Pipe lines in desert

30 Jan 2023

This Week: Why the rest of the world is starting to outperform the US

Chris Holdsworth

Chris Holdsworth

Chief Investment Strategist, Investec Wealth & Investment

A weekly macroeconomic overview from Investec Wealth & Investment's chief investment strategist, Chris Holdsworth.

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US money supply in decline, PPI falls around the world, US GDP surprises on the upside

US money supply has declined over the past 12 months. US money supply growth continues to slow and is now negative over one, three, six and 12 months.

Negative money supply growth over 12m is not common and is very different from what we are seeing elsewhere. The money supply impetus behind growth and inflation is well behind us.

PPI inflation continues to fall across the globe, except in Japan. German PPI inflation dropped from 28% to 22% in December and has more than halved since August last year. UK PPI inflation is now at 16.5%, down from 25% in June last year. Chinese PPI inflation is at -0.7% and US PPI inflation has dropped to 6.2%, down from 12% in March last year.

Japan is a notable exception, with Japanese PPI inflation sticking to around 10%.

Unlike most of the rest of the globe, Japanese CPI inflation increased again in December to 4%, raising the prospect that Japan will shortly adjust its ultra-loose monetary policy.

US GDP surprises on the upside, again. US GDP growth in Q4 was 2.9% vs the consensus forecast of 2.6%. It was the second beat in a row.

Residential investment continued to detract from GDP and it is hard to see how that will turn soon. A large chunk of growth in Q4 was due to an inventory rebuild.

Inventories are now largely rebuilt, so we shouldn’t pencil in a similar boost to growth over the coming year.

Real final sales to private domestic purchasers were marginally positive in the quarter – there has been a steep slowdown in private domestic consumption over the past year.

Separately, the US leading indicator was down for the 10th month in a row, which is another indication that a recession in the US is on the cards. 

Another reason not to get excited by US equities, US housing market slows further, core inflation indicator falls further

Another reason to not get too excited about US equities. The strength in the US labour market over the past few months has been somewhat at odds with a number of signs of economic slowdown. The unemployment rate is very much at the low end of the spectrum at 3.6%.

Low unemployment also typically coincides with weak US equity returns. Presumably, this is a result of low unemployment coinciding with the back end of the economic cycle. We would need to see the US at the start of the next cycle – and with much higher unemployment – to expect high real returns even before accounting for the current extended valuation. 

The US housing market continues to roll over. US home sales were down 36% year-on-year in December – the biggest decline on record.

The good news is mortgage rates have rolled over but they are still around 6%.

And while the backlog has started to clear, there is still a near-record number of homes currently under construction.  

Mortgage applications have picked up but are still very low.

According to Redfin data, the median home price sale is down around 12% off the peak in the middle of last year.

US core PCE inflation slows but the Fed won’t be happy yet.  US core PCE inflation came in at 4.4% in December, in line with the consensus forecast and down from 4.7% last month.

While the decline in core PCE inflation is encouraging, annualised six-month core PCE inflation is still well above the Fed’s target, at 3.7%.

Annualised three-month core PCE inflation is still high too at 2.9%, even though it has come in materially. We’ll likely need a few readings closer to 2% to see the Fed relax on the inflation front.

Even if month-on-month core PCE inflation were to be in line with the 20-year median going forward, we still have a core PCE inflation reading above 2.5% in June. 

European gas prices fall further, the rest of the world starts to outperform the US, tepid earnings season so far, MPC hikes by 25bps, energy transition ramps up

European gas prices continue to decline. Energy prices in Europe continue to collapse, which has led to the first upgrade for EU growth forecasts in over a year.

The rest of the world (that is, apart from the US) starts to outperform. The past decade has been characterised by consistent outperformance of the US equity market relative to the rest of the globe.  However, that has started to reverse, coinciding with a degree of US dollar weakness. We expect equities in the rest of the world to continue to outperform over the coming year.

It’s been a tepid earnings season in the US. So far, 143 companies have reported Q4 earnings. Of those, 68% have beaten on the upside but the average beat has been just 1.6%. Earnings are expected to be down 3% year-on-year in Q4,  down 7% if energy is excluded.

A few observations about the earnings:

·         The dispersion of surprises has been large.

·         Companies that have beaten expectations have gone up on the day.

·         Earnings forecasts are still optimistic given the macro backdrop.

·         Operating margins have declined across the board, and have now declined for four quarters in a row.

MPC hikes by 25bps. Last week the MPC raised the repo rate by 25bps (0.25 of a percentage point) vs the consensus forecast of 50bps. The market is now pricing in rates to remain around these levels for around 12 months before the MPC starts to cut.

If the MPC follows that path, and inflation follows the MPC trajectory, the net implication is we will have a very restrictive monetary policy (interest rates well above inflation) by September this year. It is quite likely that we will see a cut from the MPC before then.

Finally, the global energy transition investment is ramping up. Last year saw investment in renewables equal fossil fuel investment for the first time on record. Most of the investment was in renewables and electrified transport, while hydrogen seems to have a long way to go. 



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