A lack of wage growth and where we are in the economic cycle are the two topics investors are not giving enough thought to because of the Brexit ‘noise’, according to managers from JP Morgan Asset Management.
Brexit has undoubtedly dominated headlines over the past few years and is among investors’ main concerns. But with so much time dedicated to researching the impact of the UK’s exit from the EU, investors may be missing other important areas of concern.
Google UK searches for Brexit over 5yrs
Source: Google Trends
Indeed, last month, Rathbones Unit Trust management’s James Thomson explained that a fragile global economy was his biggest concern for global investors.
Below, FE Trustnet asked JP Morgan Asset Management fixed income chief investment officer Nick Gartside and UK equities manager James Illsley what UK investors would be focused on if Brexit was not on the agenda.
Gartside, who manages the JPM Unconstrained Bond fund, said that politics is a new factor for markets that is now beginning to dominate investors’ decision-making.
“There are so many countries with elections – there is always an election somewhere – and uncertainty manifests itself in many different ways depending on the country,” he said.
“I think the question is ‘how do markets deal with that’ because it is very difficult. We say what impact is that going to have on growth and inflation in that country and that is something we think we can get a grip on.
“You can see what someone has been elected on and what they are going to implement. That then feeds through into bond markets.”
However, by removing political uncertainty investors would be more in tune with what is happening in the underlying economy, according to Gartside.
This decade, for example, has been comparable to the ‘NICE’ decade as named by Mervyn King, which stands for ‘non-inflationary, consistently expansionary’.
“That was the period that started in 1997 and went on to 2007 when the Bank of England was made independent and is probably a good historical analogy,” said Gartside.
Back then, debates centred around inflation, growth and other economic indicators that were subdued and much of that applied to today.
However, the main issue for investors to grapple with is wage growth, or more specifically the lack of it, as it gives a good indication that longstanding economic models are beginning to break down.
Gartside asked: “Take the UK – unemployment is at a 40- if not 50-year low and everybody has got a job – arguably there even isn’t enough workers in places. Yet where is the wage growth?
“Traditionally what you would expect when unemployment gets to very low levels is workers then have bargaining power and you get higher wages but it has not happened.”
As the below chart shows total pay increased by 2.4 per cent between April-June 2017 and April-June 2018, with the latest inflation figures from the Office for National Statistics suggesting inflation had hit 2.5 per cent in July.
Great Britain nominal average earnings annual growth rates, seasonally adjusted
Source: Office for National Statistics
There are many reasons for this, including a lack of productivity growth, which is something that central bankers and politicians are trying to resolve.
This is the key to wage growth, Gartside explained, because if companies become more productive they have higher output and are therefore willing to take on higher costs from increased wages.
Other factors include globalisation, which has made it cheaper to manufacturer goods in other countries, as well as technological innovation.
But wage growth unlocks many things, the CIO said, as “two-thirds if not three-quarters” of people in developed countries are consumers.
“So, if you have lots of people with lots of jobs and wage increases they can buy houses, furnish those houses and you get a very rapid multiplier effect,” he said.
“Then you get high inflation, interest rates go to higher levels, et cetera. I think it is the cornerstone of everything. But we are not seeing that now so in the absence of much wage growth yes interest rates are going up but the level they are going to get to historically will be very low.”
James Illsley, co-manager on the JPM UK Equity Core and JPM UK Equity Plus funds, said that investors would be more concerned over where the UK is in the business cycle than they currently are.
“The big concern underlying is that we are in a late-stage cycle, spare capacity is low, inflation pressures are starting to build and we need to normalise monetary policy,” he said.
“I think the biggest would have been – and still is but is hidden a bit by the noise – the fact that you are seeing policy start to tighten towards the end of the cycle.”
Indeed, the Bank of England in the UK raised rates in August in a widely anticipated move by the market, with more rate hikes expected next year.
“At the start of the year investors were generally seeing [rate rises] as a positive because they saw it as a normalisation of policy that was taking away some of that emergency stimulus,” Illsley said.
“We were expecting yield curves to perhaps steepen and that a lot of cyclical areas that are late-stage but not end of cycle sectors would do quite well.”
While the process is ongoing and central banks across the world are focused on tightening monetary policy, investors have yet to catch up with what the effects might be.
“I think the UK survey suggests we are going to raise interest rates twice next year and clearly the US is going to continue to normalise its policy but that has been overlaid by concerns over trade policy and tariffs and therefore you have seen a flight to ‘safe haven’ assets and particularly the US dollar,” Illsley said.
Indeed, this year, he noted that investors have begun to move back into more defensive, bond proxy-type names – something that is not usual at this stage of the market cycle.
“This is one of the first cycles where you have seen defensives start to outperform this early before the interest curve has inverted and we have reached peak economic activity,” the manager said.
“That is unusual and I think that is a mark of caution or fear and is not necessarily at this point in time backed up by reality.
“It is similar to what we saw in the Brexit referendum where people are overly concerned too early in the cycle.”
While cyclical companies such as miners and oil stocks have continued to generally perform quite well, investors have still been prepared to pay quite a premium for defensive stocks whether it be the typical bond proxies or utilities.
“That is unusual and we would expect some of the cyclical companies continue to do well this year and into next year,” Illsley said. “That is the main effect of all the noise. Seeing people invest in defensives without the commensurate economic slowdown.”