The Latest Confirmation of a Tough 2022

The latest hard data aren’t great, but they are old hat to markets.

Output gauges haven’t yet caught up to the fresh, preliminary 2023 purchasing managers’ indexes we detailed on Tuesday—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 can reduce uncertainty. Moreover, there are some little-noticed signs of improvement, too, suggesting a lot of room for positive surprise.

Japan’s Weak Core Machinery Orders

Japanese core machinery orders, which many treat as a sign of future corporate investment, fell -8.3% m/m in November, much worse than consensus estimates of -0.9%.^[i] That is a noteworthy drop for a series that is seasonally adjusted, although 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 while non-manufacturers’ orders slipped -3.0% on tepid demand from the information service sector.^[ii]

The Cabinet Office blamed poor orders on the global economic slowdown, and while Japanese factory orders are a notoriously volatile dataset, they struggled for most of 2022—contracting on a monthly basis in 7 of 11 reported months.^[iii] Several headwinds weighed on orders, from semiconductor shortages disrupting production to flagging external demand. Moreover, the zero-COVID strategy of China, Japan’s largest trading partner, also hurt business. Though easing COVID restrictions may drive something of a near-term bounce once the issues from the outbreak cool, we don’t think a huge rebound is coming.

Regardless, Japanese factories’ struggles are well known and in line with other manufacturing-related weakness (e.g., US durable goods orders). In our view, stocks have likely digested the developments and moved on. Consider: Japanese machinery stocks led the bear market down, falling more than both broader Japanese markets and global stocks. (Exhibit 1)

Exhibit 1: Markets Are Familiar With Machinery’s Struggles

Source: FactSet, as of 1/25/2023. MSCI Japan Machinery Industry returns with net dividends, MSCI Japan Index returns with net dividends and MSCI World Index returns with net dividends, 12/31/2021 – 1/24/2023. Indexed to 100 on 12/31/2021.

November data aren’t going to shed much new insight about the future, but they do add more fodder to the overall dour moods towards the global economy—a typical backdrop for a market recovery. The weak orders could also reduce uncertainty by confirming trends stocks hinted at—allowing investors to move on. Note, too, since global stocks’ low last October, Japanese machinery stocks have led in the recent rally, rising 23.2% to the MSCI Japan’s 19.7% and the MSCI World’s 16.8%.^[iv] While it is too early to say a new bull market is underway, what leads on the way down often bounces strongest during the rebound.

Poor UK Retail Sales

UK December retail sales fell -1.0% m/m, missing estimates of a 0.5% rise.^[v] Unlike most other major economies, the UK adjusts sales for inflation—and December’s figures suggest elevated prices are weighing on consumers. Non-food stores sales dropped -2.1% m/m as retailers reported reduced spending tied to affordability concerns.^[vi] Discretionary spending in particular took a hit: “Other” non-food stores sales tumbled -6.2% as spending fell on cosmetics, sports equipment, games and toys, and watches and jewelry.^[vii] Food stores sales contracted -0.3% m/m due in part to customers’ stocking up early for Christmas in November—though supermarkets also reported a decline in volumes sold because of high food prices.^[viii]

Many worried December’s unexpected contraction signaled inflation dampened consumers’ holiday mood. While higher prices are likely the primary culprit, there are some other factors perhaps exacerbating weakness. Thanks to Black Friday, holiday discounting started in November, pulling some demand ahead—which may have impacted month-over-month reads despite seasonal adjustments. Another one-time variable possibly throwing off the usual seasonal adjustment calculations: the World Cup, which happens every four years, but typically during the summer. Postal strikes, too, may have weighed on some online spending.

From an investing perspective, though, higher prices’ hitting cash-strapped households is a well-known issue. Per the Office for National Statistics’ (ONS’) “Opinions and Lifestyle Survey,” the number of respondents reporting reduced spending due to a rising cost of living has steadily climbed over the past year. (Exhibit 2) Now, survey responses often don’t correlate with action—consumers may still spend despite saying they feel down about the economy. But when a majority of people tell a survey rising prices have weighed on their discretionary spending, markets are likely well aware of the issue, too—pre-pricing the news accordingly.

Exhibit 2: UK Households Are Aware of Rising Prices

Source: ONS, as of 1/23/2023.

Ongoing Moderation on the Inflation Front

While UK retail sales likely were hurt by hot inflation, there are nascent improvements worth noting. UK CPI rose 10.5% y/y in December, down from November’s 10.7% and extending the slowdown from October’s 41-year high of 11.1%.^[ix] Of CPI’s 12 categories, 7 detracted—led by Transport (which decelerated from November’s 7.2% y/y to 6.5%—contributing to December’s slower inflation rate).^[x] Core CPI, which excludes volatile food, energy, alcohol and tobacco prices, rose 6.3% y/y, repeating November’s rate. Despite the general improvement, pundits’ attention shifted from worrying about energy prices to worrying about surging food prices (up 16.8% y/y) and still-rising services prices.

Elsewhere, the US Producer Price Index (PPI), which tracks businesses’ costs, echoed this. It fell -0.5% m/m (up 6.2% y/y) in December—the gauge’s sharpest monthly contraction since April 2020’s lockdown-induced -1.3%. Behind the drop were falling energy (-7.9% m/m) and food (-1.2%) prices.^[xi] Core PPI, which excludes energy and food prices, rose 0.2% m/m, a tick slower than last month’s 0.3% rate. Similar to the UK, concerns about services prices—along with questions about China’s reopening and its impact on commodity prices—dotted coverage.

In our view, the focus on negatives is evidence of the pessimism of disbelief, which is often the sentiment backdrop in a market recovery. To us, the broader implication is more notable: Inflation measures in the US and overseas have been easing over the past several months. From factory prices in the US to natural gas prices in Europe, one of the dominant fears from 2022 has been gradually abating. That few seem to recognize that now is a counterintuitive reason to be optimistic about stocks in 2023.