Markets remain calm after strong US jobs data
There was an uncanny (possibly eerie?) calm in the major Western equity markets last week with the US, UK and Europe all limping higher with modest gains. Not so out East, as we saw a marked divergence between India (up over 3%) against China and Japan both suffering heavy losses of more than 3%. Oil managed to recover on Friday from sharp intra-week falls to cling above $70. Gold briefly set an all-time high above $2100 before retreating to roughly where it started a few days previously.
Bond yields were relatively stable with the UK 10-year yield down about 10 basis points, and despite stronger US jobs numbers than expected, the 10-year yield on US treasuries only drifted up about 2bps last week.
Let’s see if the calm can last till year end?
US Macro
Arguably the big US Jobs report – non-farm payrolls – has now become the most important data point for global investors, as it provides a touch point on how the world’s biggest economy is fairing and thereby enables assessment of the likely path of Federal Reserve monetary policy. ‘Red hot’ jobs would surely mean the Fed are likely to keep rates higher for longer and conversely, signs of increasing weakness, will bring forward the widely anticipated rate cuts we are looking for next year. In the event, market reaction to the numbers was more muted than I would have predicted, as non-farm payrolls at 199,000 for November were a bit higher, wage growth a bit stronger at +0.4%, and the unemployment rate a bit lower than expected at 3.7%.
The market’s initial reaction was one of (slight) disappointment (yields up/equities down). On reflection, investors seemed to conclude that there were some one-off factors at play, such as the return of striking auto workers and that actually, the numbers were still consistent with an economy on course for a ‘soft landing’. News on consumer sentiment from the University of Michigan reinforced the rosy narrative as expectations for inflation tumbled in December amid declining energy prices. When Fed officials meet later this week, they’ll almost certainly leave the central bank’s benchmark interest rate unchanged. Despite the lack of action, what policymakers say or don’t say, could still move markets, regardless of the encouraging news on inflation. I expect J Powell will push back hard on the narrative forming in markets, that rate cuts could come as soon as March. It will be interesting to see if investors are swayed by the hawkish tone or choose once more to call the Fed’s bluff! The upshot of that meeting will probably dictate whether we get an extension of the Santa Rally into year-end or a sharp reversion.
UK Macro
Expect a similar story from the Bank of England, with hawkish noises from Andrew Bailey but no change in interest rates. I have been surprised by the resilience of the UK economy all year, as higher interest rates are taking much longer to percolate through the economy than I expected. I guess, greater COVID savings and strong wage growth has kept consumer spirits up, and for those households that haven’t had to refix their mortgage yet, spending hasn’t been a problem with energy price caps also helping. That may all be about to change, but I suspect rather than a sharp fall into recession, the path of economic growth is probably going to be much shallower, potentially avoiding a recession altogether. The other side of the argument is that UK inflation could prove stickier than in the US or Europe, I am therefore more inclined to believe the BoE, over other central banks, when they say they will keep interest rates at the current levels higher for longer.
This chart shows market expectations for the path in interest rates (dotted line) and also the predicted trajectory for the UK, US and Europe (solid line). Essentially the UK will be the last to start cutting late in 2024, but then look to catch up with Fed levels, with rates around 3% by the end of 2025. Clearly, blessed relief for the property sector and those looking to refix a mortgage. Obviously, much is going to depend on the data going forward and we have our own labour market data released next week, with wage growth expected to ease down to a still scary 7.6% and month-on-month GDP data which may register a small drop for October.
But if we can muddle through with a shallow recession and with the prospects of rate cuts late in the year, I think that would be broadly positive for gilts, allowing yields to come down and probably supportive enough for equities to make positive price returns, in addition to the healthy dividends we get from UK equities. In fact, this forecast might provide some Christmas cheer:–
‘for risky assets, we expect some near-term pain given how rosy market pricing looks, but as easing cycles kick off, economic activity picks up, we forecast the FTSE 100 to surge to 8,880 and 10,000 by end-2024 and end-2025 respectively’.
Capital Economics
The ‘Coats Group Canary’
There was a strong pop in the share price of the FTSE Mid 250 company Coats Group PLC last week, after the company decided to switch off pension deficit repair payments, reaching an agreement with the trustee of its UK pension scheme. Coats Group, (Coats Viyella as it was once known) is now a thread manufacturer and like many other long-established UK companies, used to offer a Defined Benefit (DB) pension scheme to its employees. In March 2021, Coats found that it had a £193 million deficit in its pension fund, planning to pay £21 million annually until the end of 2028 to cover this. However, the deficit has now been reduced, allowing Coats to pay a one-time £10 million to create a surplus in the pension scheme. This means they can stop the annual £21 million payments five years early.
What’s that got to do with the price of fish? Well, this change isn’t unique to Coats. Many private sector DB pension funds in the UK are now in surplus. The Pension Protection Fund’s Purple Book shows over 5,000 DB schemes moved from a £483.4 billion deficit in March 2022 to a £358.9bn billion surplus in March 2023! This is mainly due to rising interest rates, and more specifically higher gilt yields, which lower the future liabilities of these funds. The decrease in liabilities is greater than the decrease in assets, greatly benefiting these schemes. In fact, The Pension Protection Fund estimates that annual pension recovery payments will drop by 88% over the next decade. This could not only enhance the earnings of UK companies but also help boost investment and productivity, as companies can focus more on current growth instead of funding future pension liabilities. Could this be a catalyst for the turnaround in the relative performance of the FTSE 250 and UK equities in general?
India vs China
For the second week running, India has outperformed China by more than 5%. Since February a relative ‘crocodile jaw’ has opened up in the returns from these two Emerging Market heavyweights and I find the chart astonishing in its symmetry!
It shows the relative performance of both India and China relative to the flat line of the Emerging Market Index, with the two index goliaths offering almost a perfect mirror image of themselves.
Now there are some justifiable reasons for some difference in returns, not least prospective higher growth rates and favourable demographics in India’s favour, but I can’t help but think this might have moved a bit too far a bit too fast, and I would likely expect some ‘mean reversion’ soon.
Down more than 12% this year, the MSCI China Index is trading at roughly 9 times its 12-month forward earnings; less than half the level for the MSCI India Index… The last time the valuation gap was this wide, was during October 2022 and in March 2022, Chinese equities outperformed their South Asian rivals over the following months, with Beijing’s policy moves acting as a key catalyst. A similar narrative could occur this time as I still expect more action from the Chinese authorities, possibly before year end. Much of the moves have been because of a near wholesale exodus of foreign investors from Chinese equities, with money naturally switching to India as a result. But there is a growing murmuring from many money managers (Soc Gen, Franklin Templeton, Fidelity, Invesco, UBS) and quantitative strategists (Jefferies) that the time is nearing for investors to look again to the land of dragons…maybe China might surprise us all next year.
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