What are Behavioural Biases- Part one

  • by Graham Bond
  • 27 Sep, 2017

Introduction

Behavioural Biases

By now, you’ve probably heard the news: Your own behavioural biases are often the greatest threat to your financial well-being. As investors, we leap before we look. We stay when we should go. We cringe at the very risks that are expected to generate our greatest rewards. All the while, we rush into nearly every move, only to fret and regret them long after the deed is done.

Why Do We Have Behavioural Biases?

Most of the behavioural biases that influence your investment management decisions come from myriad mental shortcuts we depend on to think more efficiently and act more effectively in our busy lives.

Usually (but not always!) these short-cuts work well for us. They can be powerful allies when we encounter physical threats that demand reflexive reaction, or even when we’re simply trying to stay afloat in the rushing roar of deliberations and decisions we face every day.

What Do They Do To Us?

As we’ll cover in this series, those same survival-driven instincts that are otherwise so helpful can turn deadly in investing. They overlap with one another, gang up on us, confuse us and contribute to multiple levels of damage done.

Friend or foe, behavioural biases are a formidable force. Even once you know they’re there, you’ll probably still experience them. It’s what your brain does with the chemically induced instincts that fire off in your head long before your higher functions kick in. They trick us into wallowing in what financial author and neurologist William J. Bernstein, MD, PhD , describes as a “Petrie dish of financially pathologic behaviour,” including:

  • Counterproductive trading – incurring more trading expenses than are necessary, buying when prices are high and selling when they’re low.
  • Excessive risk-taking – rejecting the “risk insurance” that global diversification provides, instead over-concentrating in recent winners and abandoning recent losers.
  • Favouring emotions over evidence – disregarding decades of evidence-based advice on investment best practices.

What Can We Do About Them?

Here are a few additional ways you can defend against the behaviourally biased enemy within:

Anchor your investing in a solid plan – By anchoring your trading activities in a carefully constructed plan (with predetermined asset allocations that reflect your personal goals and risk tolerances), you’ll stand a much better chance of overcoming the bias-driven distractions that rock your resolve along the way.

Increase your understanding – Don’t just take our word for it. Here is an entertaining and informative library on the fascinating relationship between your mind and your money:

 

Don’t go it alone – Just as you can’t see your face without the benefit of a mirror, your brain has a difficult time “seeing” its own biases. Having an objective advisor well-versed in behavioural finance, dedicated to serving your highest financial interests, and unafraid to show you what you cannot see for yourself is among your strongest defences against all of the biases we’ll present throughout the rest of this series.

As you learn and explore, we hope you’ll discover: You may be unable to prevent your behavioural biases from staging attacks on your financial resolve. But, forewarned is forearmed. You stand a much better chance of thwarting them once you know they’re there!

Anchoring Bias

What is it? Anchoring bias occurs when you fix on or “anchor” your decisions to a reference point, whether or not it’s a valid one.

When is it helpful? An anchor point can be helpful when it is relevant and contributes to good decision-making. For example, if you’ve set a 10 pm curfew for your son or daughter and it’s now 9:55 pm, your offspring would be wise to panic a bit, and step up the homeward pace.

When is it harmful? In investing, people often anchor on the price they paid when deciding whether to sell or hold a security: “I paid £11/share for this stock and now it’s only worth £9/share. I’ll hold off selling it until I’ve broken even.” This is an example of anchoring bias in disguise. Evidence-based investing informs us, the best time to sell a holding is when it’s no longer serving your ideal total portfolio, as prescribed by your investment plans. What you paid is irrelevant to that decision, so anchoring on that arbitrary point creates a dangerous distraction.

Blind spot Bias

What is it? Blind spot bias occurs when you can objectively assess others’ behavioural biases, but you cannot recognize your own.

When is it helpful? Blind spot bias helps you avoid over-analysing your every imperfection, so you can get on with your one life to live. It helps you tell yourself, “I can do this,” even when others may have their doubts.

When is it harmful? It’s hard enough to root out all your deep-seated biases once you’re aware of them, let alone the ones you remain blind to. In “ Thinking, Fast and Slow ,” Nobel laureate Daniel Kahneman describes (emphasis ours): “We are often confident even when we are wrong , and an objective observer is more likely to detect our errors than we are.” (Hint: This is where second opinions from an independent advisor can come in especially handy.)

