more bad news could be seen.
Bearing this in mind, more conservative investors will likely be waiting on the sidelines rather than delving into “risky” assets. This implies a consolidative, though potentially choppy, phase in the FTSE, sterling and other risky assets through the summer.
By September we should have a better picture of activity in the first half of this year and crucially, we will have a firm picture of the second quarter and whether stability was indeed achieved by the G10 economies in this period, which should provide a better indication of when growth will finally reappear.
This knowledge will prove a more stable backdrop for investors to assess risk and fresh direction should appear in the markets.