Investment Comment
23rd February 2024
Green shoots put a pivot at risk
2023 was a year of waiting for a recession that never came. Would there be a “hard landing” or a “soft landing”? For the US at least, the answer seems to have been “no landing”, at least for now. The economic backdrop has been consistently weaker here in Europe and last week the UK technically entered a recession as the UK economy shrank in Q4, marking two successive quarters of negative growth which is technically a recession. It’s worth noting that this is the first estimate of economic growth for the quarter and so may well be revised in the future. It would only take a small upward revision to change the picture but nevertheless the growth picture in the UK has been stagnant. However, GDP (Gross Domestic Product) data is a backward looking measure and more recent data suggests that the UK economy may be perking up as spring approaches.
Yesterday saw the release of PMI (Purchasing Manager Index) data for the US, UK and Europe. The PMI is a much followed economic indicator that uses data derived from surveys of senior business leaders to track the health of the economy and provides insights into key economic drivers. Importantly the data is timely and released well in advance of comparable official economic data (such as GDP) making it much more useful as an economic indicator. The UK data showed a notable uptick rising to a 9-month high and highlighted an improvement in customer demand and new business volumes. Eurozone data also picked up, beating expectations despite notable weakness in German manufacturing, albeit the headline level at sub-50 is still suggestive of a contracting economy. The US data was slightly weaker than expected but still suggestive of an expanding economy and the US manufacturing sector, which has been in contraction for the last year appears to have returned to growth.
Recent PMI data suggests an uptick in the UK economy and improvement in Europe. The US has consistently been in expansion territory over the last year.
Source: Artorius, Bloomberg.
An index reading above 50 represents an expanding economy compared to the previous month, whereas a reading under 50 represents contraction.
Is the central bank pivot at risk?
Investors started the year confident that inflationary pressures had been tamed (at least in the US) and that the Federal Reserve (“Fed”) would obligingly cut interest rates significantly through 2024, or at least that is what markets suggested. Market pricing implied that the Fed would cut interest rates seven times starting in March (i.e. interest rates would fall by 1.75% from 5.25% to just 3.5%). However, better than expected economic data and a blip in the most recent inflation data has rapidly changed expectations and brought the market much closer to the Fed themselves, who have consistently flagged a much more cautious path for interest rate cuts. Current pricing suggests just three interest rate cuts starting in June but some, most notably former US Treasury Secretary Larry Summers, are suggesting that the next move might need to be up rather than down. This reflects a concern that stronger economic growth might lead to more persistent above target inflation. While this has seemed the least likely scenario, recent data suggests that the chances have risen.
This dramatic shift in expectations for interest rates has significant implications for borrowers. In our latest Investment Outlook we flagged a potential improvement in the UK housing market, which was supported by improving mortgage rates as banks reflected falling interest rate expectations in their deals. As the outlook changes, a number of banks have been pulling deals to allow them to reprice upwards to reflect new assumptions, which could threaten the nascent recovery.
Implied number of interest rate cuts by the end of 2024 for US/UK/EU central banks
Source: Artorius, Bloomberg
Anachronism or institution
The Dow Jones Industrial Average (“Dow”) is a venerable yet anachronistic institution. First created in 1896, the Dow is an equity index comprising of 30 US blue chip companies. The original stocks chosen aimed to represent the major areas of the US economy, excluding Transportation and Utilities which had their own indices, and to some degree that mission is continued albeit “there are no qualitative rules for inclusion”. It will regularly be one of the first names you’ll see when looking at market performance on most market data sites.
Most indices are weighted by market capitalisation, i.e. the largest companies have the largest weights in the index usually in proportion to their size. For example, in the S&P 500, Microsoft at over $3trillion in size is around 7% of the index, whereas Chevron at a little under $300billion is around 0.7%. However, the Dow is quite unusually a price-weighted index, i.e. the companies with the highest share prices (irrespective of the value of the company) have the highest weights in the index. The largest component of the Dow is UnitedHealth Group at almost 9% of the index, based on a share price of $526 despite a market cap of only $486bn. By contrast Apple has a market cap of $2.8trillion but is just over 3% of the index based on its share price of $184.
The news this week was that Amazon will finally be joining the Dow (replacing Walgreen Boots Alliance), albeit at only half the index weight of more traditional retailer Home Depot, despite having 4x the sales and 5x the value. It may seem odd that the 4th largest company in the US wasn’t previously included in the index, but actually only 2 of the 10 largest stocks are included (Apple and Microsoft); there is no Magnificent 7 here and so unsurprisingly the Dow was a laggard in 2023. However, what is surprising is that despite its oddities the Dow has actually done a good job at matching the broader S&P 500. Looking back over the last 20 years, the two were running neck and neck until last year when the Dow’s smaller exposure to Technology, and the main beneficiaries of AI (most notably chipmaker NVIDIA, which rose over 200% in 2023), left it trailing. If the AI bounce proves to be more hype than substance then maybe the Dow will continue to match its younger competitor.
The Dow has generally tracked the S&P 500 well but a lower Technology weighting led to marked underperformance in 2020 and 2023
Source: Artorius, Bloomberg
All expressions of opinion reflect the judgment of Artorius at 23rd February 2024 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions. Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.
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