That time of year

It’s that time of year for forecasters to rejoice in the opportunity to produce forecasts for the year ahead. Economists like Christmas – it brings the gift of a spotlight for their year ahead projections. However, when those economic growth forecasts start landing in your inbox, it might be worth keeping the following simple charts in mind.

We look here at the US market (simply because it is the heartbeat of the market overall and is so influential, but the analysis holds equally elsewhere) and the annual relationship between the growth rate of the economy and the return on the S&P 500.

Chart 1 shows the annual nominal return for the S&P 500 from 1990 onward plotted against the annual nominal rate of growth in US GDP.

Quite strikingly, there is absolutely no relationship at all between annual nominal US growth and annual nominal US equity returns (look at those coefficients, zeroes everywhere).


Let us torture the data a little to see if we can squeeze something useful from it. Chart 2 shows the annual rate of growth of real US GDP plotted against annual nominal US equity returns.

No change, still irrelevant. Where the economy goes the market does not follow.


So, with that in mind, perhaps it is time to give your economist a break this year. Not surprisingly, we will not be winging our economic growth forecasts to your inbox.

It’s not the economy, stupid.

P.S. Here is the same chart for the UK.




UK inflation… where?

September 15, 2015

Although Annual Core Inflation slipped to 1% in August and Headline Inflation to zero, the devil, as always, remains hidden in the detail…

Look at the diffusion index of UK inflation – It looks at 80 individual sub-components of the UK inflation headline number and looks at what proportion are inflating (and at what rate) versus what proportion are disinflating (and at what rate).

If inflation rises sharply because, let’s argue, just 3 components surge higher while 77 plunge, that is less indicative of an underlying inflation problem than a broad-based/widespread increase in prices. The breadth of inflation/disinflation is as important, if not more so, than the level:

  • 52% of the index components have actually experienced deflation in the last 12 months.


  • 66% of the index components have an annual inflation rate below 1%.


  • 77% of the index components have an inflation rate below 2%.


  • And finally, 70% of the index components have seen annual inflation decline over the last 12 months.


  1. So, UK inflation is exceptionally low. The breadth of low inflation is unprecedented and the overwhelming majority of index components have seen inflation decline in the last 12 months. Nothing particularly concerning here for the Bank of England.
  1. As we have argued many times, UK inflation has “Made in China” stamped on it. In a world of increasingly open markets, where trade grows faster than production, where investment in fixed capital as a proportion of Global GDP is at the highest level in 30 years and where the world’s largest exporter, China, is still growing its manufacturing fixed capital stock at a rate almost 6% points faster annually than demand growth in the developed world, you get disinflation. In addition, with inevitable Chinese devaluation you get deflation. In this world, UK companies are price-takers and not price-setters. The price-setter is the marginal supplier of capacity and that is unquestionably China… whose main export will soon be deflation. Any company trying to fight that tide to be a price-setter will lose market share, profitability, employment and its business.
  1. UK real economy inflation, as measured by the CPI and RPI, really is out of the control of the Bank of England. The Bank should raise interest rates to reign in monetary sector runaway inflation (houses and financial assets) to arrest the dire consequences of QE sooner rather than later. If a price has to be paid, it is better paid today than tomorrow. The same is true for the Fed in the United States. The longer the delay, the worse the consequences.



UK inflation… widespread disinflation

August 18, 2015

While people generally focus on the headline number, the more useful information, as always, is contained in the detail of the index. We look at the 80 main sub-components of the index to see if there is any uniformity in the trend for inflation seen at the headline level. Any reversal in trend will be evident at the sub-index level first:

  • Of the 80 components, 50% have deflation over the last 12 months, looking back over the last decade (and more) that is an extraordinary degree of price deflation.


  • Of the 80 components, 65% have inflation below 1% over the last 12 months and 78% have inflation below the 2% level in the last 12 months.



  • Most importantly, 70% of the sub components in the UK inflation index have seen their rate of inflation decline in the last 12 months.

There is simply no sign, at this point, of any latent inflationary pressure. Indeed, the Chinese devaluation (the beginning of a trend), persistent global oversupply (compounded by ongoing over investment in China and the Emerging Markets) and the weak global growth environment all suggest disinflation and deflation are the greatest risk.


