Archive for April, 2015

Under Pressure

The FTSE 100 index hit a new high only a few days ago, closing above 7100 for the first time on Monday. Risk assets have generally had a strong year. There has not even been any visible excitement over the prospect of a secessionist wipeout in Scotland or any of the other shocks which have been postulated by Westminster pundits in the run up to the election next week. But tensions rose yesterday when the US GDP print for Q1 came out almost flat against expectations for a lacklustre but positive +1%. Markets took the number badly. Was it a sign that the global economic motor is slowing – yet again? Has the pricing of risk got ahead of itself?

There have undeniably been signs of pressure on the US. One agent of the weak growth number was a decline in net exports: by the end of March the dollar had strengthened by more than 20% on a trade weighted basis over a period of nine months. Currency strength was expected to weigh on corporate earnings too. As earnings season opened earlier in the month forecasts were for a 6% drop in EPS for the S&P 500 index relative to Q1 2014. And it is not just the US of course. China has come under scrutiny for growth outcomes well below the 9% averaged by the economy over the past 20 years. Towards the middle of the month data for retail sales and industrial production disappointed the market consensus, and there are signs that the manufacturing sector has fallen back into slight contraction.

After the run markets have had so far and the experience of most of the last few years it is perhaps natural to expect a period of retrenchment, if not a modest sell off, over the next little while. If the economy is indeed under pressure then this could catalyse such an event as well as justifying it. The picture is more mixed than it might appear, however. From the US we had stronger than anticipated employment data out only this afternoon, with initial jobless claims down to 262,000 – within reach of the previous low of 259,000 recorded in April 2000. And corporate earnings have not collapsed as feared: with two thirds of the index’s members now having reported, S&P 500 EPS are up by 3% over the previous year and the forecast for the whole index this season has come up to -1%. In China too, foreign investment growth has continued its solid run, service sector activity has accelerated and some progress has been made on structural reform (an area which is often overlooked).

Furthermore, the world’s glass is half full as well as half empty. Given the size of its markets, power of its central bank and global economic influence it is inevitable that the US should occupy much of our thoughts. While the titan across the Atlantic has been struggling a little, however, the weary colossus of Europe has begun to show improving signs of life. Similarly, while the growth rate of the world’s most populous country has fallen back it has been overtaken by stronger than expected economic expansion in the second most populous: India, where GDP growth for 2015 was projected to reach 5.5% at the beginning of the year is now forecast to see 7.4% (using Bloomberg consensus data). This speaks to the continued variability of outcomes identified as a market theme by this blog for the current calendar year, and it should also make us wary of interpreting particular data as evidence of general gloom.

Before leaving the subject of growth behind it is worth looking at the behaviour of the oil price over recent weeks. The collapse in crude was the most significant market event of the last few months of 2014. It generated pronounced volatility in equity markets and its disinflationary impact thrust bond markets higher – especially in Europe, where yields have reached record lows. The price stabilized over Q1 (a cornerstone of the rallies we have seen). Indeed it now appears to have bottomed, with both the Brent and West Texas Intermediate futures contracts up over 20% this month.  This has had effects which few might have predicted back in December, such as helping the Russian stock market become one of the world’s top performers over the year to date.

It also means a bottom for oil-driven disinflation, though it is likely to be a few months before this washes through to annual CPI numbers. At the same time, that US labour market data reminds us that underlying pricing pressures will have been gathering strength. Only this morning the Employment Cost Index rose by its highest annual rate – 2.6% – since 2008. Looking forward, it is perhaps here that we might find genuine reason for concern on the macro front, and another source of variability between markets as the year plays out.

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30/04/2015 at 5:27 pm


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