Confirmation Bias

What is it? We humans love to be right and hate to be wrong. This manifests as confirmation bias, which tricks us into being extra sympathetic to information that supports our beliefs and especially suspicious of – or even entirely blind to – conflicting evidence.

When is it helpful? When it’s working in our favour, confirmation bias helps us build on past insights to more readily resolve new, similar challenges. Imagine if you otherwise had to approach each new piece of information with no opinion, mulling over every new idea from scratch. While you’d be a most open-minded person, you’d also be a most indecisive one.

When is it harmful? Once we believe something – such as an investment is a good/bad idea, or a market is about to tank or soar – we want to keep believing it. To remain convinced, we’ll tune out news that contradicts our beliefs and tune into that which favours them. We’ll discount facts that would change our mind, find false affirmation in random coincidences, and justify fallacies and mistaken assumptions that we would otherwise recognize as inappropriate. And we’ll do all this without even knowing it’s happening. Even stock analysts may be influenced by this bias.

Familiarity Bias

What is it? Familiarity bias is another mental shortcut we use to more quickly trust (or more slowly reject) an object that is familiar to us.

When is it helpful? Do you cheer for your home-town team? Speak more openly with friends than strangers? Favour a job applicant who (all else being equal) has been recommended by one of your best employees? Congratulations, you’re making good use of familiarity bias.

When is it harmful? Considerable evidence tells us that a broad, globally diversified approach best enables us to capture expected market returns while managing the risks involved. Yet studies like this one have shown investors often instead overweight their allocations to familiar vs. foreign investments. We instinctively assume familiar holdings are safer or better, even though, clearly, we can’t all be correct at once. We also tend to be more comfortable than we should be bulking up on company stock in our retirement plan.

Fear

What is it? You know what fear is, but it may be less obvious how it works. As Jason Zweig describes in “ Your Money & Your Brain ,” if your brain perceives a threat, it spews chemicals like corticosterone that “flood your body with fear signals before you are consciously aware of being afraid.” Some suggest this isn’t really “fear,” since you don’t have time to think before you act. Call it what you will, this bias can heavily influence your next moves – for better or worse.

When is it helpful? Of course, there are times you probably should  be afraid, with no time for studious reflection about a life-saving act. If you are reading this today, it strongly suggests you and your ancestors have made effective use of these sorts of survival instincts many times over.

When is it harmful? Zweig and others have described how our brain reacts to a plummeting market in the same way it responds to a physical threat like a rattlesnake. While you may be well-served to leap before you look at a snake, doing the same with your investments can bite you. Also, our financial fears are often misplaced. We tend to overcompensate for more memorable risks (like a flash crash), while ignoring more subtle ones that can be just as harmful or much easier to prevent (like inflation, eroding your spending power over time).

Framing

What is it? Thinking, Fast and Slow ,” Nobel laureate Daniel Kahneman defines the effects of framing as follows: “Different ways of presenting the same information often evoke different emotions.” For example, he explains how consumers tend to prefer cold cuts labelled “90% fat-free” over those labelled “10% fat.” By narrowly framing the information (fat-free = good, fat = bad; never mind the rest), we fail to consider all the facts.

When is it helpful? Have you ever faced an enormous project or goal that left you feeling overwhelmed? Framing helps us take on seemingly insurmountable challenges by focusing on one step at a time until, over time, the job is done. In this context, it can be a helpful assistant.

When is it harmful? To achieve your personal financial planning goals, you’ve got to do more than score isolated victories in the market; you’ve got to “win the war.” As UCLA’s Shlomo Benartzi describes in a Wall Street Journal piece , this demands strategic planning and unified portfolio management, with individual holdings considered within the greater context. Investors who instead succumb to narrow framing often end up falling off-course and incurring unnecessary costs by chasing or fleeing isolated investments.

Greed

What is it? Like fear, greed requires no formal introduction. In investing, the term usually refers to our tendency to (greedily) chase hot stocks, sectors or markets, hoping to score larger-than-life returns. In doing so, we ignore the oversized risks typically involved as well.

When is it helpful? In Oliver Stone’s Oscar-winning “ Wall Street ,” Gordon Gekko (based on the notorious real-life trader Ivan Boesky) makes a valid point … to a point: “Greed, for lack of a better word, is good. … Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind.” In other words, there are times when a little greed – call it ambition – can inspire greater achievements.

