Bob’s Journal for 2/6

The United Kingdom’s 47-year-long membership in the European Union (EU) ended last week.

The separation, commonly called Brexit, was mostly uneventful. While there was no economic calamity or social upheaval, that’s partly because the Brexit process isn’t over.

The deal that was negotiated between the United Kingdom (U.K.) and the EU in 2019 allowed many of the key issues to be deferred. The only immediate effect of the withdrawal is that the United Kingdom loses voting rights in the EU.

While the United Kingdom remains in the single market and customs union, it now has no say in any decisions made by the EU.

The two entities agreed to a standstill period in 2020 during which they will try to negotiate the full details of Brexit.

That leaves a great deal of uncertainty. The two sides are far apart in their negotiating positions, as has been the case since the Brexit vote prevailed in the U.K. referendum.

It is very likely that the two sides won’t reach an agreement by the end of 2020. Some EU leaders already have publicly said that the two sides are very far apart and an agreement by the end of 2020 has a very low probability of happening.

If that’s the case, then under the current agreement, the United Kingdom will fully leave the EU at the beginning of 2021 and be subject to World Trade Organization (WTO) rules plus any individual trade agreements it negotiates with countries.

The WTO rules are less favorable to British businesses and consumers than the EU’s. So, sliding under the WTO umbrella is likely to have a negative effect on the British economy and markets.

It is possible that the United Kingdom will request, and the EU will agree to, extensions of the standstill period. While that would be contrary to public statements and campaign pledges U.K. Prime Minister Boris Johnson made, he was flexible in negotiating the 2019 agreement with the EU and might be flexible again. It is also possible that the two sides will negotiate an agreement on basic trade issues during 2020 and leave other issues for the future.

Until these issues are resolved, however, Brexit is a big drag on the British economy. Business investment has been down substantially since the Brexit vote. Surveys of business leaders are decidedly pessimistic. Investment and hiring will most likely be delayed as long as the negotiations are underway, and many British businesses are continuing their plans to move their corporate headquarters out of the country.

How Much Do Investors Benefit From Low ETF Fees?

Low fees are a major attraction of exchange-traded funds (ETFs) for many investors.

In fact, there is a fee war going on. It seems that an ETF announces lower fees almost every week and many analysts have begun to talk about zero fees being the future of ETFs.

But investors might not be benefiting from any of this.

Research that was recently published in the Financial Analysts Journal and summarized here found that average ETF fees declined 34.2% from 2009 to 2017. Yet, the expenses that were paid by ETF investors actually increased.

The researchers found that the newest and fastest-growing ETFs had the highest fees. That’s because investors have been choosing to invest in the ETFs with the highest fees.

These higher-fee ETFs tend to be those with narrow investment mandates instead of the broad-based index funds that have recieved most of the attention in the fee war. The newest, trendiest twist on investing seems to attract a lot of ETF investors, regardless of the fees.

The newer ETFs also tend to be more complex than older ETFs and are more actively managed. Other factors that play a role in the higher fees are the use of leverage and the use of an enhanced index or an inverse of an index instead of a well-known, broad-based index. Also, many of the expensive ETFs are structured as funds of funds instead of as single ETFs.

Investors appear to be more attracted to the funds with these features than they are to older, broad-based, low-fee index ETFs.

The Data

Personal income and spending continue their moderate trends. Income increased 0.2% in December, compared to 0.3% in November. The recent high was a 0.5% increase last August.

Personal spending increased 0.3%, the same rate as in November. The spending rate has been fairly steady for six months.

The PCE Price Index is showing a little life. The headline index increased 0.3% in December. It was unchanged as recently as August and September. The index now is up 1.6% over 12 months.

Excluding food and energy, the PCE Price Index increased only 0.2% in December. It has increased by only 0.1% each of the four previous months. Over 12 months, it increased 1.6%.

Consumer sentiment, as measured by the University of Michigan, increased to 99.8 in January from 99.3 in December. That’s the highest reading in eight months. The current conditions segment of the index declined while expectations improved.

The service sector of the economy did a little better in January. The PMI Services Index rose to 53.4 from 53.2. The ISM Non-Manufacturing Index rose to 55.5 from 55.0. Both indexes were a little bit above expectations.

Manufacturing surveys were mixed this week. The PMI Manufacturing Index declined to 51.9 in January from 52.4. A reading above 50 indicates that the sector is growing.

The ISM Manufacturing Index increased to 50.9 from 47.2. This is above expectations, which follows a period of six months when the index came in below expectations. This is the highest level for the index since July. It has been below 50.0 and indicating that the sector was declining for five months.

Factory orders had a big jump in December, increasing by 1.8% following a 1.2% decline in November. The manufacturing component increased 0.5% and, excluding energy and defense, it increased by 0.6%. Also, new orders increased for the third consecutive month.

The ADP Employment report said that 291,000 private sector jobs were created in January, well above the expectation of 157,000. This is the highest level for this report since May 2015.

The Markets

The S&P 500 rose 1.91% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 1.94%. The Russell 2000 increased 2.06%. The All-Country World Index (excluding U.S. stocks) added 0.97%. Emerging market equities gained 0.69%.

Long-term treasuries lost 1.60% for the week. Investment-grade bonds declined 0.06%. Treasury Inflation-Protected Securities (TIPS) fell 0.43% but high-yield bonds gained 0.68%.

In the currency arena, the U.S. dollar increased 0.30%.

Energy-based commodities tumbled 2.63%. Broader-based commodities fell 1.69% and gold declined 1.20%.

Bob’s News & Updates

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