💭 The Paradoxical Dilemma the Bank of England Faces
With the BoE forecasting inflation to remain above 2% until 2026, rate cut rates aren't expected to come en masse. However, cloudy employment data may throw a spanner in the works.
Hello there! I'm John Choong, Senior Equity Research Analyst at InvestingReviews. Every week, I dissect the latest macroeconomic data and what it means for your stocks. Join me, as I dig into the financial world's nitty-gritty.
🗞️ This Week’s Headlines
🧊 The labour market continues to cool: The unemployment rate in the three months to January rose to 3.9%. Meanwhile, average weekly earnings growth over the same period dropped to 5.6% (inc. bonus) and 6.1% (ex. bonus).
🇬🇧 The recession may be over: The UK may have seen its shortest recession ever. Monthly GDP grew 0.2% in January, rebounding from -0.1% in December. But the economy is still weak, with GDP -0.3% worse off than a year ago.
📋 RICS balance hits highest level since October 2022: Expect house price to continue their rebound as the RICS house price balance (a leading indicator for house prices) continues to climb from its lows.
📊 Markets This Week
📈 FTSE 100: 7,727 (↑0.88%)
🇬🇧 FTSE 250: 19,513 (↓0.45%)
🧾 5-Year Yield: 4.023% (↑2.31%)
💵 GBP/USD: $1.27/GBP (↓0.92%)
🎟️ Persimmon: 1,270p (↓6.27%)
⭐️ Sector Highlights and Lowlights
🛒 Supermarkets: M&S (LON:MKS) shares are finally gaining again, up 7% since hitting their YTD bottom. This comes after RBC RY 0.00%↑upgraded their price target, citing a brighter consumer outlook and easing cost pressures.
🛵 Food Delivery: Deliveroo (LON:ROO) reported its first ‘profit’ (EBITDA) for the first time, making it one of the first food delivery platforms to achieve such a feat. Still, the investment thesis remains cloudy for many due to a lack of growth.
🏦 Banks: Like M&S, Barclays (LON:BARC) also got a decent upgrade on the back of a strong outlook. JPMorgan JPM 0.00%↑ increased their price target for the bank — a positive considering how bearish JPM are on UK shares.
🏘️ Property: 42% of house hunters are said to plan to accelerate their purchase plans this year vs 35% in mid-2023. They fear prices climbing again, which could price them out of the market, according to a Bloomberg survey.
✈️ Airlines: Further complications surrounding Boeing BA 0.00%↑ and deliveries saw airline stocks decline this week. Worries about higher prices stemming from a lack of aircraft/capacity could impact revenue, thereby spooking investors.
☕️ Unemployment could be a shard in warm tea
This week’s softer unemployment and wage data helped to push gilt yields down, as it built on a budget with no crazy surprises. But unfortunately, this progress was swiftly reversed by a hotter-than-expected US CPI print, pushing rate cut expectations back. And while this shouldn’t affect monetary policy on this side of the Atlantic, the BoE is notorious for slavishly following the Fed’s footsteps, which is why yields shot back up.
Nonetheless, things could still unwind rather quickly, especially if CPI comes in cooler than projected next week. But while markets continue to keep a sharp eye on the all-important inflation figures, it’s the other side of the BoE’s mandate that hasn’t gotten as much attention as it should be getting — the unemployment rate. Like the Federal Reserve in the US, the BoE also has a dual mandate:
“To maintain price stability, and subject to that, to support the economic policy of His Majesty's Government, including its objectives for growth and employment”.
With inflation approaching the 2% mark, the argument that a wage-price spiral is starting to fade, as the 3-month annualised wage growth rate now sits at 3.5%. And if February’s PAYE median pay growth comes in as per forecast at 5.5%, it would be the lowest rate of growth since November 2021. With this rate of decline, wage growth should return to pre-pandemic levels in about six months’ time.
As such, investors alike should be pivoting their focus to the unemployment data, as an unravelling in the labour market could lead to a situation that will be more difficult to resolve than inflation itself. This is because unemployment acts like an avalanche that can very quickly snowball into something a violent recession, which no amount of quantitative easing can resolve easily (see Japan pre-2023 or UK post-2008).
Having said that, the latest unemployment figure only showed a modest increase to 3.9% — near historical lows. However, it’s crucial to note that this data has to be taken with a huge pinch of salt due to its poor quality of data. The labour force survey (LFS) has been lacking participants since mid-2023, and is going off population data from 2022.
According to the latest KPMG/REC survey, there’s a very different picture brewing. In February, vacancies dropped at their fastest rate since start of 2021, while candidate supply rose sharply for the 12th straight month. Additionally, lower demand was registered in eight out of the 10 sectors, with retail and executive/professionals seeing their steepest contractions since the start of 2021.
In addition to that, year-on-year employee growth has been on a decline. Provisional estimates for February show a mere growth rate of 1.2%, which would mark the lowest rate of growth since June 2021, and eight consecutive month of declines — not overly surprising considering the ONS’ report of vacancies falling in 14 out of the 18 sectors it tracks.
