MarketMinder Europe provides our perspective on current issues in financial markets, investing and economics. Our goal is to analyse key topics in an entertaining and easy to understand manner, helping you see the news of the day in a unique perspective.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
US gross domestic product (GDP, a government-produced measure of economic output) rose an inflation-adjusted 2.9% annualised in Q4, decelerating slightly from Q3’s 3.2% but topping analysts’ consensus estimate for 2.3%.[i] (Annualised growth rates represent the rate at which GDP would grow over a full year if the quarter-on-quarter percent change repeated all four quarters.) Whilst this suggests to us recession (a broad decline in economic activity) didn’t start in Q4, under the bonnet, we think the data here extend the trend of mixed figures that we observed for much of last year—seemingly allowing many commentators we follow to see whatever they want in the results. For investors, we caution against the potential tendency to extrapolate backward-looking figures.
Start with US GDP’s big private sector components: consumer spending and business investment.[ii] Personal consumption expenditures (PCE), 71% of GDP, rose 2.1% annualised, contributing about half of headline growth.[iii] This slowed from 2.3% the previous quarter, which some commentators we follow suggest indicates trouble lies ahead.[iv] Perhaps. But with inflation (economy-wide price increases) slowing, we would be careful about drawing such conclusions.[v] Trend-wise, PCE growth was led by broad-based services spending—the lion’s share of PCE—with all categories seeing gains last quarter.[vi] Most goods categories also contributed, including motor vehicles and food away from home, which were notable detractors in prior quarters.[vii]
Business investment rose 0.7%, but it was more mixed below the surface.[viii] Intellectual property development (think software, research, media and entertainment) rose 5.3% annualised, continuing a long string of gains.[ix] Structures (commercial and industrial building) also saw slight 0.4% annualised growth after six straight quarterly declines.[x] However, equipment—mainly in information processing—fell -3.7% annualised.[xi] From our observations, though, this series has been quite volatile over the last year and a half amidst supply chain disruptions. However, transportation equipment has now grown three quarters in a row, suggesting to us bottlenecks are easing for that equipment category.[xii]
Output gauges haven’t yet caught up to the fresh, preliminary 2023 purchasing managers’ indexes we detailed on Wednesday—both in terms of timing and the data themselves, which weren’t rosy. However, the latest output data’s findings provide insight on certain parts of the global economy—which we think can reduce uncertainty. Moreover, based on our coverage, there are some little-noticed signs of improvement, too, suggesting a lot of room for positive surprise that can be the foundation of a stock market rebound, in our view.
Japan’s Weak Core Machinery Orders
Japanese core machinery orders, which many observers we follow treat as a sign of future corporate investment, fell -8.3% m/m in November, much worse than consensus estimates of -0.9%.[i] (Core machinery orders are for capital goods excluding ship and electric utility firms.) We think that is a noteworthy drop for a series that is seasonally adjusted (adapted to remove skew from holidays, weather and other recurring events), although our research has found this metric tends to be more variable than others. Weakness was broad: Manufacturers’ orders fell -9.3% m/m due to a slump in semiconductor production equipment whilst non-manufacturers’ orders slipped -3.0% on tepid demand from the information service sector.[ii]
January isn’t over yet, but thanks to the fine folks at S&P Global, we have our first inkling of how the global economy started 2023. Yes, flash purchasing managers’ indexes (PMIs, monthly surveys that track the breadth of economic activity) for January are out, and we think there are some hints of good news—further suggesting 2023’s economic landscape has a good chance of shaping up better than the dismal projections we have seen from financial commentators we follow. Big negative economic surprise that hits stocks hard remains unlikely, in our view.
The Eurozone Expands a Bit
Most noteworthy, in our view, was the eurozone’s composite PMI, which combines manufacturing and services output, rising to 50.2.[i] PMI readings over 50 imply expansion, so this suggests output rose a smidge for the first time since June.[ii] Manufacturing stayed in contraction at 48.8, but services flipped to growth at 50.7.[iii] Now, the two individual countries reporting thus far seemingly told opposite stories. Germany and France’s composite readings both stayed in contraction at 49.0 and 49.7, respectively—but German services grew whilst French services contracted, whilst Germany’s manufacturing PMI contracted and France’s grew.[iv]
What next? After last year’s parallel stock and bond market routs, we find that question is on many investors’ minds.[i] In the very short term, anything is possible—near-term volatility is unpredictable, in our view. But we think stocks and bonds are primed to rebound this year as uncertainty fades and last year’s alarms prove to have overshot the emerging reality. How so? Read on.