When is it harmful? In our cut-throat markets (where you’re up against the Boeskys of the world), greed and fear become a two-sided coin that you flip at your own peril. Heads or tails, both are accompanied by chemical responses to stimuli we’re unaware of and have no control over. Overindulging in either extreme leads to unnecessary trading at inopportune times.

Herd Mentality

What is it? Move over, cows. You’ve got nothing on us humans, who instinctively recoil or rush headlong into excitement when we see others doing the same. “The idea that people conform to the behaviour of others is among the most accepted principles of psychology,” says Gary Belsky and Thomas Gilovich in “ Why Smart People Make Big Money Mistakes .”

When is it helpful? If you’ve ever gone to a hot new restaurant, followed a fashion trend, or binged on a hit series, you’ve been influenced by herd mentality. “Mostly such conformity is a good thing, and it’s one of the reasons that societies are able to function,” say Belsky and Gilovich. It helps us create order out of chaos in traffic, legal and governmental systems alike.

When is it harmful? Whenever a piece of the market is on a hot run or in a cold plunge, herd mentality intensifies our greedy or fearful chain reaction to the random event that generated the excitement to begin with. Once the dust settles, those who have reacted to the near-term noise are usually the ones who end up overpaying for the “privilege” of chasing or fleeing temporary trends instead of staying the course toward their long-term goals. As Warren Buffett has famously said , “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

Hindsight

What is it? In Thinking, Fast and Slow ,” Daniel Kahneman credits Baruch Fischhoff for demonstrating hindsight bias – the “I knew it all along” effect – when he was still a student. Kahneman describes hindsight bias as a “robust cognitive illusion” that causes us to believe our memory is correct when it is not. For example, say you expected a candidate to lose, but she ended up winning. When asked afterward how strongly you predicted the actual outcome, you’re likely to recall giving it higher odds than you originally did. This seems like something straight out of a science fiction novel, but it really does happen!

When is it helpful? Similar to blind spot bias (one of the first biases we covered) hindsight bias helps us assume a more comforting, upbeat outlook in life. As “ Why Smart People Make Big Money Mistakes ” authors Gary Belsky and Thomas Gilovich describe it, “We humans have developed sneaky habits to look back on ourselves in pride.” Sometimes, this causes no harm, and may even help us move past prior setbacks.

When is it harmful? Hindsight bias is hazardous to investors, since your best financial decisions come from realistic assessments of market risks and rewards. As Kahneman explains, hindsight bias “leads observers to assess the quality of a decision not by whether the process was sound but by whether its outcome was good or bad.” If a high-risk investment happens to outperform, but you conveniently forget how risky it truly was, you may load up on too much of it and not be so lucky moving forward. On the flip side, you may too quickly abandon an underperforming holding, deceiving yourself into dismissing it as a bad bet to begin with.

Loss Aversion

What is it? “Loss aversion” is a fancy way of saying we often fear losing more than we crave winning, which leads to some interesting results when balancing risks and rewards. For example, in “ Stumbling on Happiness ,” Daniel Gilbert describes: “Most of us would refuse a bet that gives us an 85 percent chance of doubling our life savings and a 15 percent chance of losing it.” Even though the odds favour a big win, imagining that slight chance that you might go broke leads most people to decide it’s just not worth the risk.

When is it helpful? To cite one illustration of when loss aversion plays in your favour, consider the home and auto insurance you buy every year. It’s unlikely your house will burn to the ground, your car will be stolen, or an act of negligence will cost you your life’s savings in court. But loss aversion reminds us that unlikely does not mean impossible . It still makes good sense to protect against worst-case scenarios when we know the recovery would be very painful indeed.

When is it harmful? One-way loss aversion plays against you is if you decide to sit in cash or bonds during bear markets – or even when all is well, but a correction feels overdue. The evidence demonstrates that you are expected to end up with higher long-term returns by at least staying put, if not bulking up on stocks when they are “cheap.” And yet, the potential for future loss can frighten us into abandoning our carefully planned course toward the likelihood of long-term returns.

Mental Accounting

What is it? If you’ve ever treated one dollar differently from another when assessing its worth, that’s mental accounting at play. For example, if you assume inherited money must be more responsibly managed than money you’ve won in a raffle, you’re engaging in mental accounting.

