By Jan Faure
Global markets trended lower in February as above-consensus inflation data and robust US employment data raised concerns that the Fed may maintain its aggressive monetary-tightening policy for longer. In the US, the S&P 500 index and NASDAQ Composite declined by 2.6% and 1.1% respectively. In Europe, the Euro Stoxx 50 index added 1.8% (-0.8% in USD) while the UK’s FTSE 100 index increased by 1.3% (-1.0% in USD). In Asia, Japan’s Nikkei 225 index gained 0.4% (-4.4% in USD) while Hong Kong’s Hang Seng index slumped 9.4% (-9.5% in USD).
The US dollar strengthened and treasury yields rose as data showing stubborn inflation and a resilient consumer raised concerns over higher for longer rate hikes by the US Federal Reserve. US CPI data came in above expectations at 6.4% year-on-year in January (consensus estimate 6.2%), slightly below the previous month’s 6.5% print. Core PCE inflation, the Fed’s preferred measure of inflation, rose to 4.7% YoY in January from 4.6% YoY in December. US retail sales, manufacturing production and personal spending data were also comfortably ahead of expectations.
The data came on the back of strong US jobs numbers that has raised the risk of further rate hikes (beyond recent consensus) to stem inflation. US non-farm payrolls for January came in at 517k, significantly higher than expected (190k), showing the resilience of the job market. The increase was driven by significant jobs growth in the service industries (particularly leisure and hospitality). Millions of service jobs were lost during the Covid pandemic, and these workers are still re-entering the workforce, creating excess demand (job openings exceed the number of unemployed 2-1 in the US).
The US unemployment rate dropped to 3.4%, the lowest level in 53 years and below the pre-pandemic level of 3.5%. The robust employment data dampened hopes that the Fed would halt rates hikes as soon as May. However, on the positive side, the strong jobs data does lend support to the prospect of a soft landing (or shallow recession) in the US. Economic growth is still expected to weaken (but by how much?) as prolonged negative real wage growth detracts from consumer spending.
Higher interest rates are a headwind for risk assets as companies navigate the challenge of higher wage levels, rising input costs and a deceleration in consumer activity. The earnings performance of S&P 500 companies during the Q4 earnings season continued to show an overall weakening in earnings and earnings expectations. With approximately 95% of S&P 500 companies having reported results by month-end, 68% reported positive earnings surprises (source: FactSet Research). This is below the long-term average above 70%.
For Q4 2022, the blended earnings decline for the S&P 500 is -4.8% year on year. Looking ahead, analysts expect earnings declines for the first half of 2023 (-5.7% Q1 and -3.7% Q2), but earnings growth for the second half of 2023 (+3.0% Q3 and +9.7% Q4). With the inflationary environment exerting upward pressure on input costs and downward pressure on consumer demand, companies are unsurprisingly placing more focus on cutting costs.
The odds of a recession in the US (and Europe) in the immediate future (first half of 2023) have receded somewhat over the last few weeks as strong economic data point to a strong labour market and a durable consumer. There is however a marked slowdown in activity in the housing market, while credit card debt has increased and the savings rate declined. This creates an uneasy feeling for the second half of the year where the consumer’s ability to uphold spending (the lifeblood of the US economy) will be severely tested.
Adding to the unease is the risk of the Fed over-tightening, leading to a deep recession, however, this should be avoidable given the strength of the labour market. Investors should take solace from the fact that markets (both equity and fixed income) have materially repriced for risk over the last 12 months. The short-duration investment grade bond market, for example, is offering an attractive dollar yield for low relative risk. Equity markets in aggregate are neither cheap nor expensive but offering fair value for long-term investors.
Table 1: Global Indicators – Local reporting currencies