Too Quiet?
Too Quiet?
It is as if the fears of the past three years, inflation, stagflation and recession, have slunk away. Whilst the autumnal chill has returned to the northern hemisphere (and some mighty hurricanes in the US), investors appear to have turned away from the wall of worry and concluded that all is well in the world, well at least in the US. US economic data has come in better than expected, with growth expectations being revised higher, and at the same time, inflation pressures continues to ease.
Quarterly updates from companies will get into full swing in the coming weeks. Ahead of these updates, equities have moved higher. It is notable that this upward move has been widespread across equities (i.e. not just in the mega-cap tech stocks). In addition, bond yields have moved higher as expectations for interest rate cuts in the US have been curtailed.
US elections, both Presidential and Congressional, are approaching and could result in policy changes if either party gains control of both Congress and the Presidency.
In the UK, things have got better, with stronger economic growth and falling inflation. Indeed, lower inflation does open the door to deeper interest rate cuts in 2025. This slightly contrasts with the US, where rates may not fall by as far as predicted. The divergent path of rates is likely to show up in weaker Sterling, which has been strong through much of 2024.
Where’s the risk?
Over the past few months US economic data has been benign for the investment backdrop. Better than expected growth numbers combined with continued easing of inflationary pressures has meant that economic growth forecasts for 2024 have been raised. The chart below shows the level of economic ‘surprise’. When data is released that is stronger than forecast (forecasts made by economists have a habit of making weather forecasters look reliable), then that pushes the score in a positive direction. When the economic data undershoots expectations that then drags the index lower. Of late, the surprise has moved from negative to positive as recent economic growth releases have been better than forecast.
US economic data has been better than expected: as shown by the rise in the Citi economic surprise indicator in the past few months
The consensus economic growth forecast for 2024 (as shown by Gross Domestic Product (GDP)) has rebounded since the fears of recession in 2023, and has continued to climb in recent months
Whilst there are signs of a slowing in the US labour market, the reality is that the US economy is humming along at full employment. One way to measure this is shown by the workforce participation rate of 25-55 year olds. Currently around 83.8% of that demographic is in work. This is the highest since the turn of the century. What is striking given the robust employment backdrop is that wage inflation is easing, which in turn has enabled the Federal Reserve to cut interest rates.
The US labour market is close to full employment with over 83% of 25-55 year olds in employment (as shown by the right hand side axis (RHS)) and wage inflation is easing
However, the better-than-expected economic growth backdrop, has meant that interest rates may not be cut by as much as previously thought. As recently as September, investors had priced in that US interest rates would be cut to about 2.75% by December 2025. They are now only expected to be cut to somewhere in the range of 3.25%-3.5%. The change in interest rate expectations has pushed bond yields higher over the past few weeks. Unlike the bond market sell-off in 2022, the current bond market relapse seems to have been ignored by the equity market.
China acts
China’s Ministry of Finance has outlined its much-awaited fiscal support policies to boost the ailing economy. Beijing will significantly expand its fiscal package in a bid to shore up the economy and contain risks from the property market slowdown and debt overhang.
Detailed specifics may be given in early November on the size of stimulus, but it could be as large as 4-5 trillion Chinese Yuan for the next year, or between $560-$750 billion US Dollars. It is to be seen if this scale of support accelerates economic growth in the near term as the economy battles with the debt overhang of the property bubble and the long-term demographic implications of a shrinking workforce, which are reminiscent of Japan post 1989.
There is a continued risk of a hostile US and EU political backdrop that challenges the Chinese economic climate, but there are also concerns over the ‘investability’ of the country for overseas investors. Against that, Chinese equities remain inexpensive relative to wider equity markets, but have significant home-grown issues and overseas headwinds to battle. The initial response to the announcement of the fiscal package has seen the equity market up by nearly 40% in a month from the beginning of September, but over the past week the MSCI China index has fallen back nearly 13% and remains some 48% below the 2021 peak.
