The combination of earnings and economic data are suggesting that the US (and global) economy is slowing as inflation slowly comes off its peak level, even though labour markets in most economies remain robust. To be fair, the economic data is not exactly plummeting, and earnings have been about in line with (muted) consensus analysts’ expectations. My views are as follows:
The big six US banks signalled concerns about the trajectory of the economy in the coming quarters by increasing loan loss reserves in the fourth quarter, with JPM leading the pack (credit losses of $2.3 bln booked in 4Q22, comprised of $1.4 bln increase in net reserves and $887m of bad loan write-offs, results here). Not all banks increased reserves so much, meaning that different banks might have different views on the degree of economic slowdown in the coming quarters.
Corporate earnings have been more or less in line with more modest consensus analysts’ expectations. Some companies have slightly beat their top and / or bottom line expectations, and some have slightly missed. More concerning perhaps (with the exception of TSLA as usual) is what is being said on the management calls following earnings’ releases. Many companies are providing cautious guidance because their customers are indicating that they have concerns about the future direction of the economy. As Microsoft’s CEO Satya Nadella said on the earnings call with investors and analysts following the release of his company’s quarterly results (transcript here):
“As I meet with customers and partners, a few things are increasingly clear. Just as we saw customers accelerate their digital spend during the pandemic, we’re now seeing them optimise that spend. Also, organisations are exercising caution given the macroeconomic uncertainty.”
PMI manufacturing and services data improved (in the US) in December (vs November), but both still remain well below 50 which is considered contractionary. The latest PMI release is here. On the other hand, 4Q22 GDP released on Thursday showed a Q-o-Q decline but growth of 2.9% was better than economists had been expecting (release here). This is the sort of mixed economic news that is trickling in, although these themes are apparent:
Inflation has peaked and is starting to slowly decline
The job market remains reasonably resilient
The economy is still growing, but it is slowing
The UST yield curve remains sharply inverted and is screaming “recession”. The 2yr-10yr UST yield differential is -69bps, near its most negative since the autumn of 1981, as you can see in the graph below from FRED.
Corporate credit spreads – both investment grade and high yield – remain reasonably stable and are at levels that do not indicate concerns about a slowing economy. This is somewhat at loggerheads with what US banks are signalling in various degrees by increasing reserves, and the rhetoric coming from many corporates as far as outlook in the quarters ahead.
There are indeed enough reasons to be concerned. However, given the increase in most global stock markets this year, one can only conclude that a scant minority of investors are truly concerned about the future of the economy. The S&P 500 has increased 5.8% so far in January, and the NASDAQ Composite has increased an unbelievable 10%. Moreover, as share prices rise, momentum players are returning and this is pushing stocks even higher.
Outside of the US, the improvement in risk appetite is equally and in some cases even more robust than in the States, at least if measured by YtD performance in equity prices.
The UK economy continues to be the most troubled, but this has not stopped the FTSE 100 increasing 4.2% YtD, after being the only major developed market index to finish in positive territory in 2022.
European equities have benefitted from lower energy prices, and there is increasing evidence that the slowdown in the world’s second largest economic bloc is not expected to be as bad as first thought. This has pushed the STOXX 600 up 6.8% YtD.
Japan’s central bank remains very accommodative, suggesting that the relaxation of the yield curve control target in December might have been an anomaly. Even Japanese stocks (Nikkei 225) are up YtD 4.9%.
China is gradually reopening although the market this week is closed for Chinese new year. The Shanghai index is up 5.7% YtD, and the MSCI EM index is up a staggering 9.9%, with emerging markets also benefiting from a weaker US Dollar.
Stock prices fluctuate over time. Even so, I have concerns that we have come too far, too fast. The froth in valuations has increased since the beginning of the year. The usual suspects in terms of momentum investors – both retail and institutional (i.e. hedge funds) – are also being stoked by FOMO, not wanting to miss this mini-rally to start the year. This has caused stock prices in many cases to delink from the expected trajectory in underlying earnings in the coming quarters.
No one can predict the future, try as we may. My recommended approach is to tread very carefully and wait for things to settle down, because the path forward will be more challenging than YtD performance suggests. Make sure you have real conviction about the stocks you hold (or are considering adding), as well as comfort with the valuations of the stocks based on historical metrics through cycles. All this said, and if you just can’t wait, my suggestion (and this is not investment advice) would be to dollar-cost average into the positions (or add gradually), ensuring that you are willing to look out at least three years before you self-judge your investment acumen.
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