Please see below article received from EPIC Investment Partners this afternoon, which provides an economic update for the US.
As we anticipated, the August U.S. payrolls report brought unwelcome news, indicating a more pronounced slowdown in the labour market than expected. The latest figures show job gains reached only 142,000, considerably lower than the market forecast of 165,000. Additionally, previous reports were revised downwards, with last month’s already weak figure of 114,000 adjusted even further to a mere 89,000. On the other hand, the unemployment rate fell to 4.2%, in line with market expectations.
The weaker jobs report follows the Bureau of Labour Statistics’ annual benchmark revision of total non-farm employment, which recently reduced job figures by 818,000.
In response to the report, the bond market reacted favourably, with the yield on the 10-year Treasury note dipping a few basis points from yesterday’s 3.73% to 3.68%. This decline highlights a shift in market sentiment regarding the Federal Reserve’s interest rate strategy, as investors anticipate potential adjustments to monetary policy in September in light of the weaker labour market.
With U.S. interest rate expectations diminishing, the Japanese yen appreciated in the foreign exchange market, rising from 143.5 to 142.5 against the U.S. dollar. This movement reflects both a flight to safety as investors seek refuge in traditionally stable assets amidst growing economic uncertainty, and longer-term expectations of a U.S. dollar decline as interest rates fall.
The implications of this payroll report are significant. While the disappointing job growth in isolation might suggest a 50 basis point cut, the steady unemployment rate could prompt the Federal Reserve to opt for a more modest 25 basis point reduction. It presents a challenging balancing act for the Fed, weighing the weakening jobs data over recent months against the fact that U.S. inflation has not yet reached its 2% target.
As the markets digest this information, all eyes will be on the Federal Reserve’s upcoming September meeting, where officials will need to consider these labour market developments carefully.
Please check in again with us soon for further relevant content and market news.
Please see below article received from Brooks Macdonald this morning, which provides a global market update for your perusal.
What has happened
Markets on Thursday looked to be a little softer on balance, as investors held their breath ahead of an arguably pivotal US jobs report due later today. Remember that the last monthly US payrolls data was one of the principal catalysts for an economic growth scare, putting markets in a brief but violent tailspin in early August. Otherwise, Thursday saw a slightly better-than-expected US Institute for Supply Manufacturing (ISM) Services Purchasing Manager Index (PMI) for August, coming in a 51.5, where 50 is the dividing line between month-on-month economic expansion versus contraction. Given services makes up around three-quarters share of the US economy, it puts the recent weaker manufacturing print earlier this week in some perspective.
Looking for a better set of US payrolls
Later today, we get the latest (August) monthly US employment ‘non-farm payrolls’ report. After the weaker than expected print last month, markets are hoping for a better showing this time around. According to the median estimate of a Bloomberg survey of economists, payrolls are expected to have risen by +165,000 in August, following July’s +114,000 increase. As for the unemployment rate, that is expected to have edged down to 4.2%, versus the 4.3% print last month. As an aside, it is worth keeping in mind that, as we saw last month, it is quite possible for the payrolls to show net gains, and still see the unemployment rate higher – rather than a sign of weakness, it can actually be a positive, as the unemployment rate ticks up to reflect more people coming back into the workforce available to work, but while looking for a job, are initially classified as being out of work.
Oil price having a difficult week
In commodity markets, the oil price, at one point down nearly -8% for the week earlier today, looks to be on track for its worst weekly loss in almost a year. With the Brent crude oil price down at around US$ 73 per barrel currently, its lowest level since late last year, the driver for the price weakness appears to be a difficult softer-demand versus ample-supply outlook. That outlook is despite the latest announcement from the OPEC+ oil producing group yesterday (denoting the Organization of the Petroleum Exporting Countries, plus certain non-OPEC countries, including Russia), where following a virtual meeting, the group announced that it would delay planned longer-term production increases (as part of unwinding their previous production curbs) by two months.
What does Brooks Macdonald think
There is an awful lot riding on the US employment report later today. Last month’s weaker than expected print could arguably be put down, in part, to the extreme weather disruption caused by hurricane Beryl. For context, readers will remember that this hurricane was the earliest-in-the-year maximum category-5 hurricane to ever be recorded in the Atlantic basin. There is no such weather excuse this time around. Instead, markets will want to see some reassurance that after some mixed jobs reports data of late, that the US economy is still doing relatively okay. In terms of what is currently being priced in for US interest rate cuts later this month (at the US Federal Reserve meeting decision due 18 September), markets are pricing in around 35 basis points of cuts, so still between either a 0.25% cut or a larger 0.50% cut.