When is it helpful? In his early paper, “ Mental Accounting Matters ,” Richard Thaler (who is credited for having coined the term), describes how people use mental accounting “to keep track of where their money is going, and to keep spending under control.” For example, say you set aside £250/month for a fun family outing. This does not actually obligate you to spend the money as planned or to stick to your budget. But by effectively assigning this function to that money, you’re better positioned to enjoy your leisure time, without overdoing it.

When is it harmful? While mental accounting can foster good saving and spending habits, it plays against you if you instead let it undermine your rational investing. Say, for example, you’re emotionally attached to a stock you inherited from a beloved aunt. You may be unwilling to unload it, even if reason dictates that you should. You’ve just mentally accounted your aunt’s bequest into a place that detracts from rather than contributes to your best financial interests.

Outcome Bias

What is it? Sometimes, good or bad outcomes are the result of good or bad decisions; other times (such as when you try to forecast future market movements), it’s just random luck. Outcome bias is when you mistake that luck as skill.

When is it helpful? This may be one bias that is never really helpful in the long run. If you’ve just experienced good or bad luck rather than made a smart or dumb decision, when wouldn’t you want to know the difference, so you can live and learn? 

When is it harmful? As Kahneman describes in “ Thinking, Fast and Slow ,” outcome bias “makes it almost impossible to evaluate a decision properly – in terms of the beliefs that were reasonable when the decision was made.” It causes us to be overly critical of sound decisions if the results happen to disappoint. Conversely, it generates a “halo effect,” assigning undeserved credit “to irresponsible risk seekers …who took a crazy gamble and won.” In short, especially when it’s paired with hindsight bias, this is dangerous stuff in largely efficient markets. The more an individual happens to come out ahead on lucky bets, the more they may mistakenly believe there’s more than just luck at play.  

Recent Posts

by Graham Bond 08 Jan, 2018

REVIEW OF THE PAST QUARTER:

November saw the Bank of England raise interest rates to 0.5 per cent, marking the start of the policy-normalisation process. The autumn budget came later in the month and contained significant downgrades to growth forecasts for 2017-2022. The gloom was somewhat offset in December, when a deal was reached between the UK and the EU, putting an end to a tumultuous first phase of Brexit negotiations. On the continent, October saw the European Central Bank extend a less generous version of its quantitative easing programme while keeping interest rates on hold.

In the US, expansionary tax reforms were passed by Congress and the House of Representatives, leading the Federal Reserve to raise its growth forecasts for 2017 and 2018 to 2.5 per cent, shortly after raising interest rates by 0.25 per cent. The reforms include a cut to corporate tax from 35 to 21 per cent. The quarter also saw US President Donald Trump nominate Jerome Powell as Janet Yellen’s successor. He will take over as Chair of the Federal Reserve in February.

In October, Japanese Prime Minister Shinzo Abe secured a strong mandate for his hard line against North Korea with a convincing majority. Elsewhere in Asia, after what was deemed President Trump’s successful tour of the continent, North Korea launched its most powerful missile ever - allegedly putting the entire US in range.

THE ACTUARIAL VIEW:

The last three months have seen little in terms of concrete developments to move markets, yet markets remain buoyant. For the first time in years, however, we are seeing accelerating growth almost uniformly across the globe. The global picture has generally been one of falling unemployment levels and low inflation. This is a slightly curious phenomenon, as high employment would be expected to stoke demand, but can perhaps be explained by low wage growth.

The exceptions to this are the US and the UK. The US has been raising interest rates for some time, and the UK has recently raised rates for the first time in years. This, in some ways, is also curious as raising rates would generally signify strong growth activity. In the US, however, growth is expected to slow whilst the UK is experiencing a period of high inflation and growth falling much faster than expected, as the fallout from the EU Brexit referendum and an impasse in the subsequent negotiations begin to bite. Overall, changes for asset allocations are modest, with a slight move away from the UK into other equities. The prospects for property have decreased as higher rates generally put pressure on capital values.

 

WHAT TO LOOK FOR IN Q1 2018:

·         Japan: There is a Bank of Japan meeting on January 22-23. An outlook report will be published the same day. The next meeting will be on March 8-9.

·         US: Federal Open Market Committee meetings will take place on January 30-31 and March 20-21. February 3 will see Jerome Powell take over from Janet Yellen as Chair of the Federal Reserve..

·         Europe: There is a European Central Bank meeting on January 25 with a press conference later in the day. The 2018 Russian presidential election takes place on March 18.

