What is the world's 4th largest economy saying?
In this series of essays I want to examine a number of areas, measures and indicators to try to gauge the real health of the UK economy. The world's 4th largest economy has been on a bit of a run recently. The average homeowner is reportedly £100k richer since New Labour took the helm and no doubt Old Conservative would point to the remarkable gains in the FTSE that brought wealth, or the illusion of it, to countless other citizens during their time in charge. Political policies or leanings will not be an indicator I will consider as I firmly believe what has happened in the UK (merely a reflection of what has happened in the whole of the Western World to a greater or lesser degree) would have happened if the hapless Liberals had been in charge.
Lets consider some of the indicators flashing BUY or SELL or merely flashing!
1. Yield Curve - Essentially the differential between short term interest rates (as measured by the BOE base overnight lending rate) and long term interest rates (as measured by the yield on long dated Government Bonds - Gilts). The more typical curve is an upward slope signifying lower short term rates and higher long term. More recently this slope has inverted as a result of the BOE rate increases to present 4.75%. Is this the top of the cycle, by all accounts it is or at least very close to. However that does not reduce the impact of the inverted yield curve that has existed for some months. Federal Reserve research and history shows the inverted yield curve to be a better predictor of recession than most economists (that said the success or failure of Manchester United is a better predictor of recession than most economists!) - See John Mauldin's "Canary in a Coalmine" article for a more thorough discussion of the inverted yield curve - Can we then expect a recession beginning tomorrow? Not exactly but the inverted curve does tell us that conditions have changed and that the growth pattern seen in recent - or even not so recent - years is going to change. Another excellent predictor of the relative strength of the economy is the stock market. The FTSE tells it's own story, a story we will consider shortly.
When was the last recession in the UK? Can anyone remember? The fact that it was more than a decade ago is in itself a pretty significant indicator. Has the UK government found the magic cure to do away with the business cycle? Is the 4th largest economy in the world somehow "better" than numbers 1,2 & 3 (2&3 presently in recession)? Does this prove that a service and consumer driven economy is better than or at least less prone to cycles than a manufacturing economy? Or perhaps is the former just better able to function in a debt based society than the latter.
What is the effect of the lack of recession on the UK consumer? Along with many other factors we will discuss later the lack of any significant downturn in the UK business cycle of the last 10+ years has embolden the UK consumer. Planning carefully for tomorrow, in case tomorrow brings trouble, has virtually gone out of the window. Tomorrow WILL be as good if not better than today. Savings is old fashioned, inefficient and downright foolhardy UK savings rate has fallen by 60% since 1980 to just 5% today). Why save for a rainy day when there are no, and have not been any, clouds in the sky for such a long time. Invest that is what you should do. Investing has become an addiction. Wealth creation is every ones right. Stocks, Property, Foreign property, Gold, Antiques.
Not so long ago I dared suggest to a colleague that the stock market had topped (no brainer FTSE high 6970 DEC 31 1999 been nowhere near it since) and that property has likewise seen its peak - the response. -
"impossible - what will people invest in" -
Like they HAVE to HAVE something to invest in!! - as I said, an addiction, a right -
A gigantic SELL signal
2. Stock Market - The second measure or indicator of the real health of the UK economy that I would like to consider is the stock market. Again the stock market has a far better track record at predicting turning points in the UK economy than any economist so we'd better give it a chance.
Like the economy the FTSE has been on a bit of a run recently - Hey any chance of a link!!! The FTSE 100 peaked right at the dawn of the new millennium, what followed was a financial disaster for anyone invested at that time, a fall of about 60% bottoming in March 2003. Since that time we have returned to steady growth which, in the last 2 years, has retraced 50% of the decline.
What has the economy done during this time?
Peak GDP growth recorded in Q2 2000 (just after the FTSE peak - economy LAGS stocks) @ 4.4% pa, falling to just 1.5% pa in late 2002.
Since then, and following the lead of the FTSE, the UK economy has recovered to a peak growth rate of 3.5% p.a. in Q2 04. Latest stats show Q4 04 coming in at an annualised rate of 2.8%.
Where are we now? The FTSE has recently broken through 5000 and with it record levels of bullishness. (This most recent sprint above 5000 suggests we will see good GDP growth figures for Q1 2005). Recent surveys put Fund Managers cash levels below 4% and threatening the all time lows seen, strangely enough in Dec 1999 and Dec 2003 - Did we see market tops then??!!?
Now some would say the FTSE will continue to go higher because the economy is so strong.
Think about it........
- record levels of employment
- record levels of corporate profits (UK Bank & Oil sectors just released record profits)
- record levels of bullishness
- record levels of "consumerism" with attendant record levels of DEBT
- near record low interest rates (despite recent and consecutive rises from Bank of England)
- record levels of wealth -(read house prices)
Be honest - How much better can it get? Priced to perfection? Upside potential limited by utopian reality?
No the truth is the economy LAGS the stock market and the FTSE is flashing (what colour?)
Technical Analysis says...
The 2000 - 2003 decline erased 3700+ FTSE100 points in 5 clear Elliot waves (3 down 2 up) - impulsive wave pattern. The upside since March 2003 has retraced a fibonacci 50%.
The 2000 - 2003 decline lasted a little over 38 months, the "bounce" since March 2003 has lasted 24 give or take a day. What is 24/ 38.5 almost exactly 62%. So we have a 5 wave decline, retraced by a 3 wave correction extending to about 50% in about 62% of the time at a psychologically important level - 5000 - with extreme bullishness, no record able levels of fear, a belief that recessions are history and an addiction to investing -
What do you think the FTSE is saying? ***********SELL****************
Of course, the FTSE may go on to reach 61.8% of the 2000-2003 decline, that would take it to about 5500, a 10% increase from today. The investor should think carefully before jumping on board for another 10%, next wave down is number 3 - you thought 2000-2003 was bad!!
In the second part of this article I will consider consumer spending patters, debt levels, the effect of the housing market and, in an attempt to get a handle on "the mood of the masses" - social trends and observations including, amongst other things, music and football (oops! Soccer).