Strong US data starts to impact market expectations

Chief Investment Officer's team
22 January 2024


  • Last week was mixed on financial markets, with US data confirming current economic strength
  • Fed Funds futures for the end of the year started to move higher, impacting treasury yields and the dollar
  • Stock markets printed an all-time high in the US, and a multi decade record for Japan’s Nikkei

Last week was not about crucial economic data, but the releases confirmed a reality that markets liked to ignore: strong retail sales, low jobless claims, and a jump in confidence confirm that the Fed has no need to cut rates imminently nor aggressively. Indeed, the number of rate cuts implied by future contracts slowly started to moderate, from 6 to 5 (25 bps) in 2024. The implied probability of them to start in March also dropped.

US Treasury yields took note, with rising yields on all maturities of 6 months and longer. The dollar appreciated, also supported by geopolitical tensions, keeping oil prices steady. US exceptionalism continues: retail sales in the UK were disappointing, China’s Q4 GDP was not impressive, and data from Europe did not show any sign of improvement. The week ahead will provide more colour to the picture, with flash PMIs as well as US GDP and core PCE inflation for Q4. The ECB and BoJ will both hold their policy meetings. A stronger dollar explains why, despite an all-time high in US stocks and a multi-decade record for the Nikkei, global equities are barely positive so far in dollar terms, while money market funds take the top spot.

Our positioning remains favourable to the latter, but also to bonds, including high-yield. Our central scenario is certainly not as aggressive as 5 rate cuts from the Fed (we expect 3, starting from mid-year), but we also expect the global economy to continue slowing down. We carry a modest underweight in DM stocks and a more pronounced one on hedge funds and global REITS, as well as an overweight in gold. We are neutral on stocks from emerging markets, where China is actually the clear reason for their negative returns so far this year. India and the UAE, our preferred regions, are actually up 1.2% in US$ terms. Have a great week.

Strong US data starts to impact market expectations

Cross-asset Update

The fight against inflation is considered won, both by central banks and investors. The ongoing disinflation process alongside moderating, yet positive growth in the United States constitutes the so-called Goldilocks scenario by now fully discounted by markets. Other major economic areas are not enjoying that same kind of resilience, notably the eurozone and China, so markets continue to operate against the backdrop of US exceptionalism, whereby US growth supports both the world economy and risk assets. The disinflation process should continue, as the effects of post-pandemic stimulus wane and monetary policy remains restrictive. But now that the base-case scenario is fully priced in, investors will be increasingly putting it to the test. And since the economy cannot grow too much, without stoking concerns about inflation and tighter policy, nor too little as a recession could follow, the very narrow Goldilocks path could leave more room for a no-landing, or a contraction scenario.

As long as hard data remains strong, markets are more likely to see a no-landing scenario, with growth eventually reaccelerating. And this seems to be the case for now, with retail sales last week surprising to the upside even as consumer inflation expectations moderated according to the University of Michigan sentiment survey. Hence, yields rose from oversold levels and the dollar strengthened, although money market bets about early cuts this year moderated only somewhat. Yet, the equity rally was not broad, that one would on the other hand expect it to be should the recovery be at hand. Technology led benchmarks higher, while other S&P 500 sectors underperformed the broader index or were actually negative for the week. Likewise, the S&P 500 equal-weighted lagged badly to close in the red, alongside Europe and the EM equities. So, investors are cheered by stronger data, yet are not confident to embrace a full recovery scenario. What sort of dispelled those doubts was the strong outlook reported by Taiwan Semiconductor Manufacturing Co., the largest chip foundry in the world, that projected revenue growth to rebound to at least 20% this year, as well as a higher range for capital expenditure, suggesting a recovery in global smartphone and computing demand. Also, Fastenal, a distributor of industrial and construction supplies whose sales trends are a good real-time read on the US industrial economy, beat on earnings and revenue despite the ongoing manufacturing contraction. And the company actually highlighted manufacturing end markets doing well in its press conference.

Should a recovery come to pass, inflation and yields would be coming back to haunt investors basking in expectations of early Fed cuts. The jury is still out, and for now the narrow equity rally is set to continue.

Strong US data starts to impact market expectations

Strong US data starts to impact market expectations

Strong US data starts to impact market expectations

Fixed Income Update

Hawkish central bank communication combined with solid data from the US has pushed the government yield curves up across the developed markets. Markets may be too optimistic about 2024 easing expectations, as evidenced by Governor Waller's comments on a slower pace of rate cuts, "no reason to move as quickly, cut as rapidly as in the past." March rate cut expectations have fallen to 41% as of last week compared to a whopping 78% on 12th Jan. ECB Governor Lagarde also pushed back against early rate cut expectations hinting that the ECB may start looking at rate cuts in the summer. ECB and BoJ have policy meetings this week while the Fed assemble next week. The US December retail sales print came in stronger than anticipated at 0.6% vs expectations of 0.4% and November print of 0.3%. The UST yield curve bear-steepened further as the 10-year crossed 4.1%, and the 30-year increased by more than 14bps to trade above 4.3%. We believe these are good levels to start adding duration in portfolios.