·         UK: Monetary Policy Committee announcements with minutes are scheduled for February 8 and March 22. An inflation report will be published on February 8. Talks on a trade deal between the UK and the EU are currently expected to begin in March, the same month that a two-year EU Brexit transition deal is expected to be agreed.

·         Other Data: The Office for National Statistics is set to release its UK productivity bulletin for July to September on January 5. The UK consumer price inflation bulletins for December, January and February will be released on January 16, February 13 and March 20 respectively. The US Census Bureau will release its US International Trade in Goods and Services reports for November, December and January on January 5, February 6 and March 7 respectively.

UK EQUITY

Most Likely:EU Brexit sentiment will continue to drive UK sterling, which in turn will move large-cap exporters. Recent positive developments, with Brexit talks moving into the second round, mean further UK sterling strength from here is limited, so large caps will close the gap with recent outperforming smaller and medium sized companies. Coming off the back of recent strength, we would expect oil and commodities to trade sideways from here, which is profitable and positive for stocks within these sectors.

Worst Case: Chinese de-levering will halt demand in commodities and oil, which will result in price weakness and falls in those large sectors. Further EU Brexit posturing may weaken UK sterling (with exporters doing relatively better) as real wages continue to fall and inflation bites. Any sustained imported inflation will raise short term rates dragging income stocks lower.

Best Case: Sustained progress in EU Brexit talks encourages businesses back into capital investment that, at long last, begins to stimulate growth. Stronger UK sterling is a drag on exporting stocks in this scenario - expect domestics to outperform like in 2016. Softer Chinese monetary policy will be positive to commodities and oil stocks as OPEC cuts are maintained.

CASH

Most Likely: It is likely there will be no changes to interest rates and inflation will start to fall. This means that losses on cash will narrow in real terms. Inflation will remain above target if the significant depreciation of the pound following the Brexit vote has not yet had its full effect on consumer prices. However, it should come down from the 3.1 per cent reached in the year to November, barring any significant currency movements.

Worst Case: While interest rates are put on hold, inflation could rise, pulling real returns further into negative territory. One likely explanation would be a depreciation of the pound following a breakdown in Brexit talks. This would raise import prices for UK firms and it is likely that they would pass some proportion of their increased costs onto consumers, as they have done since the Brexit vote.

Best Case: For cash savers is that inflation falls while rates are raised by 0.25 per cent in January, meaning that losses narrow in real terms. A rise in the price of UK sterling would be the most likely explanation. Any consequent fall in inflation would raise real returns to cash. However, it seems likely they would remain negative even in this best-case scenario.

GLOBAL EQUITY

Most likely: The economic backdrop is supportive and moderate growth looks set to continue in 2018 across Europe, Japan and the US. Despite late-cycle dynamics in the US, short-term recession risk is low - wages and rates have room to rise before it becomes problematic for the economy. Japan is in the ‘sweet spot’ of the economic cycle, allowing the best of corporate Japan to perform well.

Worst case: Markets could price in regulatory uncertainty around data privacy and anti-trust, derailing the technology rally. Risk of new elections in Germany may lead voters towards right-wing populist party AFD (‘Alternative for Germany’), which has thrived on dissatisfaction with established parties, leaving European equities vulnerable. Slowing buybacks and dividend growth with little margin improvement, may imply unspectacular returns for Japanese equities.

Best case: US earnings could see a boost, with the largest beneficiaries being banks, airlines and oil refiners resulting from proposed tax cuts. European equities should benefit from continuing profit margin expansion, low inflation and falling stockmarket correlations. Japanese equities should benefit from healthy earnings and progressive corporate reform.

FIXED INCOME

Most Likely: The market’s view of EU Brexit is likely to determine the course of gilt yields over the next quarter. When a deal or a softer Brexit looks more likely, yields are likely to rise; whereas when a ‘no-deal’ or ‘hard’ Brexit looks more likely, yields are likely to fall as domestic inves­tors seek the safety of government bonds. Slight gains in corporate bonds are likely as the UK is unlikely to tip into recession.

Worst Case: A collapse of the Conservative government and a new election could lead to Labour’s Jeremy Corbyn either leading in the polls or winning the vote by the end of the quarter. This would lead to an expectation of much greater public spending and a weaker economy, which could lead to gilts selling off as international investors flee and domestic investors look to diversify. Corporate and high-yield bonds would also do badly in this environment.