Bloomberg as at 06/09/2024. TR denotes Net Total Return.
Please check in again with us soon for further relevant content and market news.
Please see below the Daily Investment Bulletin from Brooks Macdonald, which was received early this morning (30/08/2024):
What has happened
Today marks the end of a remarkable month in markets – a cursory glance at current headline equity indices belies the hiatus that hit investors at the start of the month. Indeed, even despite the latest volatility in US megacap technology company Nvidia’s share price with its results earlier this week, markets have continued to recover their poise. As a case in point, the equal-weighted version of the US S&P500 equity index yesterday notched up a fresh record high. It was also a decent day in Europe yesterday with the pan-European STOXX600 equity index closing just a hair’s breadth beneath its all-time high that it hit back in May.
US GDP data pushes back on recession fears
Buoying the market’s positivity in the past 24 hours has been a better-than-expected US Gross Domestic Product (GDP) release (in real terms, adjusting for inflation), pushing back further on recession fears that worried markets in particular just a few weeks ago. The second estimate of US Q2 GDP was published yesterday, and it was even more positive than the first estimate that was released late last month. The latest US GDP print for Q2 was revised up to a quarter-on-quarter annualised growth rate of +3.0% and coming above the preliminary first reading for Q2 of +2.8%. Cutting the data another way, the Q2 year-on-year print now stands at +3.1%. All in all, these numbers really do not support a near-term US recession outlook, especially when you consider that the US Federal Reserve’s so-called ‘longer-run’ GDP assumption for US annual GDP growth is at +1.8%.
More data to end the month
Later today we get the latest US Personal Consumption Expenditures (PCE) monthly inflation reading for July. This data matters, but arguably especially so at the moment, given the US Federal Reserve (Fed) is at a pivotal inflexion point for its interest rate policy, with markets expecting the Fed to cut rates next month. As a reminder, the PCE inflation data is the measure that the Fed officially targets, so this will help inform the Fed as they look to shape their next policy choices.
What does Brooks Macdonald think
Anyone hoping for a meaningful thawing in the frosty relationship between China and the US could be in for a long wait. This past week has seen US national security adviser Jake Sullivan hold three days of talks in China, including a meeting with China’s president Xi Jinping. Of particular note, in his meeting with China’s Foreign Minister Wang Yi, Sullivan said the US would “continue to take necessary actions to prevent advanced US technologies from being used to undermine our national security”.
Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.
Please see the below an article from Epic Investment Partners providing their thoughts on the recent US economic data that has been published.
Earlier this week, we posed the question: “Where did the jobs go?” Yesterday, the Bureau of Labor Statistics (BLS) offered an answer, albeit an unsettling one. They admitted to an error in their estimates, revealing that the “true” payroll number for the year ending March 2024 was a staggering 818,000 less than previously reported.
The whereabouts of these missing jobs remains shrouded in uncertainty, a mystery even the BLS can’t unravel. However, the most likely explanation points towards the birth/death model as the culprit. This statistical tool, employed by the BLS to estimate job creation or loss from new business formations and closures, is a crucial component of the Current Employment Statistics (CES) survey.
However, the CES survey’s reliance on sampling established businesses inherently overlooks job fluctuations stemming from newly formed or recently closed enterprises. The birth/death model strives to bridge this gap, but the COVID-19 pandemic has dramatically disrupted business dynamics, making its application more complex than ever.
The surge in business formations during the pandemic and the subsequent unpredictable patterns have thrown off the statistical relationships and trends that the birth/death model relies upon. This could lead to significant inaccuracies in the BLS’s job estimates, potentially overestimating job growth during economic slowdowns and underestimating it during periods of improvement.
The implications of these revelations are far-reaching. Since the BLS cannot pinpoint the source of the errors, the payroll data will be adjusted by a flat 68,000 per month for the period ending March 2024. This casts a shadow over July’s already weak jobs report, suggesting the “true” number was much worse.
The trend of increasing errors over time adds another layer of complexity. While we cannot simply subtract 68,000 from July’s payrolls, it is highly probable that next year’s BLS revisions will reveal a much larger adjustment. Even an adjustment of 68,000 would bring July’s NFP reading down to a mere 46,000, well below the rate needed to prevent a rise in unemployment.
