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Feedback from the Global Asset Allocation Committee
Last week our Global Asset Allocation Committee (GAAC) met following the Global Investment Strategy Group meeting the week before. There were no significant changes, and the GAAC remains underweight global and US equities, and overweight global and US fixed income.
Global equities continue to screen as expensive, largely due to the US. US earnings are still above trend, with a multiple that is above trend too. We expect that earnings growth will slow and there is a material risk that it coincides with a derating.
We see more opportunities elsewhere. Japanese equities for example are experiencing a trend change in governance with GDP growth having picked up too. Broad-based inflation pressures in Japan (more below) should help company toplines, while the recent rate increase has been small and further increases are likely to be marginal. Shifts to consensus remain positive, which stands out relative to the rest of the globe, and domestic investors still have relatively low allocations to equity.
European equities also screen as cheap, partly offsetting the risk from earnings being well above the trend. European economic data seem to have turned, with a record trade surplus recently recorded. We have shifted our global mid and small-cap exposure to neutral.
US fixed income volatility has been in decline and we expect it will continue to decline as the Fed tapers its programme of quantitative tightening, which should lead to lower yields. We also expect yields to compress as the US economy slows. We expect the correlation between global fixed income and equities to decline over the year ahead.
The US leading indicator is up month-on-month
After 23 consecutive monthly declines, the US leading indicator was up month-on-month in February. Most of the increase was due to the rally in the S&P 500 and an increase in hours worked.
The leading indicator is now down 6% year-on-year after bottoming at -8.2% in April last year. A decline of this scale without a recession is unprecedented.
While the leading indicator has turned, the US is not completely out of the woods just yet. Consumer expectations are still very depressed and default rates are still inching up.
2023 also saw an unusually large percentage of emergency withdrawals from defined contribution plans, which is consistent with credit card charge-off rates ramping up.
Risks to US growth ahead
Last week we indicated that there are several risks to US GDP growth over the coming years. Growth in the US is expected to slow from 2.5% in 2023 to 2.1% in 2024 and 1.7% in 2025. Debt-to-GDP in the US is near all-time highs, leading one to question the extent to which the US government will be able to provide fiscal support should the economy slow.
US government expenditure is still running well above receipts. Outside of the pandemic, the difference is at its highest since the Global Financial Crisis. The White House is budgeting for the deficit to gradually decline in nominal terms over the coming few years – in other words, receipts growth is expected to outpace expenditure growth.
Government interest expense is already over 3% of GDP – presumably crowding out other expenses. We expect the interest expense to remain elevated for the foreseeable future.
There is a strong link between US nominal GDP growth and US debt-to-GDP three years later. High debt levels are typically associated with lower GDP growth three years later.
If high debt levels are associated with weaker growth, and weaker growth is typically associated with weak earnings (as highlighted last week), this is another reason to expect lower earnings growth in the US over the year ahead.
Growth in corporate tax receipts is likely to be low, putting pressure on aggregate government receipts.
The relationship between debt-to-GDP and bond market performance (three years later) is not as clear, but a higher debt-to-GDP ratio is typically associated with weak bond market returns.
US inflation expectations pick up
Post the recent uptick in the oil price, US inflation expectations have increased. The two-year inflation swap is now at 2.5%, up from below 2.1% at the end of last year.
FOMC keeps rates unchanged
As widely expected, the Federal Open Markets Committee (FOMC) kept rates unchanged last week. There were a few interesting developments though. Fed officials now expect higher growth, lower unemployment and higher core inflation this year than at the December meeting. Nonetheless, there was a dovish tone as Fed chief Jerome Powell indicated that tapering of quantitative tightening is not far off and the Fed still expects three rate cuts this year.
Total social finance growth in China slows
Chinese total social finance in Feb came in well below expectations. The net result is a year-on-year decline in the three-month average total social finance number (-4%), down from +17% year-on-year growth in January. The decline suggests that the rebound in Chinese activity referred to below may not last more than a few months. We’ll need to keep a close eye on this series over the coming few months.
Chinese data picking up
Chinese industrial production was up 7% year-on-year in the first two months of the year, well above the consensus forecast of +5.2%. Retail sales were a slight miss but still up strongly at +5.5%.
Investor FOMO is at near record levels
The difference between the price of two-month 10% out-of-the-money calls and puts is the lowest it has been since 2008. Typically, out-of-the-money puts are more expensive than out-of-the-money calls as investors pay up for protections against short-term downside risk. The price is now close to parity – presumably as a result of investors fearing missing out on a further rally.
Record-breaking trade surplus in Europe
The combination of a fall in energy prices and an increase in exports has seen Europe’s monthly trade surplus reach a record high of +€28bn in January. It seems the terms of trade shock stemming from Russia’s invasion of Ukraine has now been unwound. One obstacle to euro strength out of the way.
The Bank of Japan hikes
Last week the Bank of Japan increased rates marginally from -0.1% to a range of 0% to 0.1%, and shifted away from yield curve control. The underlying reason is increasing confidence that inflation will sustainably meet the central bank target of 2%.
SA inflation surprises on the upside
South African consumer inflation was 5.6% in February, mildly above the consensus forecast of 5.5% and up from 5.3% in January. The month-on-month increase was sizeable, at 1.2%, ensuring that inflation will be at levels the Reserve Bank considers uncomfortable for the near future. By our estimate, we’re due another 42c/litre fuel price increase at the beginning of next month. The net result is that we now expect inflation in South Africa to touch the top end of the band from June to August before dropping to near 5% by September.
Listen to previous episodes
Macro Monday Ep21: US data paints a murky picture of the jobs market
Investec Wealth & Investment Chief Investment Strategist Chris Holdsworth looks at the latest nonfarm payroll data, global activity, inflation in Europe and China and SA’s GDP print.
Macro Monday Ep20: Key price indicators in the US
Investec Wealth & Investment Chief Investment Strategist Chris Holdsworth discusses why a key price indicator was probably not much of a concern or surprise for the Fed.
Macro Monday Ep19: Indications of a slowdown in the US
Investec Wealth & Investment Chief Investment Strategist Chris Holdsworth discusses the disconnect between US GDP data, the leading indicator and other data series – pointing to a slowdown, though a recession is less likely.
Macro Monday Ep18: Global inflation is falling
Investec Wealth & Investment Chief Investment Strategist Chris Holdsworth looks at global Inflation data and what it means for monetary policy, weak data coming out of the US for January, and is South Africa in recession.
Macro Monday Ep17: Global economic activity picks up
Investec Wealth & Investment Chief Investment Strategist Chris Holdsworth discusses high frequency economic data which suggests there’s an uptick in economic activity across the globe so far at the beginning of the year, inflation in China and the fiscal position in South Africa.