Best Case: For gilts, the best case would be a collapse in the EU Brexit talks and a severe downturn in UK economic data, both of which should lead to risk-aversion and higher demand for safe-haven assets. For corporate and high-yield bonds, the best case would be the opposite, which would lead to lower default risks and higher corporate bond prices.

EMERGING MARKETS EQUITY

Most Likely: Emerging markets are likely to make positive returns this quarter, although less than they saw in 2017 as valuations in the market start to normalise following a strong period. South Africa is likely to have a strong quarter thanks to the results of the ANC leadership election in December, while Brazil is likely to lag as the president is unlikely to succeed in getting pension reform through before elections. Local factors are likely to become critical to returns in each country.

Worst Case: A global downturn, led by the US, could lead to serious headwinds for the region. The US dollar would likely rise, which would be mostly negative for emerging market economies, while investors would seek out the safety of developed world government bonds and equities.

Best Case: If the developed world continues to grow slowly and rate rises are delayed, then emerging markets are likely to remain in favour. The whole region could become more richly-valued if equity markets in the developed world are sluggish while economic growth is steady, encouraging investors into the developing region.

PROPERTY

Most Likely: Pressure from the EU Brexit negotiations eases following a late-hour divorce deal being struck. Not much change is expected in the UK as companies wait for clarity. Income should continue to drive returns, with disparity among sectors. Capital values might compress a little but should remain localised, with London offices being the most at risk. Low to mid-single digit returns are the most likely outcome for the asset class.

Worst Case: Rapidly-rising rates are a threat to property markets as they reduce the yield gap between bonds and property, and make the asset class less attractive. This is a risk for US real estate investment trusts (REITs) in particular, as the US Federal Reserve shows confidence in the strength of the economy’s growth. In the UK, fundamentals have not changed but a stalemate in EU Brexit negotiations, or any sort of bad news, will likely depress investors further.

Best Case: In the UK, early progress on a new trade agreement with the EU would lift investor sentiment and help companies plan for office-space requirements. This would be supportive of capital values. Low interest rates for longer also support the attractiveness of the asset class, and Europe is well positioned in this respect.


A PDF copy of the market commentary is available here


 


by Graham Bond 27 Sep, 2017

By now, you’ve probably heard the news: Your own behavioural biases are often the greatest threat to your financial well-being. As investors, we leap before we look. We stay when we should go. We cringe at the very risks that are expected to generate our greatest rewards. All the while, we rush into nearly every move, only to fret and regret them long after the deed is done.

by Graham Bond 13 Sep, 2017

August is traditionally a quiet month as people go on holiday, factories close and parliament takes a break. Sadly, this year was dominated by terrorist atrocities in Barcelona, and by an increasingly combative rhetoric from North Korea that culminated in the firing of a missile over Japan. This brought about a heightened demand for perceived “safe-haven” assets, whilst the price of gold surged to an eleven-month high and reached its highest level since President Trump’s election in November 2016.

Weather has dominated the headlines, with Tropical Storm Harvey hammering Texas and the US Gulf Coast. This was followed by Hurricane Irma, bringing devastation to the Caribbean, Florida and beyond. Jose and Katia are the latest to bring havoc of what is still the beginning of the tropical season.

UK

The FTSE 100 Index rose by 0.8% during August. The only real change we may see to the pound over the coming months, is the removal of the old circular coin in mid-October! it continues to struggle again the EURO and USD.

UK equity markets rose over July, although the overall performance of large companies was eclipsed by that of mid-caps. While the blue-chip FTSE 100 Index rose by 0.8%, the FTSE 250 Index rebounded from a poor June to end July 2.3% higher.

Royal Bank of Scotland (RBS) reached an agreement with the US Federal Housing Finance Agency over the mis-selling in the US of high-risk mortgage products before the financial crisis. RBS will pay US$4.75 billion to settle the case. Elsewhere, payment processor and fellow FTSE 100 constituent Worldpay confirmed that it was to be taken over by US payment processor Vantiv.

The UK economy posted quarterly growth of 0.3% for the second quarter of the year, compared with first-quarter growth of 0.2%. Growth in the services sector was boosted by a strong contribution from the UK retailing and film industries. The International Monetary Fund (IMF) downgraded its forecast for UK economic growth in 2017 from 2% to 1.7%, citing “weaker-than-expected activity” in the first quarter.