The Federal Reserve is not oblivious to the overstatement of job numbers. In last year’s Jackson Hole speech, Powell acknowledged the potential for inflated job growth figures due to the intricacies of the birth/death model amid the pandemic’s disruptions.
Expect this year’s speech to reiterate this concern. The new data provides the Fed with ample justification for rate cuts, perhaps as much as 50 basis points in September, especially if inflation continues its downward trajectory. The missing jobs, it seems, may pave the way for significant changes in US monetary policy.
Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.
Please see the below article from Invesco detailing their thoughts on the latest bout of market volatility. This article is from their Multi Asset team on the reasoning behind the ‘global sell off’:
Global stocks have fallen sharply from their all-time highs in the last few weeks.
It appears we are on the brink of that next broad-based 10% decline as the economy weakens, the Federal Reserve passed on lowering interest rates at the July meeting and investors continue to lighten their holdings in expensive tech stocks.
It is hard to say with precision how long this bout of volatility will last for, and even though market participants appear to have quickly moved from pricing an overly rosy picture to an overly negative one, we think that at this stage, investors shouldn’t necessarily throw in the towel.
The current state of play of financial markets
Risk assets performed strongly since the start of the year, driven by hopes for a goldilocks economic scenario and a rush into US tech stocks fuelled by enthusiasm for artificial intelligence technology. At their peak on July 16th, global equites were up 14% in GBP terms.
In the last few weeks however, sentiment started to shift, with global equities giving back half of their year-to-date gains. Bonds on the other hand have offered multi-asset investors some reassurance as this more classical growth-driven sell-off has seen government bonds cushion part of the blow in equities by moving in the opposite direction.
Notwithstanding the alarming moves, investors should note that most markets are still up for the year as shown below.
What has triggered the sell-off?
It’s hard to pin this on any single event. Below we list what we think are some of the key culprits.
1. Recession fears?
After several months of stability, economic data around the world has started to soften with the most noticeable decline being in the US – evidenced by last Friday’s unexpected 114k new jobs added (lower than the 215k average of the last year) and the unemployment rate jumping to 4.3%, the highest since October of 2021. Although that’s not in and of itself an unhealthy unemployment rate, its sudden march higher has raised concerns for a potential recession.
2. Fed too slow to act?
Post the 2022 pull-back, equity markets have been unstoppable, buoyed by falling inflation and growing expectations of rate cuts, particularly from the US Fed. But during last week’s meeting, the Fed didn’t cut rates as many had hoped triggering fears that the Fed may be too late to act before a slow in hiring turns into rampant layoffs.
3. AI trade losing steam?
After benefitting from stellar returns, investors started to unwind big positions in the likes of Apple, Nvidia, Microsoft, Meta, Amazon, Alphabet and other tech stocks. Warren Buffet, Berkshire Hathaway’s CEO for instance recently sold half of Berkshire’s stake in Apple, which many see as a troubling sign for the health of the tech sector. Because these companies make up an enormous chunk of the overall value of the S&P 500, when investors sell off tech stocks, that has a massive detrimental effect on the broader market.
4. Unwinding of the Japanese yen carry trade
While less structural in nature, the mayhem that swept across world markets was amplified by a market strategy known as the “carry trade.” Japan’s benchmark Nikkei 225 plunged 12.4% on Monday and markets in Europe and North America suffered outsized losses as traders sold stocks to help cover rising risks from investments made using cheaply financed funds borrowed mostly in Japanese yen. Markets recovered much of their losses on Tuesday. But the damage lingers.
More common than you think
Drawdowns (a decline of less than 10%), are always coming. Since the early 1980s, there has been a greater than 5% drawdown in the S&P 500 Index in every year but two (1995 and 2017). Even in this year, which had felt relatively benevolent until the past few weeks, the S&P 500 Index experienced a 5% drawdown in April before climbing to an all-time high in the middle of July.
On the other hand, corrections (declines of greater than 10%) happen less frequently. Corrections typically don’t just emerge out of nowhere. Often, they’re the result of policy uncertainty and/or surprising weakness in economic activity. The market has currently gone since Nov. 2, 2023, without an official correction, representing a 188-day period of a resilient economy and declining inflation.
Reasons to remain constructive as the dust settles
We appear to potentially now be on the brink of that next 10% decline as the economy weakens, the Federal Reserve passed on lowering interest rates at the July meeting and investors continue to lighten their holdings in expensive tech stocks.
