The US economy runs hot

US growth is running hot

There is increasing evidence that the US economy is reaccelerating. The September US flash PMI reading came out at 58, up from 56 in August and the highest reading since July 2021. S&P Global mentioned that 58 is consistent with 5% GDP growth. The improvement came from both manufacturing and services and was accompanied by higher price pressures.

The Atlanta Fed GDPNow estimate is running at 5% too. The Bloomberg consensus forecast for third-quarter growth is still at 2.8%. We can expect some material upgrades to growth forecasts over the next week or so, but even so, a monster beat may be on the way. It is quite remarkable that the US economy appears to be growing at 5% while the US benchmark crude oil price is trading above $90/barrel and diesel prices are at all-time highs. One wonders what it would look like if oil retraces back to $60/barrel.

In contrast, European growth appears to be running at 0%, and leading indicators suggest Chinese growth is likely to be soft as well.

When US growth outperforms the rest of the world, we would typically expect to see US dollar strength. If the US economy continues to grow at this pace, we will have to revisit our underweight US dollar call. Similarly, sustained growth at this pace allows the US to grow out of its debt problem. It is still early days, but growth at this sort of pace is quite remarkable.

Oil update

One reason oil prices have been relatively contained is the continued weakness in Chinese imports. China has kept its oil purchases in the seaborne market at about 40% below pre-war levels.

Incidentally, the cost of moving oil across the globe has ramped up. Daily rates for very large crude carriers moving oil from the Persian Gulf to Asia have gone from regularly under $100,000 a day to $1.1m a day, according to Javier Blas at Bloomberg. To put that to scale, the cost of shipping crude from the Persian Gulf to China is about $22/barrel. The ramp-up in transit costs from the Persian Gulf has caused oil shipping costs worldwide to shoot up.

Shipping costs in general have risen. Even though oil prices have been relatively contained, they will still be putting upward pressure on inflation. In addition, transit costs are likely to be another channel pushing up inflation.

Meanwhile, US core personal consumption expenditure (PCE) inflation forecasts have ticked up. Core PCE inflation is a key indicator that the US Federal Reserve (Fed) monitors.

It’s a similar story with European inflation forecasts. Transit costs are not the only driver, but they are an important one and we can expect central banks to be on the back foot for some time. 

Fed hikes, along with other central banks

Over the past two weeks, we have seen rate hikes by the Fed, the Bank of Japan, and the European Central Bank (ECB). More is expected to come.

Global bond yields have moved up as central bank inflation expectations have shifted. The US 30-year bond yield is at the highest level in around 20 years.

The days around speeches by Federal Open Market Committee (FOMC) board members and nonfarm payrolls releases have accounted for 90% of the rise in the US long bond yield over the past six years.

It has been a difficult few years for US bond investors. The Bloomberg US Treasuries total return basket is still 8% down from its July 2020 value. In real terms, US bond investors are down 30% since July 2020.

Equities are still rallying, though

Despite higher bond yields, the Nasdaq and S&P 500 are trading at record highs.

And most developed markets are trading at a premium to their 15-year median forward price-to-earnings ratios. Higher rates haven’t yet led to a derating – suggesting that stronger growth and earnings expectations have so far offset valuation pressure from higher discount rates.

SA Reserve Bank hikes

Last week, the Monetary Policy Committee (MPC) raised rates by a quarter of a percentage point (25 bps), as expected. The MPC materially raised its inflation forecasts and warned that it will ‘act as needed’ to bring inflation to 3%. As with the rest of the world, we can expect the MPC to continue pushing rates higher in the near term. 

Keeping an eye on issuance

For much of the past two decades, buybacks and merger and acquisition activity reduced the net supply of listed equity, providing a technical tailwind to existing shareholders. Net issuance has now turned positive. 

Documenting 125 years of market performance

An interesting piece of work was recently published by the CFA Institute (‘Exponential Wealth: Centuries of Stock and Bond Returns’ by Roger G Ibbotson and Laurence B Siegel). Resource-rich countries and the US have had the best-performing equity indices over the past 125 years. Wars took a toll on the worst-performing countries. South Africa has been the best-performing stock market over the past 125 years in real local-currency terms and is trading at a forward price-to-earnings multiple of around 10 times.

The US had the third-smallest annual decline (and one of the best years) among the countries tracked. It is a similar story for Australia. The US and Australia have exhibited unusually defensive long-run equity return profiles.

Sweden, Switzerland and South Africa have provided the best bond returns over the past 125 years.