Having fallen by 1.2% in May, retail sales volumes rebounded in June, rising at a monthly rate of 0.6%. Sports retailer Sports Direct revealed a drop of almost 59% in full-year profits, which were weighed down by a period of bad publicity and the effects of the pound’s weakness. Sterling rallied to its highest level against the US dollar since September 2016 during July.

Supermarket retailers Sainsbury’s reported a stronger-than-expected sales increase during its first quarter, but sounded a warning note over the impact of mounting inflationary pressures. The UK’s annualised rate of consumer price inflation eased unexpectedly in June, falling from 2.9% in May – its highest level since June 2013 – to 2.6%, and posting its first drop since October 2016. The decline was primarily caused by a fall in motor fuel prices, and the news went some way towards alleviating pressure on the Bank of England (BoE) to consider tightening monetary policy.

The rate of unemployment in the UK fell to its lowest level since 1975 in the three months to May, declining to 4.5%. However, wage growth continued to lag inflation: average earnings (excluding bonuses) rose at an annualised rate of 2%. Moreover, once inflation was stripped out, real weekly wages fell at an annualised rate of 0.5%, stoking concerns about the possible impact on economic growth.

UK equity indices generally rose during July, although medium-sized companies generally performed better than their larger counterparts. Over the month, the FTSE 250 Index rose by 2.3%, while the blue-chip FTSE 100 Index climbed by 0.8%. Meanwhile, the FTSE 250 Index’s yield fell from 2.71% to 2.65% during July, and the yield on the FTSE 100 Index eased from 3.84% to 3.80%. In comparison, the yield on the ten-year gilt edged down from 1.33% to 1.29% over the month.

Support services and construction firm Carillion issued a profit warning and announced the suspension of its dividend pay-out. Elsewhere, HSBC Holdings announced a new share buyback of up to US$2 billion, taking its buyback total to US$5.5 billion. According to HSBC’s CEO, Stuart Gulliver, the company has paid “more in dividends than any other European or American bank” over the past 12 months.

UK Investment dividend pay-outs hit a new second-quarter record in 2017, according to Capita Asset Services’ quarterly UK Dividend Monitor, reaching a total of £33.3 billion. Dividends were boosted by a strong contribution from companies in a “resurgent” mining sector, where second-quarter pay-outs rose at an annualised rate of 73%. During July, miner Anglo American revealed stronger-than-expected half-year results and a sharp decline in debt, and announced the early reinstatement of its dividend pay-out. Its dividend policy will target a pay-out of 40% of underlying earnings. Anglo American announced the cancellation of its dividend pay-out in December 2015 as part of a restructuring programme designed to address a downturn in commodity prices.

Total underlying dividend payments of £28.6 billion were augmented in the second quarter by special dividends totalling £4.6 billion. Sterling’s weakness continued to flatter pay-outs from UK companies: underlying growth in the second quarter was 12.6%; however, when the currency effects were stripped out, underlying growth was a slightly more modest 7.8%. Looking ahead, although the second half of the year is expected to be quieter than the first half in terms of dividends, Capita still expects 2017 to be a record year.

EUROPE

Uncertainties surrounding Brexit continue. The UK will "soon regret" leaving the EU, European Commission President Jean-Claude Juncker has said. Inflation hit 2.9%, ahead of the Bank of England’s target of 2%....ongoing concerns of a rise in interest rates continue.

The euro rose to its highest level against the US dollar since January 2015 during August, driven up by concerns over the impact of Tropical Storm Harvey in the US, and by the strengthening European economy. The eurozone’s economy expanded at an annualised rate of 2.2% during the second quarter.

 The euro’s appreciation generated some apprehension about the impact on corporate earnings in the region. Over August, the Dax Index fell by 0.5%, while the CAC 40 Index edged 0.2% lower.

European Central Bank (ECB) President Mario Draghi played down speculation that the central bank intends to start winding down its programme of economic stimulus measures soon. Mr Draghi said: “The last thing that the Governing Council may want is actually an unwanted tightening of the financing conditions that either slows down this process or may even jeopardise it”. Mr Draghi hailed the measures as successful, citing “all the economic sentiment indicators (and) survey indicators (which) are either at all-time highs or close to that”. The euro rose to its highest level against the US dollar since the beginning of 2015; meanwhile, the Dax Index fell by 1.7% and the CAC 40 Index dropped by 0.5% over the month.