It is hard to say with precision how long this bout of volatility will last for, and even though market participants appear to have quickly moved from pricing an overly rosy picture to an overly negative one, we think that at this stage, investors shouldn’t necessarily throw in the towel.
Growth slowdown is not the same as recession
In our opinion, this macro backdrop is consistent with an incoming deceleration but not indicative of imminent recession risks given:
Ongoing resilience in consumer and corporate balance sheets
The labour market is cooling, but not falling off a cliff
Banks do not appear to be tightening lending standards significantly
There does not appear to be significant excess in the economy
As of today, growth is solidly in positive territory on a global basis, with developed markets growing between 1-2% and consensus expectations signalling similar growth rates over the next two years.
The Fed should join the rate cut party soon
Last week, the Fed kept its main interest rate between 5.25 per cent and 5.5 per cent. However, the combination of a slowing jobs market, cooling inflation and the negative market reaction should lead the central bank to finally act. Historically, markets tended to perform well in easing cycles that were not associated with recessions. All eyes are therefore set on the Fed’s next meetings scheduled for September, November and December.
Tech stocks may be falling out of favour, but we don’t think this is their end
Tech stocks are still trading at lofty valuations, and while this may temper future upside potential, we don’t think investors will completely shy away from the sector. To evaluate the sustainability of their performance, investors should eschew reliance on charts of share price performance and focus instead on business fundamentals and valuations. While not unassailable these companies have large moats, very strong balance sheets, and many have revenue streams that are far less cyclical than tech companies of the past.
Please continue to check our blog content for advice, planning issues, and the latest investment, market and economic updates from leading investment houses.
Please see below article received from EPIC Investment Partners this morning, which provides a global market update.
The global market rout that began on Monday showed signs of easing on Tuesday, with the Nikkei 225 rebounding more than 8% after its worst day since 1987. However, investors remain on edge as they grapple with the implications of a potential US economic slowdown and the Federal Reserve’s policy stance.
The catalyst for the sudden risk-off sentiment appears to be growing fears of a “hard landing” as central banks, particularly the Fed, attempt to tame stubborn inflation without tipping economies into recession. Friday’s shockingly weak U.S. jobs report crystallised these concerns. It raised doubts about the health of the economy and the Fed’s ability to engineer a soft landing while keeping rates at 23-year highs.
According to Mohamed A. El-Erian, the market turmoil can be attributed to five key factors: worries about a US growth slowdown undermining “American exceptionalism”, concerns that the Fed’s policy stance is too restrictive, crowded investment positions being caught offside, geopolitical risks in the Middle East, and domestic political developments ahead of the US presidential election.
Nonetheless, the volatility outburst underscores the precarious and non-linear path to policy normalisation. As central banks attempt to delicately balance cooling demand whilst avoiding a hard landing, markets are prone to air pockets. Investors should brace for choppy and potentially divergent conditions across asset classes in the coming months. In this environment, selectivity and relative value are crucial.
Within equities, companies with pricing power and resilient margins are likely to weather the storm better. In fixed income, high-grade credit offers attractive yields with lower default risk. Wealthy nations’ bonds are a strong addition to the portfolio aside from plain vanilla US Treasuries given global recessionary risks.
Looking ahead, incoming US inflation and jobs data, as well as the Fed’s Jackson Hole Symposium, will be key watchpoints for any hints of a monetary policy pivot. More broadly, staying nimble and reactive will be critical as even small data surprises can spark outsized market moves in this fragile environment. While the path ahead might remain bumpy, the volatility spike does not fundamentally alter the broader macroeconomic backdrop at this stage.
In this “middling” macro regime, a focus on quality, value, and resilience across asset classes remains the prudent approach. If the market’s ups and downs leave you feeling a bit queasy, just remember: every roller coaster eventually comes to a stop.
Please check in again with us soon for further relevant content and market news.
Please see below article received from Brooks Macdonald yesterday, which provides a global market update as we enter August.
