Investment Comment
27th October 2023
Don’t spend it all at once
'You should never bet against the American consumer', is sage advice and yesterday’s GDP data was a salutary reminder for anyone predicting a US recession.
Strong consumer spending was the main driver of a 4.9% annualised increase in GDP (Gross Domestic Product), according to preliminary figures released yesterday. That was a jump from a 2.1% rise in Q2 and the strongest rise in almost two years, well ahead of expectations despite high interest rates. The rise was driven by very strong consumption data, supported by a rise in inventories and continued growth in government spending. Indeed, this continued strength in government spending, with the US running persistent budget deficits, may well be the main reason why monetary policy seems not be working as its effectiveness is being blunted by stimulative fiscal policy. On the weaker side, business investment fell 0.1%, which is a disconcerting signal for future growth prospects and it is unlikely that the growth in inventories or consumption can continue at this pace. For the consumer, spending is increasingly financed by credit or drawing down on savings and this month has seen the restarting of student loan repayments, which have been on hold since the pandemic, and will weigh on consumption going forward.
The US economy rallied strongly in the 3rd quarter growing nearly 5% (annualised) but can this be sustained?
Source: Artorius, Bloomberg
The Federal Reserve (Fed) meets next week to decide interest rates and while this is not expected to influence their decision (expectations are for no change in rates), the ongoing strength in the economy points to a risk that the Fed may need to raise interest rates higher in order to mitigate demand and bring inflation back to target. Even if rates are not increased again, they seem likely to be higher for longer.
Headline numbers tend to make the press but GDP is a backward looking measure. It tells us that growth has been much stronger than expected. For more timely data, we look at other indicators such as PMI (Purchasing Managers’ Index) data, to give indications around the health of economies. Data released this week suggests that US economic activity remains strong in October but things look a bit gloomier on this side of the Atlantic. The chart below shows the latest headline PMI data for the US, UK and EU. Numbers over 50 represent an expansion in economic activity over the previous month, whereas below 50 represent a contraction. Whereas the US is above 50 and turning more positive, the UK and EU are below and falling, suggesting contraction and the likelihood of recession.
PMI data shows contrasting performance between the US and Europe, for the US growth looks strong but the UK and EU are struggling.
Source: Artorius, Bloomberg
With this weakening trend in economic activity in the eurozone, it was no surprise that the ECB (European Central Bank) held rates steady at 4% this week. Market consensus is that we’ve reached the end of the hiking cycle, with inflation falling and slowing economic growth, and so the next step would be for the ECB to cut rates. However, despite inflation slowing markedly in recent months, it is still well above target and so patience will be required.
The Bank of England meets next week and the picture is similar, inflation remains too high but is falling (albeit slowly) and economic activity is soft. Against this backdrop, expectations are also for no change in interest rates, at least for now.
Earnings
Third quarter earnings are in full swing in the US and, while some mega-cap tech companies have disappointed (Alphabet, Meta, Tesla), the emerging picture is that third-quarter corporate earnings match the strong GDP numbers. Among companies that have reported (about 40 per cent of the S&P 500), nearly four in five have beaten earnings expectations, and on average by 7.7% compared with a one-year average of 4.4%, according to FactSet (a US financial data company). Whereas at the start of the earnings season expectations were for near zero growth, this has now risen to over 3% earnings growth for the quarter as results have come in. This has not been reflected in equity markets so far, with the impact of poor results from some market heavyweights bringing indices down alongside ongoing concerns about headwinds from interest rates staying higher for longer and the threat of escalation in the Middle East.
China
China has been one of the great disappointments of the last few years for investors, with Chinese equities significantly underperforming global equities and other emerging markets, which have proven robust. A rally following the reopening of the economy as the “zero-covid” policy was abandoned proved short lived and weaker growth and turmoil in the property market has weighed on performance. Many investors had hoped for a major policy response (much as was seen during the global financial crisis in 2008) to boost the economy but that has not been forthcoming. However, perhaps that is changing. This week markets were surprised by the announcement of a new round of fiscal stimulus with an extra 1 trillion Yuan ($137bn) for infrastructure and reconstruction efforts. This rare budget revision suggests a more pro-growth stance and should give a major boost to economic growth. It was also supported by the first visit of President Xi to the central bank, the symbolism of which suggests greater focus on the economy and financial markets. While some scepticism is warranted, this boost to the economy along with low valuations for Chinese equities could well improve investor sentiment in an unloved market.
Chinese equities have been a global laggard underperforming both global equities and other emerging markets – could new stimulus change this trajectory?
Source: Artorius, Bloomberg
All expressions of opinion reflect the judgment of Artorius at 27th October 2023 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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