Bear markets (typically prolonged, fundamentally driven declines exceeding -20%) are painful to endure, in our experience, and 2022 was no exception for US and world stocks in dollars. Whilst UK stocks and global returns in Sterling never reached bear market territory tied to currency swings, given that world stocks experienced a bear market last year, we think that distinction is important.[ii] Late in bear markets, we find patience is usually rewarded, as our research shows recoveries begin with typically sharp V-shaped jumps. In our view, that likely occurs this year, which we think UK investors are likely to experience regardless of the downturn’s nature in Sterling. It may have already begun—since 12 October, the MSCI World Index is up 15.5% in dollars, even with December’s back-and-forth and last week’s slide.[iii] In pounds, world stocks are also up 9.5% from their 16 June low.[iv] Or maybe more downside lurks, from a new negative or investors’ working out some last spurt of angst. Recession (broad economic contraction) chatter amongst many commentators we follow certainly appears to be hitting sentiment hard now. Yet even if there is a recession, we don’t think it is likely to sway stocks materially. Markets—and CEOs—largely think a downturn is likely, based on available surveys and data.[v] Stocks ordinarily bottom before growth returns, according to our hisorical analysis. In all of these scenarios, whilst the timing is impossible to pinpoint, we think the conditions are ripe for a new bull market to get cooking in 2023, as stocks’ three main drivers—politics, economics and sentiment—point positively.
Politically, the US presidential cycle’s third year supports better-than-average returns, in our view. Now, as always, MarketMinder Europe is nonpartisan, favouring no party nor any politician, with our analysis assessing political developments’ potential market effects only. So what matters to us isn’t the personalities or partisan particulars, but the fact that US midterm legislative elections brought a split Congress, with Republicans winning the House of Representatives and Democrats maintaining Senate control, ensuring political gridlock for the next two years. This ushers in what we call the Midterm Miracle for stocks. Our review of electoral history shows midterms often deepen gridlock, reducing the risk government enacts anything radical to upset markets, and that typical backdrop reigns now.
In recent months, a curiosity has emerged in US economic data—a split between the two competing purchasing managers’ indexes (PMIs, surveys of growth’s breadth) for the services sector.[i] Whilst the Institute for Supply Management’s (ISM’s) readings remained in expansion, S&P Global’s started contracting in July and stayed there, below the 50 mark indicating more firms contracted than grew, the rest of the year. But now the divergence is no more, as ISM reported Friday that its services gauge also slipped into contraction in December. Barely, at 49.6, but down nonetheless.[ii] Given the ISM Services PMI’s relatively lower monthly variability and tendency to contract only when recession strikes, this development got plenty of attention from financial commentators we follow.[iii] However, we don’t think it revealed anything new for stocks.
Exhibit 1 shows the growing split between ISM and S&P’s Services PMIs last year. As you will see, even before they diverged directionally, S&P’s was usually a few points below ISM’s.
Exhibit 1: A Tale of Two Services PMIs
On the heels of December’s dim manufacturing purchasing managers’ indexes (PMIs), services and composite PMIs showed contraction in many of the world’s major economies.[i] (PMIs are monthly surveys that track the breadth of economic activity as companies report a yes or a no to their company growing or contracting. Readings above 50 indicate expansion, whilst below 50 indicates contraction.) Perhaps services’ contraction is less broad-based than manufacturing, given their readings are closer to 50.[ii] Yet most are still below, suggesting contraction. That said, as we wrote last week, we think what likely matters to stocks looking forward isn’t whether economies shrink, but whether any recession (a decline in broad economic output) is a surprise or surprisingly nasty. A quick tour of the latest surveys of economists, CEOs and fund managers shows recession is a popular forecast this year, suggesting negative surprise power is quite limited.
Take survey results in the US for example. The US Federal Reserve Bank of Philadelphia’s (Philly Fed’s) quarterly survey of professional forecasters tracks a few dozen economists’ gross domestic product (GDP, a government-produced measure of economic output) growth projections for the US for the next several quarters. From their forecasts, the Philly Fed calculates the mean probability of US GDP growing (or contracting) at a given rate. In Q4, economists put the mean probability of a US recession occurring within the next 12 months at 43.5%. That is the highest estimated probability in the series’ history, which begins in 1968.
Exhibit 1: Philly Fed Survey of Professional Forecasters
The New Year is officially underway, but 2022 still lingers on in a sense, as December’s economic data are only just starting to come out. First up: The business surveys known as Manufacturing Purchasing Managers’ Indexes (PMIs), which showed factories worldwide finished the year on a poor note—which didn’t surprise economists, based on the consensus expectations compiled by FactSet.[i] Manufacturing’s troubles have been well-documented throughout financial commentary we follow, but our research suggests heavy industry is uniquely vulnerable to last year’s biggest headwinds. The potential silver lining? With those headwinds widely known and now, in our view, starting to fade, we think global markets could be poised to begin pricing in an economic recovery much sooner than commentators we follow have stated is likely.
Exhibit 1 rounds up the major manufacturing PMIs. As you will see, all remained under 50—the dividing line suggesting more respondents reported contraction than growth. That extends the trend that materialised around midyear.