What has happened
If, like me, you had holiday and time away from markets in July, then you probably missed something of a game of two halves in markets in the month that wrapped up yesterday. Early on in July, markets at an index level were doing well, with the US S&P500 equity index hitting a succession of record highs. We also saw government bond prices up (and bond yields down) during the month, on the back of hopes that interest rate cuts would increasingly start to filter through, especially in the case of the US on the back of a softer US inflation print. But about half-way through July, equity market leadership shifted, as tech stocks fell. The so-called ‘Magnificent 7’ group of US megacap tech stocks were down over -10% from peak to trough, entering technical correction territory. Given their weight in US equity indices, that was a big headwind for larger-stock index performance. Instead, we saw a meaningful rotation into the smaller capitalised end of the stock market, as rate cut hopes lifted the outlook for smaller companies who are generally much more sensitive to funding and credit conditions. Indeed, the outperformance in July of the US Russell 2000 small cap equity index over the US Nasdaq technology equity index was the largest in any month since February 2001. Coming back to tech, it was a better day yesterday, with good results from Meta after the US close driving the company’s shares up over +7% in after-market trading. Nvidia shares meanwhile staged an impressive one-day rally up +12.81% yesterday.
US job data points to further cooling, supporting Fed rate cut hopes
A broad gauge of US labour cost growth closely watched by the US Federal Reserve (Fed) cooled in the calendar Q2 by marginally more than analysts had been forecasting. Out yesterday, the US Employment Cost Index (ECI) a broad measure of labour costs, increased by +0.9% in Q2 sequential quarter on quarter (QoQ). This was weaker than the +1.0% expected, after rising +1.2% QoQ in Q1. In year-on-year terms, the ECI was up +4.1% in Q2. Separately, a report from the US-based ADP Research Institute showed US companies added the fewest number of jobs in July since January, while wage growth fell to the slowest pace since 2021 for both so-called ‘job-changers’ and ‘job-stayers’ alike. That was a constructive backdrop for the Fed meeting later in the day, where rates yesterday were kept on hold as expected, but Fed Chair Powell pointed markets in the direction of a first US rate cut in the current cycle to likely come in September. Specifically, Powell said that if the Fed get the data that they hope to get, then a reduction in the policy rate could be on the table at the September meeting.
Investors are proving to be less forgiving
The current calendar Q2 corporate reporting season is seeing a somewhat mixed picture unfold, and in turn it is prompting a somewhat mixed reaction in markets. We highlighted this in our post-Asset Allocation Committee meeting communication out earlier this week. That is to say, according to Factset who have reviewed the latest US S&P500 company reports, while the percentage of companies reporting positive earnings surprises is above average levels, the magnitude of earnings surprises is below average levels. Furthermore, while the aforementioned index is reporting its highest year-over-year earnings growth rate since Q4 2021, the market has been rewarding positive EPS surprises reported by companies less than average and punishing negative EPS surprises reported by companies more than average.
What does Brooks Macdonald think
The market reaction to the latest round of US quarterly earnings results makes sense. Mindful that we are roughly only coming up towards half-way through the results season, nonetheless, these results are landing having followed a period of very strong equity market performance, where the US S&P 500 equity market had notched up fresh record highs as recently as mid-July. As a result, there is a lot less room for manoeuvre left in equity valuations should company results, or their outlooks not beat expectations, in particular focused around megacap US tech stocks. In valuation terms, the MSCI USA equity index 12-month forward Price-to-Earnings Per Share ratio is currently 21.00x versus the past 30-year average of 16.98x. Interestingly, such a valuation gap versus historical averages is virtually non-existent when looking at equity markets on a global ex-US basis. Here, the MSCI All Country World excluding US equity index trades on 13.48x versus the average since 2001 of 13.44x.