US election balance
US Presidential polling suggests Vice President Kamala Harris holds a narrow national advantage over former President Donald Trump, while key swing states are virtually tied. This means the actual electoral outcome remains finely balanced.
Changes in the US Presidency have tended to produce temporary volatility but have limited impact for longer-term investors. As a result, making large sectoral shifts to reflect predictions about the outcome is dangerous, in our view. This is especially the case given that the actual post-election outcome isn’t a binary situation. By this we mean that the Presidential vote is just one vote for one part of the US political system. Voters will also be deciding on the make-up of the Senate and the House of Representatives in Congress. It is possible that the actual outcome could be one of four scenarios, described below.
The potential outcomes are diverse: a blue sweep scenario (Harris with a unified Democratic Congress), an outcome where Harris wins but with a divided Congress (Republican Senate, Democratic House), Trump wins with a divided Congress (Republican Senate, Democratic House) or a red sweep scenario (Trump with a unified Republican Congress).
The following table shows what commentators assess are the policy stances on different issues according to each Presidential candidate. For equity investors the biggest difference may centre on the impact of the corporate tax plans and tariffs. Trump’s tax plans are likely to boost the profits of US equities, but the tariff plans are likely to lead to higher inflationary pressure and may lessen the chances of interest rate cuts.
Policies differ between Presidential candidates: but actual policy outcomes depend on the balance of power within Congress
Source: Artorius
The economy, earnings data and the Fed interest rate outlook remain more important for medium term investors. And thus, ahead of the election on 5th November, equity investors await the quarterly updates from companies that are scheduled to be delivered over the next few weeks. The initial tone of updates to date have been positive, but the likes of Amazon, Meta and Nvidia will be key in driving the market direction.
UK enjoys a better backdrop ahead of Budget Day
Economic data out of the UK has been better than expected. The housing market continues to build momentum, as shown by the recent reports from the Royal Institution of Chartered Surveyors (RICS) who issue a monthly survey which takes the temperature of the housing market.
The New Buyers Enquiries indicator points to a recovery, with more households searching for homes to buy. Historically, when the numbers of New Buyer Enquiries increase, house prices subsequently climb and housing market transactions rise. This in turn stimulates consumer spending across a wider range of sectors.
Economists have revised economic growth forecasts for 2024 upwards reflecting better than expected economic growth data in the past six months (as measured by Gross Domestic Product (GDP))
Another key surprise has been the path of inflation. For a few months it did look as though UK inflation was remaining more elevated than other countries, limiting the scope for interest rate cuts. However, the bond market welcomed the lower than expected inflation data on the 16th October and now predict that the Bank of England may cut rates by more than expected in 2025.
Lower UK inflation (as measured by Consumer Price Index (CPI)) opens the door to lower interest rates in 2025 from the Bank of England
The flip side of weaker inflation and expectations of more interest rate cuts in the UK is that Sterling may reverse some of the strength seen so far in 2024. Against a backdrop where the Federal Reserve may not cut interest rates by as much as previously predicted, Sterling may weaken against the US Dollar over coming weeks, especially if the UK budget brings in measures that cut spending and raise taxes.
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Conclusion
The macro-economic worries of the past few years appear to have reduced. Inflation continues to ease, and economic growth appears to be picking up, at least in the US and UK. The only-downside of the better than expected data is that US interest rates may not fall as much as had been predicted in the US.
If corporate profits remain resilient, then equities may not need lower interest rates to keep moving higher, so the next few weeks of corporate updates will be key.
US elections, both Presidential and Congressional, are approaching and could result in policy changes if either party gains control of both Congress and the Presidency.
In the UK, things have got better, with stronger economic growth and falling inflation. Indeed, lower inflation does open the door to deeper interest rate cuts in 2025. This slightly contrasts with the US, where rates may not fall by as far as predicted. The divergent path of rates is likely to show up in weaker Sterling, which had been strong through much of 2024.
Important Information
Artorius provides this document in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 18th October 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.
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