Exhibit 1: Around the World in Manufacturing PMIs
What to make of the US economy? Sentiment measures and many financial commentators we follow portray conditions as quite bad. In our view, the latest economic data are mixed, with two of this year’s stronger American indicators potentially showing some cracks in November. In our experience, the consensus view amongst commentators we follow is: Things aren’t good and are about to get worse, with many pencilling in an American recession (a period of contracting economic output) next year. We won’t deny that a recession is possible. But from an investing perspective, we don’t think a US recession is an automatic market negative, as our research suggests stocks care more about how expectations align with reality. In our view, the popular reaction to the latest November data suggests positive surprise may not be hard to achieve.
Starting with the “Personal Income and Outlays” report, where the US Bureau of Economic Analysis (BEA) announced real (i.e., inflation-adjusted) personal consumption expenditures (PCE) were flat in November, stalling after October’s 0.5% rise.[i] Goods spending fell -0.6% m/m whilst services spending ticked up 0.3%.[ii] PCE price indexes showed inflation slowed, as headline prices rose 5.5% y/y following October’s 6.1%.[iii] November was headline PCE’s first month below 6% since January this year, continuing the deceleration since June’s high of 7.0% y/y.[iv] A big factor: energy prices’ ongoing slowdown. Though PCE energy goods and services prices continued rising at double-digit rates (13.6% y/y in November after October’s 18.4%), they have decelerated considerably from June’s 43.6% clip.[v] But energy prices aren’t the only ones slowing, as core PCE prices (which exclude energy and food) eased to 4.7% y/y from last month’s 5.0%.[vi]
Separately, the US Census Bureau announced November durable goods orders fell -2.1% m/m, a reversal from October’s 0.7%.[vii] The widely watched nondefense capital goods orders (excluding aircraft)—also known as core capital goods orders and which corresponds to the equipment segment of business investment—rose 0.2% m/m.[viii] Several commentators we follow had a similar take on all these data: Inflation may be easing, which is positive, but consumer spending and business demand are softening, which is bad.
Steadfast. Iron-willed. Throughout the autumn, as Japan’s yen plunged to generational lows versus the dollar, officials at the Bank of Japan (BoJ) clung to a policy called yield curve control, whereby they set an official ceiling of 0.25% for 10-year Japanese government bond (JGB) yield.[i] As long-term interest rates globally rose this summer and autumn, the BoJ announced it would continue making “unlimited” bond purchases if necessary to prevent the 10-year yield from punching through the ceiling.[ii] When higher long rates outside Japan seemingly pulled investment from Japanese assets to their Western counterparts—weakening the yen—officials maintained the ceiling and used foreign exchange reserves to support the exchange rate.[iii] But that changed Tuesday, when the BoJ suddenly reversed course and loosened its capped rates, known also as an interest rate peg. 10-year JGB yields jumped, the yen strengthened and commentators we follow globally called it a game changer with global implications—the rate rise being just the tip of the iceberg.[iv] But we think a more sober, less-theatrical analysis reveals this wasn’t so huge a shift.
For one, we have long observed that pegs are seemingly made to be broken, so we think it shouldn’t be too surprising that BoJ Governor Haruhiko Kuroda and his colleagues took advantage of a recent global fall in long rates to make some tweaks and avoid the perception that it was surrendering to market forces (meaning, that speculators had forced its hand by trying to force rates higher).[v] At Tuesday’s meeting, policymakers raised the 10-year JGB yield’s allowed bandwidth to 0% plus or minus half a percentage point, effectively setting the ceiling at 0.50%.[vi] But lest you think this is some big pivot, they also upped their monthly JGB purchases from $55 billion (£45.4 billion) to $67 billion (£55.3 billion) per month.[vii]
Upon announcing the move, the BoJ cited concerns about market function—not a shift in its inflation outlook.[viii] Reading between the lines, we would guess policymakers are arguing they successfully beat the JGB market into submission when defending their peg earlier this year and that continuing to do so would now bring more risks than benefits, including difficulty pricing corporate bonds and other assets that use JGBs as a baseline rate. Increasing its JGB purchases—and leaving the policy rate at -0.10%—seemingly underscores its belief that even with the recent uptick, inflation remains too slow, with feeble monetary drivers masked by energy prices lately.[ix] Hence it remains committed to what it views as loose policy—negative rates and quantitative easing (QE) bond buying—which we would crudely summarise as indicating the monetary beatings will continue until morale improves. Banks will likely still struggle to lend amidst slim net interest margins (meaning, the small gap between their funding costs and the potential interest rate they can charge on new loans).[x] JGBs appear likely to remain in short supply for investors as the BoJ keeps adding to its huge holdings. And we think international investors will probably still see little to no reason to plop some money in the yen—not when all other comparable assets globally have much higher yields.[xi]
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
This article reflects the opinions, viewpoints and commentary of Fisher Investments MarketMinder editorial staff, which is subject to change at any time without notice. Market Information is provided for illustrative and informational purposes only. Nothing in this article constitutes investment advice or any recommendation to buy or sell any particular security or that a particular transaction or investment strategy is suitable for any specific person.
Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.
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