Inflation persists, Japan soars
Markets last week
Most markets provided variable and middling returns last week…and then there was Japan! Which had a storming week rising over 6% – more on that market later. I was personally surprised we didn’t see some bigger moves, either on the back of the US/UK air strikes on Yemen or the disappointing US inflation data. Both oil and bond yields didn’t move that much. It feels like investors haven’t made up their minds if this is going to be a good or a bad January. Perhaps the stream of earnings that we are going to get out of the US over the next few weeks will dictate sentiment for the first quarter?
Turn of Japan
Japanese stocks have seen a remarkable surge in early 2024, and that on the back of an already strong 2023. Admittedly for overseas investors, much of that gain has been eaten away by a weaker Yen, although that might change this year when the BoJ finally turns the screws on yield curve control. Somewhat under the radar, the sleepy Japanese corporate sector has been undergoing significant reform and government initiatives like the NISA program (based on our own ISA scheme) are having an effect. The capital reforms have been particularly transformative, leading to improved returns on equity, higher dividend yields, and increased stock buybacks. Japanese companies are streamlining by shedding non-core activities and enhancing cost management, balance sheet utilisation, and governance.
Chinese investors are notably contributing to the market surge, heavily investing in Japanese stock exchange-traded funds (ETFs). Furthermore, the introduction and recent enhancements of tax-free accounts in Japan have significantly fuelled this rally. Market strategists expect it to continue, with large-cap, high-dividend, and small cap growth stocks especially attracting buyers, particularly from overseas and through the tax-exempt savings accounts. Without question a lot of money that would ordinarily have flowed into China is findings its way into Japan and India for that matter. Something Chinese authorities will be doing their best to reverse, now that the equity market performance, or lack of it, has caught the attention of Xi Jinping.
Last week, we got some good news from our own economy as the UK’s real GDP rebound of 0.3% in November 2023 suggests the economy might have avoided a recession in 2023. This uptick, coupled with falling mortgage rates and the potential for tax cuts due to lower market interest rates, raises hopes of us averting a recession in 2024 as well. The GDP growth was driven by two main factors: a recovery in services output (particularly in health, transport and entertainment sectors), and a boost in retail activity from early Black Friday discounts.
Despite these gains, consumer-facing services output and construction activity showed signs of struggle, indicating that we still have plenty of economic challenges ahead. However, the overall increase in November, including a rise in manufacturing output, suggests that a broad-based economic rebound might have started. Although we are a long way from being out of the woods, and if GDP declined in December, the government might still face the embarrassment of the UK suffering a mild technical recession. But earlier PMI data hinted at a slight improvement in December, so Sunak might escape the bad headlines for the moment.
Even if a recession is avoided, the economy likely just stagnated in late 2023, with a similar trend expected in early 2024. Nonetheless, and probably too late to save the Conservatives, things should be improving by the second half of 2024, potentially stronger and earlier than expected due to recent reductions in market interest rates.
US: CPI Inflation numbers higher than expected, PPI Lower
The latest update from the Bureau of Labor Statistics indicates that America’s disinflation is occurring more slowly than expected. Both headline and core consumer price index (CPI) figures showed less reduction in inflation than anticipated. Even the Fed’s preferred measure; ‘Supercore’ inflation (which covers the services sector, excluding shelter) disappointed.
The recent report dampens hopes of a swift return to the Fed’s 2% inflation target, suggesting there may be challenges ahead on the last mile of disinflation. Worryingly, while supply chain normalisation has been a deflationary factor, it may fade, but thankfully shelter inflation is still cooling. Adding to the confusion (in a good way), was Friday’s wholesale inflation data (PPI). Wholesale prices unexpectedly declined in December with the PPI index down 0.1% for the month and ended 2023, only up 1% from a year ago. Economists surveyed by Dow Jones had been looking for a monthly gain of 0.1%. Putting that in context and showing just how far we have come from the dark days; the index had surged 6.4% in 2022. I think distilling the abundant information we have, it suggests a more complex disinflation process in 2024, which is another way of saying that investor sentiment may yet swing fairly wildly, if disappointed by the pace of rate cuts this year.
I was, however, pleased with the reaction of financial markets to these events. The CPI data could have seriously derailed markets if investors were of a more bearish disposition. After the initial shock, when equities fell and yields spiked higher, everything calmed down and markets finished the week pretty much as they were before the CPI release. The immediate challenge that investors are slowly processing, is that we face the likelihood of policy disappointment.
It is fair to say that investors have probably got over excited at the pace and timing of rate cuts next year. Yes, they are coming, but these will not be as thick and fast as hoped for. Once investors adjust to this new reality, I think the bull market in equities can renew its upward march as the simple global macro-outlook – moderate deceleration, gradual disinflation and lower interest rates – remains intact, and my own hunch is that growth will surprise to the upside this year. How long it takes for investors to get over the disappointment of a more subdued rate cut environment remains to be seen… but I think markets might even resume their upward path if we get a strong Q1 earnings season.
Speaking of earnings, they kicked off last week with the Big Banks; JPMorgan, Bank of America, Wells Fargo and Citigroup together earned $104 billion in 2023, up 11% from a year earlier. Each of the four banks posted one-time charges, dragging down quarterly profits as they collectively set aside almost $9 billion to pay a special Federal Deposit Insurance Corp fee, related to the failures of Silicon Valley Bank and Signature Bank.
From the CEO and CFO debriefs it would appear that American consumers and businesses remained on surprisingly solid financial footing last year. Executives pointed to the labour market as the key to consumer strength and the fact that wage gains outpaced inflation this past summer for the first time in two years. But there are clear signs that high costs have started to leave more consumers overstretched, conversely households that built up savings during the pandemic are spending.
As for earnings from the broad S&P 500, over to FactSet, who keep an Earnings Scorecard: Top of Form For Q4 2023 (with 6% of S&P 500 companies reporting actual results), 76% of S&P 500 companies have reported a positive Earnings Per Share surprise and 55% of S&P 500 companies have reported a positive revenue surprise.
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