When combining these factors together, it’s safe to say that the labour market is cooling, and cooling quickly. So, if committee members keep playing ‘Follow the Fed’ and don’t start paying more attention to vacancies, layoffs, and the rate at which businesses are hiring, they could be in a for massive shock when the new and revised LFS comes into play in July.
Regardless, the BoE is stuck in a catch 22 — either let unemployment rise to bring core inflation down to 2% at the risk of triggering a deep recession, or let people keep their jobs at the risk of higher inflation. Whatever they end up choosing, the most important takeaway for investors is this — big cuts have always meant that central bankers left it too little too late, so maybe fewer cuts isn’t necessarily a bad thing.
🏡 Share tip of the week: Persimmon
As alluded to in Persimmon’s (LON:PSN) trading update from January and for those who paid attention to the housebuilder’s outlook throughout 2023, the numbers were always going to be an absolute bloodbath — and they were. Every possible metric (bar average selling price) was in the negative, as sales, margins, and profits all took hits of up to 67%.
As a result, Persimmon shares fell to their YTD low this week, not helped by the sombre tone struck by CEO Dean Finch. Whilst the Chief Executive remains optimistic about Persimmon’s medium-term outlook given the favourable fundamentals of the housing market with limited supply and strong demand, his guidance fell flat.
After such a torrid year, shareholders were hoping for a little more from Finch when he revealed the FTSE 100 returnee’s outlook for the year. But to their dismay, completions aren’t projected to move by much (10,000-10,500) in FY24. More disappointingly, he told shareholders to expect a similar operating margin (c.14%). Putting this together, earnings are modelled to remain flat.
The developer’s sales rates (a leading indicator for completions and margins) were also lacklustre. While its peer Taylor Wimpey (LON:TW) saw a private sales rate of 0.67 when they reported results last month, Persimmon came in with a distant 0.59, and a forward sales value of £1.55bn, as compared to Taylor Wimpey’s £1.95bn. Thus, it’s no surprise that the stock now has an average Hold rating amongst analysts.
Nevertheless, we remain bullish and retain our Buy rating. Why, you might ask? Well, while we don’t disagree with the expectation that earnings are to remain flat this year, it’s the medium-term outlook that we see plenty of potential in, which we don’t believe the market has accounted for.
We believe that given Persimmon’s healthy land bank and improving embedded gross margins over the medium term from cheap land acquisitions, combined with improved volumes by Q2’23 and vertical integration should serve as catalysts for strong margin expansion and earnings growth. In fact, we’re projecting a compound annual growth rate (CAGR) of 14.8% over the three years to FY26.
But perhaps what’s most promising is that despite taking a somewhat balanced approach to sales rates, outlets, completions, margins, and earnings through to FY26, the upside still remains lucrative, as we see earnings per share (EPS) hitting 124.7p by then.
Moreover, the firm has shown its ability to grow outlets (30 new ones this spring), as they plan to return to an average of 300 outlets over the medium term. This shows that they’re ready to meet demand when it does return, with a healthy land bank to back them up.
Sure, with the current rate environment and a lack of government incentives to boost housing demand, it’s difficult to see Persimmon returning to their Help to Buy heights of c.14,500 completions any time soon. Be that as it may, the investment case remains solid, with healthy growth and a handsome dividend yield that’s likely to stay above 3%.
On that basis, we see Persimmon having a c.12% upside from its current share price, and with room for further rerating from markets given the likelihood of a lower rate environment in the coming months. When balanced with the increasing likelihood that affordability can remain robust with low unemployment, we see Persimmon as a Buy with a price target of 1,420p.
💡 Why follow John’s share tips?
Rated as the #1 analyst by Stockomendation, John Choong has outperformed the UK stock market. Moreover, his insights are often cited in renowned publications such as the Financial Times, Bloomberg, Yahoo Finance, and many more.
🔎 Data Points to Watch Next Week
🔥 Consumer Price Index: Inflation is estimated to continue on its downward trend in February. Markets are pricing in a headline annualised figure of 3.6%, down from 4.0%, with the core figure also cooling to 4.6% from 5.1%.
🏦 Bank Rate Decision: The BoE will meet to decide the path for interest rates. Nothing drastic is expected to happen, but how many, and when these rate cuts will happen will be in the minuets, as well as how many members vote to cut.
📊 S&P Composite PMI: Considering January’s GDP print, markets will look for further confirmation that the UK has shrug off its recession. Markets are hoping for another positive read — 54.0 in March, up from 53.8 in February.
🛍️ Retail Sales Volumes: January’s strong rebound to offset December’s 3.3% decline is presumed to take a backseat. Poor weather should see volumes drop by 0.3%, but volumes ex. fuel should see a more modest drop of 0.1%.
💪🏻 GfK Consumer Confidence: Signals on how consumers are feeling about the economy are also due. A slight improve to -20 from February’s -21 is anticipated, with a better-than-expected print potentially lifting depressed retail stocks.