Year 2023 started very strong for US equity market
but does this rally has legs to continue. Pondering on the same question happy
yto share observations on US economy and markets which you may find value.
Current Narrative:
At present equity market narrative is dominated by
better-than-expected economic data of Europe, China Re-Opening and Immaculate
Disinflation in US.
Elaborating further equity markets are expecting a
scenario where Inflation in US comes down along with growth, but without
breaking system or at least economy will not go in deep recession. This will
help FED to pivot an allow interest rate to come down and risk assets will do
well in this scenario.
This trade started in October creating rebound in
US equities and drawing more and more participants into it. There are few data
points and observation which are in contrast with current narrative.
Observations
Growth
Sales growth remained strong at 11% in Q3 and
remained firmly above trend line indicating strong economic growth. This is in
line with other indicators.
There is shift in spending pattern, from goods to
services. Americans are spending an increased proportion of their disposable
income on entertainment, travelling and other services. This is not good news
for FED fighting inflation.
Wage growth is strong and more importantly, 1st
Quartile worker (Lowest paid worker) wage growth is more than inflation. Labour
market is lagging indicator. Since FED is targeting weakened labour market, it
will be very difficult for FED to change his stance.
One area where consumer balance sheet is impacted
is mortgage. Due to hike in mortgage rates US mortgage payment as a % of Income
has gone up from 13% to 26%. This will certainly hurt consumption.
Current set of data are strong and does not suggest
any slowdown or recession in economy. As James Bianco of Bianco research coined
a term “ No Landing “. This data suggesting economy is moving towards No
Landing as there is not problem in economy.
Inflation
PCE data which is FED’s preferred gauge came in at
4.7% (YoY) and 0.5% (MoM). Certainly, there is much more work to do for FED
before they stop.
FED Stance
Minutes released from FED meeting clearly suggests
that FED is not even thinking about pausing interest rates.
Bloomberg ECAN economic analysis service suggested
that there is zero mention of disinflation versus 91 mention of inflation in
FED minutes.
Minutes clearly points in a direction that
governors are more committed to do Hawkish mistake rather than Dovish mistake.
Hence macro environment has to change significantly for FED to change stance.
Market
Financial conditions for US have started to tighten
significantly since start of February mostly on account of treasury yields
going up.
10 – 2 Year yield curve has inverted significantly.
Current spread is -86 bps. No time back in history, economy has escaped
recession after such a steep inverted yield curve. Also, equity never had a
sustained rally before the curve will show steepness. This is in contrast with
actual growth data, something must give a way.
Money Supply
In US M1 growth has just turned negative. Same in
Eurozone is very close to being negative.
Quantitative tightening is going on in US and EU.
In US impact is not felt due to debt ceiling issue. Treasury is drawing
liquidity from Treasury General Account (TGA). Once issue is resolved treasury
will start issuing securities in June.
G5 Central bankers will withdraw ~2 Trillion USD of
liquidity by way of balance sheet contraction. As a % of GDP aggregate
balance sheet of G5 Central bankers contracted by 5% in 2022 and expected to
contract by 14% in 2023.
We believe global equity markets are undermining
threats due to tight liquidity, persistent US inflation, FED approach and
financial conditions. There is a high chances that this risk on trade will
reverse and will lead to increased downside volatility in market.
Data source: Bloomberg, Point of Return – John
Arthur, Equity Strategy – J P Morgan.
Comments
Post a Comment