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14 March 2019

Market Insight: Turning Tides

The European Central Bank (ECB) made an abrupt about-turn last Thursday, spooking investors as it announced the revival of its stimulus programme. The move shocked economists after the Eurozone experienced two years of tempering such extremely loose monetary policy. Such policies normally boost markets as cheap funding once again floods the market, propelling risky assets. However, the negative market reaction highlights the rising concern of the region’s slowing economy.

Even with the revival of stimulus, ECB President Mario Draghi stated that he recognises the downside risk to the Eurozone, highlighting how few tools are left in the box to combat these threats, with interest rates already at zero. Signalling their apprehension, policymakers downgraded projections for growth in the Eurozone’s gross domestic product to 1.1% from 1.7% three months ago.

China added fuel to the fire on Friday with official data from Beijing showing Chinese exports have tumbled nearly 21% in February, compared with a year ago. In addition to this, The White House also indicated that the trade deal with China was far from being agreed and there was “work left to be done”.

US employment data deepened the gloom further with 20,000 jobs being added to non-farm payrolls last month, the weakest gain in 17 months and hugely under-shooting economists’ forecasts of 180,000 new jobs. It must be noted that although there was a slowdown in new jobs, the labour data showed wages increased 3.4% over the same month a year ago, the fastest pace of growth since April 2009. The combination of a slowing economy and rising wages points to increasing pressure on corporate margins. Recent earnings reports for the fourth quarter of 2018 show global profits have decelerated in the past year, consistent with slowing global growth.

Margins play a significant role in gauging the state of the business cycle and it is important to consider the underlying contributing factors. Changes in corporate margins are the sum of output price inflation minus wage growth, plus labour productivity growth and other costs. In the US, and to a lesser extent in the United Kingdom, we are currently experiencing continued upward pressure on wages, while lacking any meaningful improvement in productivity growth. In addition to productivity growth, output price inflation is important in offsetting rising labour costs. Recent data is indicating lacklustre inflation, hence the change in stance many central banks are taking. All of these factors tend toward margin pressures and a key test for corporate profitability will be how these factors develop over the remainder of 2019.

Elizabeth Pindar, Investment Executive

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Market Insight: Turning Tides

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