Index
1 Day
1 Week
1 Month
YTD
TR
TR
TR
TR
MSCI AC World GBP
1.6%
2.2%
0.1%
12.4%
MSCI UK GBP
1.1%
2.7%
2.5%
10.5%
MSCI USA GBP
1.6%
2.5%
-0.3%
15.4%
MSCI EMU GBP
0.5%
0.6%
-0.3%
5.7%
MSCI AC Asia Pacific ex Japan GBP
1.2%
0.9%
-1.4%
8.0%
MSCI Japan GBP
4.1%
2.2%
4.2%
11.8%
MSCI Emerging Markets GBP
1.2%
0.9%
-1.2%
7.1%
Bloomberg Sterling Gilts GBP
0.5%
1.3%
1.9%
-1.1%
Bloomberg Sterling Corps GBP
0.3%
0.9%
1.8%
1.4%
WTI Oil GBP
4.2%
1.1%
-5.9%
8.1%
Dollar per Sterling
0.2%
-0.4%
1.7%
1.0%
Euro per Sterling
0.1%
-0.3%
0.6%
3.1%
MSCI PIMFA Income GBP
0.9%
1.6%
1.3%
7.0%
MSCI PIMFA Balanced GBP
1.0%
1.7%
1.2%
8.0%
MSCI PIMFA Growth GBP
1.1%
1.9%
1.0%
9.9%
Index
1 Day
1 Week
1 Month
YTD
TR
TR
TR
TR
MSCI AC World USD
1.6%
1.5%
1.6%
13.1%
MSCI UK USD
1.2%
2.0%
4.1%
11.2%
MSCI USA USD
1.6%
1.8%
1.2%
16.1%
MSCI EMU USD
0.6%
-0.1%
1.3%
6.3%
MSCI AC Asia Pacific ex Japan USD
1.2%
0.2%
0.2%
8.6%
MSCI Japan USD
4.2%
1.5%
5.8%
12.4%
MSCI Emerging Markets USD
1.2%
0.3%
0.3%
7.7%
Bloomberg Sterling Gilts USD
0.6%
0.7%
3.5%
-0.3%
Bloomberg Sterling Corps USD
0.4%
0.3%
3.4%
2.2%
WTI Oil USD
4.3%
0.4%
-4.5%
8.7%
Dollar per Sterling
0.2%
-0.4%
1.7%
1.0%
Euro per Sterling
0.1%
-0.3%
0.6%
3.1%
MSCI PIMFA Income USD
0.9%
0.9%
2.9%
7.6%
MSCI PIMFA Balanced USD
1.0%
1.0%
2.7%
8.6%
MSCI PIMFA Growth USD
1.2%
1.2%
2.6%
10.6%
Bloomberg as at 01/08/2024. TR denotes Net Total Return.
Please check in again with us soon for further relevant content and market news.
Please see the below article from Tatton Investment Management providing an insight into markets over the past week.
Don’t fear the rebalance
The rough patch for global stocks continues – yet again concentrated in the frothy US mega-caps. Smaller caps continue to be a bright spot, but in aggregate these gains are being outweighed by large-cap losses. The “Magnificent 7” (Mag7 – Apple, Amazon, Alphabet, Meta, Microsoft, Nivida, Tesla) looks far from magnificent, falling more than 11% since early July. Ultimately, though, we think the market-wide rebalance is positive.
Tesla was the worst offender last week, losing 12% share price after extremely disappointing Q2 profits. The electric carmaker is being hit by both sour tech stock sentiment and a global downturn in the autos market. Chinese overproduction means carmakers have no pricing power – and there is a similar story in microchips. Manufacturers are under real pressure.
Fortunately, that weakness is not yet spreading into services – as it historically has. The problem is firmly on the supply side, and demand has held up reasonably. For now, it looks like manufacturing weakness is a good thing for consumers – lowering their prices and giving them more money to spend on services. That could change (particularly if manufacturers cut jobs) which we will have to keep an eye on.
We welcome the large-to-small cap rotation, but Mag7 losses could still be painful for markets overall. Those companies are big enough that their troubles weigh down the entire stock market – in which US consumers are heavily invested. Still, capital readjustment helps growth prospects for smaller caps, as will the Federal Reserve’s upcoming rate cut. The case for global, not just US, growth is still strong. The UK has been a notable bright spot, for example, thanks in large part to the new government’s closer European relations.
Last week’s market wobble might not be over, for the US mega-caps at least. But the rotation will hopefully move capital from where it was too concentrated to where could have the biggest growth benefits. Investors should not fear the rebalance.
Sahm-thing to worry about?
The “Sahm rule”, a US recession indicator based on how quickly unemployment is rising, is close to being triggered. The rule says that a recession starts when the three-month average unemployment rate is 0.5 percentage points above its lowest level in the previous 12 months – because when unemployment rises, it usually rises quickly. After US unemployment climbed to 4.1% in June, the gap has now narrowed to just 0.43pp.
We are unlikely to trigger the 0.5 threshold soon for technical reasons (the previous low drops out of the monitoring period next month) but a similar regularity noted by former New York Fed president Bill Dudley (three-month average unemployment 0.3pp above the cycle low) has already been breached. Of course, recession indicators are all rules of thumb that come with exceptions, and American economist Claudia Sahm, the rule’s namesake, noted last year that her rule would not be the first to break down during this post-pandemic cycle.
