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Market Matters 7 May 2024

Going into the US Jobs data release on Friday, investors of a bearish disposition had been sharpening their knives, seeking confirmation that the Fed rates policy was failing to slow the economy. Over the last few weeks, stubbornly high inflation data had shifted sentiment toward a glass-half-empty disposition, with many market commentators giving up on the prospect of rate cuts this year in the US. Bond yields had turned higher, equity indices had been heading lower, and credit & crypto markets had sold off. But, as so often over the last six months, the bears were left nursing trading losses as the jobs report delivered an outcome the Fed must have loved, and US equity markets closed up sharply on the day and modestly for the week. 

After reviewing the performance of the other global markets, I noticed that China and Hong Kong enjoyed another table-topping weekly performance. Those investors (not us) that have given up on these Asian markets must be starting to suffer from FOMO, which may yet drag them back in and provide fresh impetus. In another move that might register on the radar of global investors, the UK marched further up into unchartered territory, with the FTSE 100 closing above 8,200. Oil continued its retreat without any new conflict in the Middle East, and gold drifted lower but seemed to consolidate above 2,300. Only the European indices spoilt the party, finishing the week a little lower as Novo Nordisk weighed on the index despite delivering an earnings beat as sales growth from its weight loss drugs showed no sign of slowing up.

According to the Bureau of Labor Statistics, nonfarm payrolls increased by 175,000 last month, marking the smallest rise in six months. Subsequent data revealed that business activity in the service sector—the largest segment of the economy—unexpectedly declined to the lowest point in four years.

 The data, softer than anticipated but not indicative of a labour market downturn, coupled with a slowdown in wage increases, has eased investors’ concerns about ‘stagflation’ or a recession. Instead, this latest employment report supports the view of a gradually decelerating economy, potentially allowing a data-driven Federal Reserve to consider easing policies as early as September.

Following the report, Treasury two-year yields (particularly sensitive to near-term Fed actions) fell by seven basis points to 4.81%. That will come as a relief, as from January, the two-year yield had been rising steadily back to levels seen last summer. This jobs data report has seen interest rate swap traders rapidly revise their positions, and they are now predicting about 50 basis points of policy easing this year, which should mean two rate cuts. With bond and equity prices up on the news, it was no surprise that the Dollar experienced its worst week since March.

Rather than fretting over a more significant slowdown that might burden Corporate America, investors are now more hopeful that the latest data could alleviate some of the stresses associated with the ‘higher for longer policy’ narrative. Crucially, the milder-than-expected payroll figures suggest the economy lacks the overheating that could drive persistent high inflation. This jobs report was just what the Fed was after, and it reintroduced the ‘Goldilocks equation’. A rate cut, albeit not until the year’s second half, is now very much back in the equation.

No wonder the equity and bond markets liked the Friday job numbers, and technology again led the charge. Investors had gone into the release in a good mood, helped by earnings out from Apple on Thursday night that were not as bad as people feared and accompanied by a massive share buyback program. We are now nearing the end of the Q1 numbers, with 80% of S&P 500 companies having reported, and by and large, it is going very well compared to expectations. The percentage of S&P 500 companies reporting positive earnings surprises (77%) and the magnitude of earnings surprises are above their 10-year averages.

The revenue growth rate for the first quarter is a little above 4%, marking the 14th consecutive quarter of revenue growth for the index. In fact, despite the recent bounce back in the market, the forward 12-month P/E ratio has fallen back below 20 and currently sits at 19.9, much more reasonable in the context of an economy still chugging away and rate cuts brought back into the equation.

Chinese assets are receiving renewed interest as signs of earnings recovery, supportive government policies, and attractive valuations draw investors. The momentum was further boosted by a recent Politburo meeting, where China’s leaders committed to addressing the ongoing housing crisis and suggested potential rate cuts could be on the horizon. At this meeting, chaired by President Xi Jinping, it was decided to explore solutions for unsold housing stock and to flexibly use economic tools to reduce overall borrowing costs. Notably, this was the first mention of adjusting interest rates and the reserve requirement ratio since April 2020, reflecting a proactive stance to support economic recovery from the pandemic’s initial impacts.

This news comes in the wake of China’s economy expanding by 5.3% in the first quarter, surpassing economists’ expectations and reinforcing confidence in the government’s target of approximately 5% annual GDP growth. However, a slowdown in March prompted calls for additional measures to sustain this growth. Investment in Chinese and Hong Kong stocks is rising among foreign funds, marking a third month of increased holdings in mainland shares—the longest streak in a year.

Yet, the great Chinese rebound has threatened before, only to disappoint, so we should treat it cautiously. However, the longer it continues, the more likely it will become a self-fulfilling prophecy, as it will drag back in underweight investors. Looking forward, the continuation of this recovery will depend heavily on consumer spending evidence from the May holiday period. There is reason for optimism with Chinese tourists travelling abroad in numbers close to pre-pandemic levels and a significant increase in visitors to Hong Kong. Meeting consumption expectations during this period could be crucial to maintain the market rally and alleviate concerns about consumer caution.

Rishi Sunak will likely lead the Conservatives into the next election as Tory rebels dropped their plans for an attempted coup. Now, that isn’t because the Tories did well – they lost nearly half of the local council seats they defended – but they didn’t do even worse, as many had feared. We will stay out of politics here, other than to say the result of the next general election is likely to be irrelevant short term for UK financial markets, as both parties are pro-business and unlikely to differ too significantly in fiscal policy. It is also true that a big Labour victory is probably already priced in and viewed by many as a good thing for economic stability in the immediate future.

There were spots of good news out of the UK last week as Britain’s housing market recovery continued into March, as mortgage approvals rose for a sixth month. Maybe buyers are being lured back into the housing market by a brighter economic outlook and increased affordability with tax cuts, higher wages, and a sharp fall in mortgage rates since last summer. Or prospective buyers are keen to get in before mortgage rates turn upward (I think rates will finish the year lower). And for you monetarists out there, we also had news that a broad measure of money supply M4 had climbed 0.3%, ending a run of falls that coincided with the UK’s mild recession. Taken together, it does fit the narrative of an economy still limping back to life.

Looking ahead to next week, we will get the BoE’s policy decision on May 9th; it is probably too early to get a rate cut, but I think we are nearing that point, and a shift in language might confirm it. We will also get preliminary estimates for GDP, which should confirm the UK economy is out of a technical recession and back on an upward trend.

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