💸 Fortune Favours the Brave
We might be headed for a technical recession, but fortune favours the brave. History shows that 2024 may be a good year to start investing or even pump more capital into stocks, but will investors?
Hello there, I'm John Choong. Every week, I dig into the financial world's nitty-gritty with three in-depth segments. Here, I spill the beans on the latest macroeconomic data, news, and even offer a share tip or two. Join me as I dissect this week’s drama.
🗞️ This Week’s Highlights
🚬 Inflation is smoking up again: Headline inflation came in at 4%, hotter than the 3.8% expected, and the first rise in 10 months. The stickier core inflation print didn’t do much better either, staying stagnant at 5.1%.
🥀 To recession or not to recession?: It’s all to play for as to whether Britain has entered a technical recession. November’s GDP was strong enough to offset October’s negative print, but December’s retail sales don’t paint a bright picture.
👖 Time to make a Mark: Newly-inducted FTSE 100 stalwart, M&S was a high flyer last year with gains only second to Rolls-Royce as the index’s top performer. The stock has slumped this year, though, but it could be a buying opportunity.
📊 Markets This Week
📉 FTSE 100: 7,463 (↓2.12%)
🇬🇧 FTSE 250: 18,874 (↓1.68%)
🧾 5-Year Yield: 3.736% (↑4.79%)
💵 GBP/USD: $1.27/GBP (↓0.58%)
🎟️ Marks and Spencer: 294p (↓4.81%)
🚬 Inflation is smoking up again
Andrew Bailey might’ve just chucked the idea of a Dry January out of the window. The latest inflation data will undoubtedly give the Governor another bout of headaches. Not only did the headline figure come in hotter than expected, it rose. Despite that, the market is still getting ahead of itself, pricing in as much as 150bps worth of rate cuts this year. Hell, some are even still calling for rate cuts as soon as April!
But is this too optimistic? On a surface level, yes. Anyone in their right mind, just by looking at the inflationary trend, would think it’d be nearly impossible for the Monetary Policy Committee (MPC) to start cutting rates before the summer with inflation looking as sticky as it is. However, a deeper dive into the data could suggest a not so insane dovish case.
But before I begin, let me get one thing straight — I don’t think 150bps worth of rate cuts is likely, unless a full-scale recession takes place for a myriad of reasons. But do I think rate cuts can begin as soon as April? Yes, and here are five reasons why:
The surprising uptick in inflation was due to the government’s higher tobacco duty introduced in December. Excluding the impact of this, inflation would’ve most likely come in flat from November, if not, just marginally higher.
The re-weighting of the basket of goods and services also had an impact. This happens every year as the Office for National Statistics (ONS) rebalances the average consumer’s basket to better reflect spending trends. In this instance, airfares were revised to hold a bigger weight in the basket, amplifying inflation.
Headline inflation is expected to fall in Q1. Although the energy price cap in January rose slightly from December, it’s worth noting that CPI is measured on an annualised basis. Energy prices will be lapping last year’s sky-high price cap of £4,279, so the drop in Housing and Household Services should offset any stickiness in other services.
Both PPI input and output, which serve as leading indicators for CPI, have fallen into deflationary territory — a trend not seen since pre-Brexit (ex. pandemic).
Wage growth is slowing and is expected to continue doing so. Average weekly earnings growth (inc. bonuses) in the three months to November declined to 6.5% from 7.2% — and that’s annualised. But if you were to compare wages in the latest three months with the three months that preceded them, and annualised this growth rate, average weekly earnings would’ve only grown by 2.8%.
Still, there are upside risks to inflation. History suggests that second waves of inflation are more likely than not, and the higher minimum wage and pensions income in April could stoke this. Geopolitical tensions are on the rise too. The current conflict in the Middle East has already seen a spike in freight costs, as ships go around the Cape of Good Hope to avoid getting blown into smithereens by the Houthis in the Red Sea.
But the silver lining is that analysts alike are divided on how much this go-around could impact inflation. On the one hand, Oxford Economics projects CPI ticking up by as much as 0.7%. But on the other side of aisle, Liberum analyst Gerald Khoo suggests “excess capacity in the container shipping market should mitigate the impact (with) limited prospects of this impacting inflation at the economy level.”
🥀 To recession or not to recession?
Last week’s GDP figures were strong enough for markets to hope that Britain may dodge another recession bullet. November’s 0.3% growth was strong enough to offset October’s 0.3% contraction, leaving it all to play for in December.
*Two consecutive quarters of negative GDP growth is technically a recession.*
But early indications suggest that it’s not looking good for Q4. Retail sales volumes in December unexpectedly tumbled by a shocking 3.2% against estimates of a 0.5% fall. This marks the biggest monthly retail sales volumes drop for December since records began — a terrible read considering the fact that it’s meant to be the industry’s busiest month of the year.
The UK economy is more than just retail, of course, but it does highlight how much Brits have cut back on spending at a time when they’re expected to spend the most. Considering the fact that retail spending is the single largest component of GDP (c.60%), the government may be heartbroken when that preliminary Q4 figure gets released on the day after Valentine’s.
