Micro Trumps Macro as Bull Run Resumes
Author: Tom McGrath – Chief Investment Officer, 8AM Global
Market Review
A cursory glance at the performance table would suggest it was just another week of solid gains from the global equity markets. But in truth, nothing was simple last week. Volatility was elevated, and before the release of Microsoft and Google results on Thursday night, it looked more likely the US equity markets would finish lower. That said, it was a solid upward recovery from the unloved Asian markets, which have begun to build powerful upward momentum. And a special mention should go to the FTSE 100, which has finally blasted past the 8,000 level with a record close at 8,140. Bond yields drifted upward after more worrying inflation data, oil was flat, the GBP strengthened against the USD, and gold gave up some recent gains.
US: Micro Mattered More than Macro
Simplistically, there are two primary drivers to the performance of equity markets. First, the big picture macro releases like GDP economic growth, jobs, monetary policy and inflationary data, and then there is the small company-level stuff like earnings growth, profits, dividends and buybacks. Last week, we got some bad macro news that spooked the markets during Thursday trading. Then, after the bell, we got strong earnings results from two of the big tech, Microsoft and Alphabet, that turned sentiment on a dime, such that investors were willing to overlook the poor economic data and focus instead on a much more promising outlook for corporate earnings in the future, sending all the US indices strongly up on the week.
Last week’s economic releases were a double whammy. We got the worst of both worlds with data that showed precisely what investors didn’t want to hear—a sharp US economic slowdown and stubborn inflation. Gross Domestic Product increased at a 1.6% annualised rate, trailing all forecasts. And a closely watched measure of underlying inflation, first quarter PCE, advanced at a greater-than-expected 3.7% clip.
Now, for a while, any regular readers of this weekly column will have heard me bang on about the resilience of the US economy, so I must confess to being mighty surprised at the data. However, further digging into the release suggests an economy on the upswing; growth is picking up in those sectors that reflect improved confidence in the economy moving forward. The downswing in inventory and a sharp slowdown in government spending that dragged the data lower are not critical determinants of the economy moving ahead, only of the data measuring growth in Q1.
In addition, the release is just the first estimate at the real level, and the actual growth rate is likely to be higher when we get further revisions. I was pleased to see US Treasury Secretary Janet Yellen confirm this fact when she told Reuters on Thursday that “US economic growth was likely stronger than suggested by the weaker quarterly data”. Let’s hope so, as I think that is the prerequisite to the more robust corporate earnings that excited markets the following day.
The more significant news was the quarterly core PCE inflation, which came in at 3.7%, as service inflation rose more than 5%. It certainly spooked the bond markets with all eyes then turned toward the detailed March PCE report that came out the following day. The so-called Core Personal Consumption Expenditures Price Index, which strips out the volatile food and energy components, increased 0.3% from the prior month. Whilst still concerning, investors had been braced for worse, so there was some relief in the bond markets as yields eased a little on the news.
Regardless, both the GDP and inflation data cannot be considered good news, and a week without any microdata would have undoubtedly led to a fall in share prices and a rise in bond yields. But Alphabet (Google) crushed sales estimates and announced a dividend. Its fellow mega-cap Microsoft also beat forecasts, lifted by corporate demand for the software maker’s cloud and artificial intelligence offerings. Both prints indicate that the innovation economy continues to benefit from heightened corporate spending and a strong consumer, and that was just the opportunity the Bulls had been looking for to send the market back up. Perhaps this is where art diverges from science, but to me, it certainly ‘feels’ as if this market wants to go higher and is looking for any excuse to put a positive spin on the news.
That thesis will be rechallenged this week as we hear from Apple, Amazon and an avalanche of other companies. We also get the latest jobs numbers and the May update from the Fed, which may shed some light on how many rate cuts—if any—we might expect this year. Hold on to your horses; it’s likely to be a volatile one.
UK Macro and Micro Update
With so much interesting stuff to report on within the US last week, I was tempted to leave this week’s report as just a US-centric one, but I felt that would be an injustice for the UK, which did, after all, finally blast through the 8,000 level. I have been championing the case for the UK, which may not offer the same blistering earnings growth as its US counterparts but is still home to some unloved, cheap, quality companies that provide attractive entry points for the contrarian investor.
Last week, we got some more good news. Looking at the macro first, the UK economy’s recovery from recession unexpectedly gathered pace at the start of the second quarter as private-sector firms reported the strongest growth in almost a year. S&P Global’s Purchasing Managers’ Index rose to a stronger-than-expected 54 in April, an 11-month high and a jump from 52.8 the previous month.
Under the radar, a significant development has been unfolding in the market. The level of M&A activity in listed equities has seen a dramatic surge this year. Last week, mining giant BHP Group made a major announcement, revealing its intention to acquire its competitor Anglo American Plc. The primary aim of this move is to bolster its copper production capabilities. Such high-profile deals not only generate buzz but also open up new investment opportunities.
Following record highs for the FTSE 100 and a shift by investors from growth to value stocks, it’s conceivable that this might herald the beginning of a more prosperous period for the UK market. The FTSE 350 is undervalued trading at a forward price-to-earnings ratio of 11.6 times, a 35% discount compared to its global developed market counterparts. Then we consider sentiment: in March, fund managers were more underweight in the UK than in any other category, but by April, the UK moved up to being the second-most underweight category. Moving from last to second last is still progress, and if the FTSE 100 keeps pushing higher and the M&A keeps flowing, it will grab the attention of global investors who must be looking for options in the highly valued US. We shall see, but don’t rule out the possibility of the UK finishing the year with better returns than many of the more richly valued markets.
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