The key question is whether unemployment will stabilise at the current rate, or job losses will spiral. Fed officials seem to expect stabilisation, largely because current unemployment is close to their estimate of the ‘neutral’ rate. This is backed up by the ‘Beveridge curve’ – data showing that there is a balancing point between unemployment and job vacancies (increases in the latter are usually thought to be inflationary). June’s unemployment was at that point, which we can interpret as neutral (as the Fed seems to) or, more worryingly, as a tipping point.
Past resilience of the US economy should perhaps suggest a positive view, but this might be counteracted by the drying up of pandemic-era savings. Upcoming rate cuts will help in any case, but businesses might not be far from cutting jobs. The US economy certainly looks more fragile than it did a few months ago.
China won’t ship out inflation
The cost of shipping freight out of Shanghai has soared recently. This has historically been an indicator of downstream inflation – thanks to its effect on Chinese goods producers, and eventually US consumers. Spiking Shanghai freight are therefore worrying many about a return to global inflation. But we think this time is different, and we won’t see inflation shipping out of China.
What seems to be pushing up costs this time is a massive pickup in US demand for Chinese goods. This is almost certainly due to Donald Trump: the former president and Republican candidate unleashed a wave of tariffs on Chinese trade during his first term, and has promised to do so again if re-elected. His administration will reportedly target 60% or higher tariffs on Chinese goods. With Trump currently the favourite for November’s election, Chinese exporters and US importers think this might be the last realistic chance to trade. So, they are rushing to exchange goods, even if freight costs seem prohibitive.
This is unlikely to result in price pressures down the line, simply because Chinese firms are in no position to put up prices. Its domestic economy is weak and the government has been exacerbating a severe overproduction problem. That has resulted in ‘dumping’ goods (particularly electric vehicles) on international markets, pushing down prices. This is one of the key reasons global manufacturing is so weak. At the moment, China is exporting disinflation.
Chinese producers will likely bear the freight shipping costs, because they have little choice. Whether Trump wins or loses in November, we should expect the rush of China-US shipping to end in 2025. Freight costs are not as inflationary as in the past.
Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.
Please see below article received by EPIC Investment Partners yesterday, which provides a global economic update.
The global economy has been spluttering for years, even before the pandemic struck. Sluggish growth, especially in economic powerhouses like China and the G7, painted a grim picture. We speculated many years ago that this slowdown was likely caused by shrinking working-age populations, a demographic trend that has persisted post-pandemic. Despite some recent glimmers of recovery, the underlying problems remain, masked by a perilous reliance on debt.
Take the United States, for example. A 2.7% GDP growth rate might seem rosy, but it’s a mirage. The US government is running a gargantuan 7% budget deficit, borrowing far more than it earns. This unsustainable fiscal policy conjures an illusion of growth, but it’s a house built on sand.
The situation isn’t much rosier in other major economies. Growth forecasts for 2024 in nations like Canada, France, Germany, and the UK are all significantly lower than their pre-pandemic levels in 2019. While US employment figures might appear robust, the reality is that the economy is propped up by government spending, not genuine productivity.
Adding to the unease is the alarming level of debt in these nations. Except for Germany, all G7 countries have a debt-to-GDP ratio exceeding 100%. Servicing such high levels of debt at interest rates above GDP growth is simply not sustainable.
This addiction to debt has ominous consequences. As Jerome Powell, the Chairman of the Federal Reserve, has cautioned, this trajectory is unsustainable. In a recent speech, Powell emphasised the gravity of the situation: “The U.S. federal government is on an unsustainable fiscal path. The debt is growing faster than the economy. It’s as simple as that.”
Powell’s stark warnings underscore the precarious nature of the current economic situation. The US, and indeed much of the Western world, is living on borrowed time. Ironically, while there is much handwringing over ESG and sustainability policies, there’s little discussion about whether government spending itself is sustainable.
In light of these mounting pressures, substantially lower interest rates are not just likely, they are inevitable. The sheer weight of accumulated debt, coupled with anaemic economic growth, leaves central banks with few options. This shift towards lower rates is not a policy choice, but an economic imperative.
The question is not whether interest rates will fall, but how far and how fast.
Please check in again with us soon for further relevant content and market news.
Please see the below article from Tatton Investment Management providing an insight into markets over the past week.
Shock, rotation, growth?
An astounding week, that started with an attempted assassination of Donald Trump, ended with the largest global IT outage in history. As a result, markets now assume Trump will be president – and have priced in the tax cut benefits to small cap US stocks. The outage caused lots of disruption, but little market volatility as yet.