IG bond spreads tightened further and are very close to their post-GFC tights. A lot of good news is priced into these spreads. At the same time, there are a multitude of risks lurking, including but not limited to heightened geopolitical risks, stronger US macro data print, and disappointing earnings and guidance. Demand driven by higher carry remains strong despite a robust issuance calendar so far. Compared to that, the High Yield spreads were relatively unchanged, increasing the IG/HY spread dispersion. Historically, HY has performed well following Fed rate cuts, with BB-rated names outperforming their B and CCC counterparts. So, staying up in quality even in HY helps.

EM Spreads have been under pressure as China disappointed both on stimulus measures and GDP growth. China's fourth-quarter GDP grew 5.2% versus a 5.3% estimate. The jobless rate rose to 5.1%, and home prices fell. Meanwhile, contrary to widespread expectations, the PBOC decided not to cut the MLF policy rate. We prefer EM sovereigns compared to their corporate counterparts owing to valuation differences. Within EM corporates, Indian HY outperformed every other segment as news flow was positive across weaker names along with good macro data from the country, including a softer CPI release and higher GDP growth projections.

GCC primary issuance shows no signs of abating. Today, PIF has announced IPTs for a three-tranche bond issuance. This would take the total bond sales from the region to around $20bn or roughly one-third of last year's total issuance. Our preference in the region is to add duration in the Investment Grade Government-Related-Entity space. We also like the short duration of the GCC HY space to generate income.

Strong US data starts to impact market expectations

Strong US data starts to impact market expectations

Equity Update

The S&P 500 and Nasdaq indices at a record high, Japan equities at a 34 year high. Inflation ticking down and strong earnings from the tech sector (semis) supporting investor sentiment. Global equities flat for the week and year with China losing 5% for the week (MSCI China YTD -10%). India and Japan our preferred markets in Asia outperforming with a marked differential continuing from 2023. Japan’s Topix Index continues to gain (+7% YTD), though the weaker JPY is dragging down returns in USD. Indian equity indices lost half a percent last week, however positive + 1.5% for the year so far. US equities gained last week, whilst Eurozone and the UK fell. The tech sector has outperformed this year by 3%, with semis led by TSMC indicating strong continuing demand for high-end chips. The Materials sector is -7% YTD as China real estate and slowing demand is weighing on commodity company performance. China seen as a global growth drag, as stimulus and policy measures continue to disappoint as does the real estate slump.

UAE markets kick off earnings with banks tomorrow and we expect high net interest income growth and strong dividend pay-outs. Plenty to choose from in the UAE in terms of high dividends from banks, real estate to utilities, with yields 4-6%.

Rates higher for longer but peak rates very much in place, slowing inflation positive for DM regions. Margins will be the key driver of S&P 500 ROE in 2024 as headwinds from borrowing costs subside. The start of Fed easing in H2 possibly, means the risk of rising borrowing costs should decline. However, elevated geopolitical tensions and the battle against inflation is not yet won and Red Sea disruptions are a cause for worry, adding to price pressures through energy and shipping costs rising.

10% of S&P names reported last week. And about 24% of the S&P is due to report this week. A vibrant reporting season in progress with the large banks announcing lower IB revenue but record net interest income, though clearly that’s peaking. They also spoke of the strength of the consumer. The US banks said in their guidance Americans have weathered Fed's rate hikes, citing continued spending, amid support from a strong labor market. Away from earnings, Tesla saw share price fall on price cuts in Germany (after similar steps in China). EVs are after three years of focus no longer a push from us right now with price wars in progress across the globe.

Positive results from Taiwan’s TSMC, which forecast a return to strong growth, with revenues expected to grow 20-25% in 2024 with an AI tailwind. Revenues from high-performance computing applications — which include generative AI — increased by 17% q/q. The global chip market remains in demand with AI applications increasingly adopted in industry globally. In the US, 6/7 Magnificent Seven stocks are up YTD, i.e., except Tesla. Apple expected to deliver ~7.5% earnings growth in 2024 vs tech+ at ~18% (consensus) and the S&P 500 at ~12%. We are lower at an estimated 6.5% growth for the S&P 500.

Strong US data starts to impact market expectations

Strong US data starts to impact market expectations

Strong US data starts to impact market expectations

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