Mr Draghi issued a cautionary note, however, warning that underlying inflation remains subdued and has not yet demonstrated “convincing signs of a pick-up”. The annualised rate of inflation in the euro area remained unchanged at 1.3% during June, remaining below the ECB’s 2% target. A survey undertaken by the ECB found that expectations for inflation in the euro area have deteriorated, highlighting the problems faced by the central bank. The survey found that the rate of inflation expected to remain below target in 2017, 2018 and 2019.

Economic sentiment in the eurozone rose in July to its highest level for ten years. Sentiment was boosted by stronger confidence in the services sector. The eurozone’s rate of unemployment fell to 9.1% during June, reaching its lowest level since February 2009. The International Monetary Fund (IMF) expects economic expansion in the eurozone to be stronger than previously predicted, and upgraded its forecast for 2017 from 1.7% to 1.9%, citing better-than-expected momentum in domestic demand. The IMF also upgraded its economic forecasts for several major European countries, including Spain – which is expected to expand this year by 3.1% - and Italy, which is forecast to grow by 1.3%.

Following a surge in demand for European equity funds in April and May, investors ’ appetite for funds in the Europe excluding UK sector declined during June, according to the Investment Association (IA). Nevertheless, in absolute terms, demand remained relatively robust and the sector experienced net inflows of £188 million during the month. Similarly, although demand for funds in the European Smaller Companies sector waned in June, net retail sales remained in positive territory.

USA

The US economy expanded at an annualised rate of 3% during the second quarter of 2017, compared with an earlier growth estimate of 2.6%. The Dow Jones Industrial Average Index edged 0.3% higher over August.

The hurricane season is still playing havoc with the production of oil, refining activity, demand and distribution. Prices rocketed in August, early September and it is very unstable.

Credit ratings agency Moody’s reported that, of the US$1.84 billion cash pile held by US non-financial companies, 87% of the pile is held by investment-grade companies, and the top-five cash hoarders can all be found in the technology sector, led by Apple.

Despite a backdrop of persistently low inflation, speculation over the likelihood of tighter monetary policy continued to put pressure on global bond and currency markets during July. The US Federal Reserve is expected to begin cutting back its balance sheet soon; meanwhile, the European Central Bank is trying to curb speculation that it intends to wind down its programme of economic stimulus measures.

EMERGING MARKETS

China’s economy posted annualised growth of 6.9% during the second quarter of 2017, having alsoexpanded by 6.9% during the first three months of the year. This growth exceeded the Chinese government’s official annual economic growth target of around 6.5%. Although the news was generally well received, it did not manage to allay broader concerns over the impact of China’s mounting debt burden, excess capacity in the manufacturing sector, and worries over a bubble in the property sector. The Shanghai Composite Index rose by 2.6% during July.

The International Monetary Fund (IMF) upgraded its forecast for China’s economic growth in 2017 from 6.6% to 6.7%, and in 2018 from 6.2% to 6.4%, citing the country’s “policy easing and supply-side reforms”. China’s industrial output rebounded in June, rising at an annualised rate of 7.6%; meanwhile, imports grew at an annualised rate of 18.9% during June, while exports rose by 8.5%. Elsewhere, retail sales increased to their highest level for more than a year during June, rising at an annualised rate of 11%. During July, China’s authorities launched a new programme – Bond Connect – which is designed to open the country’s bond market and make it easier for foreign investors to buy and sell Chinese bonds.

In India, pressure on central bank policymakers continued to intensify amid calls to cut interest rates. The Reserve Bank of India’s (RBI’s) key interest rate currently stands at 6.25%. Disappointing inflation figures were compounded by lacklustre industrial production data in July. Annualised consumer price inflation fell from 2.18% in May to 1.54% during June, while the rate of wholesale price inflation dropped from 2.17% to 0.9%. The CNX Nifty Index rose by 5.8% during July.

Brazil’s economic growth is likely to remain weak for a prolonged period, according to a report by the World Trade Organisation (WTO), although the WTO expects the country to begin a gradual recovery over 2017. The WTO believes that, although Brazil’s fundamentals are generally solid, the economy remains vulnerable to fresh political uncertainties and delays in tackling fiscal imbalances and structural reforms. Meanwhile, the International Monetary Fund (IMF) believes that Brazil’s economy is reaching a “turning point”; nevertheless, like the WTO, the IMF remains concerned about the impact of political instability. Over July, the benchmark Bovespa Index posted a rise of 4.8%.


A PDF version of the commentary is available here

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