Already lagging massively in the polls, the Conservatives will be hoping that Britain can avoid a technical recession. Britons are expected to head for the voting booths in the autumn, so Sunak & co. will have to hope that employment stays robust and that consumer confidence continues to bounce back — either through lower inflation (something mostly out of their control), keeping real wages positive, or both.
Even so, history has been kind to investors in election cycles. There have only been nine elections since the formation of the FTSE index, so the sample size is rather slim. Nonetheless, recession or not, fortune tends to favour the brave. The FTSE 350 has risen in eight of the nine election years since 1984, with an average return of 12.2%. The only time a negative return was recorded in an election year was in 2001.
That said, past performance is not indicative of future returns. But UK stocks do have one thing going for them — value. The FTSE 350 has remained flat since 2017, but average earnings have grown 66%. This has left its P/E in the doldrums (c.11) versus the global average (c.36), leaving room for upside in the short term. But this will be dependent on how soon the market decides that the UK warrants a higher multiple.
*Markets only feel comfortable ‘rerating’ to a higher multiple if there’s growth, and right now, there’s little to none.*
👖 This Week’s Share Tip: Marks and Spencer
Marks and Spencer (LON:MKS) may have had a blowout Christmas, but that hasn’t stopped its shares from going into free fall since the 8th of January, dropping 14%. But what gives? After all, the food and fashion retailer was an outperformer in both industries over the period:
🥪 UK Food Sales: £2.33bn vs £2.11bn (↑10.4%)
👕 UK C&H Sales: £1.24bn vs £1.18bn (↑5.1%)
🌍 International Sales: £288m vs £312m (↓7.7%)
Well, here’s the straightforward answer — guidance, or rather, lack there of. It’s always worth highlighting that sometimes, stellar numbers aren’t necessarily going to get celebrated because markets are always forward looking. Thus, the lack of any upgrade to M&S’ FY24 outlook was a disappointment for investors alike.
But having covered M&S for years, I’m familiar with CEO Stuart Machin’s strategy — underpromise and overdeliver — so it’s no surprise to see him sticking with his initial outlook. In fact, M&S has always been stingy with any upgrades. But I don’t blame the market; new investors who aren’t familiar with Machin’s strategy have valid reasons to wonder why an upgrade wasn’t warranted, especially after such a solid quarter.
Food volume growth was at the top of the market, boasting 7% growth as consumers traded up. The two main reason? Positive real wages and tremendous value offerings. The company’s Remarksable value range also grew sales by c.18%, while overall prices inflated below the market. Consequently, quality perception increased further, with M&S serving more customers than ever before during the Christmas period.
Meanwhile, Clothing and Home (C&H) grew ahead of the industry, which had witnessed massive discounting throughout the year, as consumers prioritised their spending on more essential goods. As a result, the increase in M&S’ full price sales mix resulted in its highest full price market share for over a decade. More importantly, the amount of clothing stock that went into sale also declined by 6%.
Be that as it may, there are some worries surrounding the potential disruptions in the Red Sea impacting margins. While that’s certainly a valid point of concern, we see disruptions having a minimal impact on FY24 margins for the most part, as most of the group’s suppliers are in and around Europe.
Moving forward, the path continues to look bright for Marks and Sparks. Sure, they’ll be lapping tougher comps, but a key catalyst going into FY25 will be the 8.5% jump in state pension income, which will put more money into the pockets of M&S' core customer base. Combined with the trend that value and quality perceptions continue to improve, and the firm should see further growth as consumer confidence rebounds.
M&S has started 2024 “with a spring in its step”, after all, and we echo the sentiment shared by management. A resumption in dividend payments, albeit minute, also helps to sweeten the investment case, as is its new, investment-grade balance sheet. We see a solid growth trajectory in both Food and C&H over the medium term, and an achievable goal to attain 1% market share growth in both businesses in the short term.
The retail industry may look bleak, especially after December’s figures, but M&S is likely to remain resilient thanks to its ever-improving value proposition and more affluent customers who are set to receive a windfall going into FY25. Lower commodity costs, higher real wages, and market share gains will serve as key catalysts moving forward. As such, we rate the stock a Buy with a price target of 315p.
🔎 What to Watch Next Week
📑 S&P Services PMI Estimates: Economists are expecting a relatively unchanged print from December at 53.5, but the devil will be in the details. Any indications that prices rose sharply and/or labour shortages, could result in another hot core inflation print in January and spook markets. On the contrary, a figure below 53.5 may see markets breathe a sigh of relief.
📝 GfK Consumer Confidence: Forecasters are pencilling in a read of -18 from -22 in December. Confirmation that consumers continue to feel better about their finances will do the Tory government, and by virtue markets (because Conservatives tend to opt for lower taxes), some good.
🛫 easyJet Q1 Trading Update: We’re expecting trading to head higher, albeit at a growth rate that’s lower than last year’s, as the budget airline laps tougher comps. The impact of suspended flights to Israel, Egypt, and Jordan in the quarter should also be present, but shouldn’t be overly disruptive. On that basis, here’s what we’re projecting:
💺 Passenger revenue: £1.12bn (↑c.15%)
🍕 Ancillary revenue: £470m (↑c.16%)
🏝️ Holidays revenue: £126m (↑c.35%)
💰 Headline EBITDAR: £83m (↑c.98%)