There is little evidence here for the Bank of England to justify a rise in interest rates. However, there is more justification elsewhere should the Bank be keen to press ahead:

  1. The private sector in the UK is running a financial deficit of 1.5% of GDP (i.e. its Gross Investment > its Gross Savings) meaning that the private sector, like the public sector, is accumulating net liabilities. This is the first time we have seen this in the private sector since 2002. The economy is accumulating debt at a rapid pace.
  1. The average house price/income ratio now stands at 5.3x and is at 6.5x in the Southeast and a record 7.8x in London. In fact, of the 9 UK regions, all have a price/income ratio above 4 (and 44% above 5).
  1. The UK is running a record current account deficit of 6.2% of GDP (this is not a consequence of a peculiarly British ability to hold very low yielding foreign assets, as some have suggested). With only modest Fiscal Tightening in recent years and the private sector going into deficit, the UK has provided the deficit that, from an accounting position, is the counterpart to the improved deficits/surpluses now being run in many of its trading partners. The final chart shows the change (as a % of GDP) in the UK Current Account since mid-2009 compared with that of the major blocs/countries around the world:

Both China and Japan have seen their surpluses decline sharply as the global economy has corrected. The UK has seen its deficit widen sharply as the Eurozone and US have improved their external positions materially.

You could say the UK, and the UK consumer, has helped hold the world up in this difficult period.


All told, overvalued housing markets/large current account deficits (private and government sector deficits) have been a warning sign in many a crisis around the world and especially in the UK. The Bank of England will find more justification here than in the inflation data.

Do you tighten to have an impact on something you can influence i.e. domestic credit conditions or tighten to have an impact on something you cannot influence i.e. the massive overhang of global productive capacity and easier Chinese monetary conditions?



Euro QE finally launches but likely to be “Damp Squib”

  • QE in UK and US have failed to stoke consumer demand inflation
  • China continues to export deflation into the Eurozone
  • QE not likely to translate to increased private sector loans

London, 22 January 2015. In response to the European Central Bank’s (ECB) announcement of quantitative easing today, Paul Marson, Chief Investment Officer of MONOGRAM, argues the programme is unlikely to work:

The question is why the biggest private sector credit boom in history – prior to the financial crisis – did not generate consumer price inflation: at the start of the crisis, core inflation was just 2% in Europe and the US. The answer to this is crucial, and explains why quantitative easing in the US/UK has raised asset prices – but not consumer inflation – and why euro QE is likely to be unsuccessful in achieving the ECB’s inflation objective.

Graph 1: UK core inflation and five year annualised inflation following QE

26.1.2015 Damp Squib Graph 1

“That underlying core inflation rates in the US and UK are lower today than when QE started is due to tide of disinflation originating from China. Chinese manufacturing goods supply is growing much faster than Western and Chinese demand for manufactured goods. This means a glut of supply which increasingly pushes down manufactured goods prices. Since China accounts for 17.1% of the total increase in world merchandise export (excluding the Eurozone) from 2002-2012, it is increasingly exporting deflation. Inflation is low, and getting lower, because the world is awash with supply – a “positive supply shock” is more powerful than the modest “positive demand shock” coming from QE.

Graph 2: Chinese manufacturing sector supply/Western demand mismatch

26.1.2015 Damp Squib Graph 2

“The problem confronting the ECB is that peripheral banks have substantially increased their holdings of [non-productive] government debt and substantially reduced (productive) loans to the private sector, amidst ongoing balance sheet shrinkage: the ECB hopes to take those bond holdings down and encourage private lending, a policy that is unlikely to have meaningful effects from exceptionally low current bond yield levels. It is more likely that bonds will replace the bonds they sold with more government bonds!”

Graph 3: Change in PIIGS MFI Assets from 2008

26.1.2015 Damp Squib Graph 3

UK Inflation: Long Term Structural Pressure from China, but Recent Falls are Driven by Oil Price

  • 8% fall in energy CPI; excluding food and energy CPI is 1.3%, down from 1.8% in January 2014
  • Structural mismatch between Chinese manufacturing investment and Western demand means China is “exporting” deflation into the Eurozone

London, 13 January 2015. Paul Marson, Chief Investment Officer of Monogram, comments on today’s inflation figures and the root causes:

“Today’s figures reflect a sharp 5.8% fall in energy CPI over the past year.  Without the impact of oil prices on food and energy, underlying CPI remains a more plausible 1.3% year on year, up from 1.2% year on year in November.

“In the long term, the UK faces the structural pressure of Chinese “exported deflation”. China’s manufacturing goods supply is growing much faster than Western and Chinese demand for manufactured goods. This means a glut of supply pushing down manufactured goods prices and western inflation in general.

China is a global price setter and its proportion of exports to the UK has grown significantly over the past decade, meaning that China will increasingly export deflation to the UK and the West.”

Graph: UK Energy CPI

 13.01.2015 UK Inflation Graph 1

Graph: Chinese manufacturing sector supply/ Western demand mismatch

13.01.2015 UK Inflation Graph 2