Weekly market update – Death and Taxes: It takes a village to maintain wealth

Despite the obvious, that market-implied rate expectations are the worst way of trying to predict rates, some of the bullishness is justified. As central banks pause rate hikes, they can’t continue quantitative tightening for much longer, for fear of driving bank reserves at the Fed down by too much. So far, the Fed and the ECB have drained more than three trillion US Dollars from financial markets. When this process stops, and central bank balance sheets start levelling out again, equity markets will be able to sustain a bull rally once again. 

So, to be clear, we don’t have any evidence to say that this Santa rally signals the beginning of a sustainable bull market just yet. Into 2024 though, a bull market prompted by the cessation of Quantitative Tightening is a real possibility. With bonds already paying a decent yield, some equity bullishness will be welcome for diversified portfolios.

My unexpected bullishness, however, was interrupted by last week’s UK Autumn Statement.

Chancellor Hunt’s proposals seem fiscally generous at the headline level. £4.5bn for manufacturing and the permanence of the full-expensing policy will be welcome drivers for Foreign Direct Investment, and National Insurance Contribution cuts could provide a roughly £10bn boost to spending.

Alas, a generation of economists who haven’t seen inflation might easily forget about the accursed Fiscal Drag. 

What is Fiscal Drag?

In essence, Fiscal Drag is an indirect tax that governments impose when they don’t change income bands along with inflation. For example, in the UK, the lower income band, beyond which income is taxed, is £12,570. Inflation, however, can ‘drag’ a nominal income higher, even if a consumer's real spending power hasn’t changed. For example, Mr. Joey Toy who runs a small toy business, earned £21,000 in 2020, and incurred costs of £10,000, making a net £11,000. In the two years following, total inflation rose by 20.6%. If Mr Toy’s costs and nominal revenue rise by exactly this inflationary figure, he now makes £13,266, which buys him exactly what £11,000 bought him in 2020. Nevertheless, as the government hasn’t changed its bands, Mr Toy now has income tax to pay.

The Fiscal Drag, all other things being equal, is projected to add £45bn to the government’s coffers by 2028 according to calculations by Bloomberg. An estimated four million people will be pulled into the 20% basic rate income bracket by 2028 and three million will be pulled above the 40% bracket. And this is with somewhat benign OBR projections for inflation. So, when all is said and done, some taxes are shuffled around, but the net fiscal effect is negligent. If anything, by 2028, the government tax intake is projected to be 37.7% of GDP, the highest in 70 years.

This brings us to the subject of Total Wealth Management. In an era where inflation is un-anchored, i.e. less predictable, price changes might affect all manner of regulation, whether intended or not. This is why wealth needs to be viewed as a whole. When investment specialists propose a product, any product, they should also be able to answer how this affects their client’s total wealth position.

The sun is setting in the land of single-wealth managers, and simple relationship managers, and rising in the land of integrated financial planning solutions.

George Lagarias, Chief Economist 

Market update

Global equities posted a negative return of -0.4% in GBP terms, however were positive in local terms. Developed markets performed slightly better than emerging markets, with US, UK and European equities returning between +0.1% and -0.4% in Sterling term, while emerging market equities suffered a -0.9% loss, despite recent stimulus measures aimed to boost the flailing property sector in China. Japan was the worst performer among the major equity regions, returning -1.3% in Sterling terms, as the Yen continues to depreciate due to the Bank of Japan’s divergent monetary policy stance, despite the adjustments made to their stance on yield curve control in recent months.

The rally in fixed income assets stalled last week, with bond yields rising across the board as policymakers adopted a more hawkish tone in an attempt to suppress calls for rate cuts. The US 10-year Treasury yield increased by 3 basis points to 4.47%, while the UK 10-year gilt yield rose 18 basis points to 4.36%.

Meanwhile, gold prices continued to rise in local terms, approaching $2000/oz and benefitting from rate cut expectations and heightened geopolitical uncertainty. However, Sterling appreciation ultimately resulted in a slight decline in GBP terms, down -0.5% over the week.

Macro news

New orders for manufactured durable goods in the United States fell sharply in October, more than reversing a 4% surge seen in September. The fall was the second largest seen in since April 2020 and was mostly driven by a 49.6% fall in demand for non-defence aircrafts and parts. Excluding defence and aircraft, the fall in new orders was a less severe 0.1%.

US flash PMIs in November pointed to a marginal expansion in services business activity and a moderate decline in manufacturing activity. The same report also found that US companies cut their workforce numbers for the first time in three and a half years, as weaker demand and cost pressures led to lay-offs.

British consumers became more optimistic about their personal finances and the outlook of the UK economy in November as an index of UK consumer confidence rose from a three-month low of -30 to -24. The overall level of consumer confidence remains weak, however.

The week ahead

Final PMIs will be released next week for regions including the UK, US and many eurozone countries. Inflation will also be in focus as the eurozone reports flash inflation figures and the US reports personal consumption expenditure data on Thursday.

Economy and investment webinar

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