It adds further pressure to mega-tech stocks, which have struggled following a massive market rotation into small caps. The global system failure might also push more money into cybersecurity (even though this particular episode wasn’t an attack), following Google’s $23bn acquisition of Wiz. We need to keep an eye on the long-term implications of this trend.
The assassination attempt has made Trump the presumptive next president in markets’ view, and there is clear excitement about another round of corporate and personal tax cuts – benefitting the small-cap Russell 2000. We welcome a rotation away from the previously dominant mega-cap tech stocks, but markets are arguably ignoring the negatives of a Trump presidency – most notably, a deterioration of US fiscal metrics and potential bond market volatility. Bond markets are calm at the moment, but that could change.
The large-to-small cap rotation is a momentum story, and we have noticed that, in recent years, momentum has become a dominant market driver. That might have something to do with the presence of AI in trading strategies, which is a slightly concerning thought (since AI-driven behaviour typically becomes very unpredictable). Nvidia is a good example: its rally has driven down its risk premia dramatically, despite being an historically volatile stock. This pattern is the same across the mega-caps, which are typically more volatile than the rest of the US stock market.
Those trends might flip if rotation continues, but we worry that mega-cap losses might start to dwarf the small-cap gains – because of the former’s sheer size. That could negatively affect market conditions or consumer confidence (through the balance sheet effect). Greater market equality might be a long-term benefit, but we need to be vigilant.
Small cap rotation
Small cap US stocks continued outperforming the tech mega-caps last week – in stark contrast to the Magnificent 7’s incredible rally for most of this year. Weaker inflation data prompted the switchover, as markets now think the Federal Reserve might cut rates this month, or by September at the latest.
That goes against the usual narrative somewhat: small caps are thought to lose out when economic activity weakens (as in a disinflation environment) because they are sensitive to near-term growth, while ‘growth’ stocks like tech are thought to be benefit when rates fall. Instead, markets clearly think rate cuts will be a big boon for small companies – possibly because borrowing costs are now such a burden that the effect of changing them is bigger.
Small caps were also boosted by expectations that Donald Trump will win the presidency, with his agenda of tax cuts and deregulation. We think there might be fiscal and bond market problems with this further down the line (he wants to expand the deficit, but his foreign policy could deter the capital inflows needed to do so), but markets are not showing signs of fear yet.
Losses for the Mag7 are harder to explain (they should benefit from tax cuts too) but we think they are mostly about momentum. The relative balance of expected earnings growth has shifted enough to make investors question the mega-caps’ huge valuations, which have become stretched after a phenomenal rally this year. We wrote a while ago that market concentration in the Mag7 was mostly because no one could match their profit growth – but this may no longer be the case. Hopes for a better balance in economic profit distribution has allowed the rotation that many have been clamouring for all year long. That inevitably drags money away from tech – but that could well be a good thing.
Renminbi strength is political, not economic
Chinese growth looks weak after disappointing GDP numbers – and many think it is weaker than the official figures say. Deflation is still a big problem; month-on-month inflation has been negative since April. The communist party’s third plenum (a key economic meeting) was remarkably quiet about the problem this week. Beijing clearly favours a gradual approach, more in keeping with Xi Jinping’s long-term deleveraging goals. Stimulus has been stop-start in recent years, as the government is reluctant to inflate the credit bubble again.
Deleveraging an economy is much smoother if export demand is strong – but that has been battered by tariffs and trade wars. These are only set to get worse if Donald Trump wins a second term, or the EU imposes its planned tariffs. In this weak environment, you would normally expect the currency to fall in adjustment, making exports more attractive. But the renminbi has remained stable against the dollar – and appreciated massively against the weak yen, making Chinese exports to Asia (where most of Chinese trade is) more expensive.
Beijing’s reluctance to devalue its currency – thereby tightening financial conditions – is surprising, and seems to be the result of other political goals, rather than an aim in itself. Devaluation would undermine domestic confidence in the economy and international perceptions of the currency. Trump would undoubtedly jump on it and call Beijing a currency manipulator, while the EU would potentially dial up tariff talk.
In terms of selling goods to the west, therefore, there would be little benefit – since the currency discount would be nullified by tariffs. The situation is different among Asian neighbours, of course, but is the Chinese economy detached enough from the west to rely on this trade? In the months and years to come, answering that question will be crucial.
Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.
