Back to Normal?
Gary Dugan, Chadi Farah, Bill O'Neill
The Global CIO Office
- Equities have recovered their poise, helped by bond yield that have stayed low
- US economic data may have surprised to the downside, but growth has momentum
- We would ride the equity rally from here with tech, interest rate sensitives and Japanese equities
- Gold’s all-time high is a good reminder of the perceived long-term risks in the global economy
- Chinese equities struggle – the drag of China’s ongoing reform has limited positive offsets
Market Update: Recovery and Resilience
Equity markets have shown remarkable resilience over the past ten trading days, recovering most of their recent losses. While equities are still trading below their yearly highs, they have rebounded by more than 7% from their 5 August lows.
The drop in bond yields has helped the equity markets. In the U.S. bond market, yields have remained near recent lows, despite better economic data, such as better-than-expected inflation numbers, which have further bolstered sentiments. As of Friday’s close, the U.S. 10-year yield had dropped 28 basis points from where it stood at the previous equity market peak on July 16th.
Investors are now pricing in a “Goldilocks” scenario—strong growth with moderate inflation—into the markets. Concerns about a potential recession have notably eased compared to just a few days ago.
Chart 1: Major Asset Classes Recover Their Poise
Source: Bloomberg
In explaining why the markets have regained their confidence in the US economic outlook, Bloomberg drew our attention to the chart below. The chart compares the Citi US economic surprise index and the Westpac US economic surprise. The difference between the two measures is that Westpac’s measure is more sensitive to whether the data is improving month-on-month rather than whether the data is above or below expectations. As the data shows, the two series tend to follow each other. However, on this occasion, the Westpac index has improved sharply, suggesting that despite the data coming in below expectations, the economy may be gaining momentum on an underlying basis.
Chart 2: US Economic Data May be Stronger Than The Surprises Suggest
Source: Bloomberg
We prefer to stay with equity markets with demonstrable support from the fundamentals. Japan has recovered much of its losses, but we believe it has further upside on the back of ongoing upgrades to corporate profit forecasts. In the U.S., we prefer tech, quality growth, and some interest rate sensitivity. The latter though has lost some of its lustre because of downgraded expectations for rate cuts currently being priced into the market.
Gold – Still Shining Bright
Despite reaching a new all-time high, gold has surprisingly stayed under the radar in the financial press. It seems to be the asset class that few want to talk about, even as it quietly outperforms. It’s almost ironic that this milestone comes just ahead of this week’s Jackson Hole Symposium, hosted by the Federal Reserve, which will feature many of the world’s leading central bankers.
One could argue that part of gold’s rise has been driven by investor concerns about the current state of global fiat monetary policy. As trust in central banks wanes, the appeal of gold strengthens.
We remain bullish on gold and continue to include a meaningful weighting of it in our strategic asset allocation models. While several near-term factors have accelerated gold’s climb to new highs, the trend has shown underlying strength throughout the year. Expectations that the Federal Reserve will cut rates at the next two meetings, coupled with a slight dip in the dollar, have contributed to gold’s recent momentum. Additionally, geopolitical tensions in the Middle East have also played a role in driving prices higher. However, we sincerely hope that the opportunity for peace in Gaza will be seized by all parties involved.
Chart 3: Don’t Shout it out Loud, but Gold just Hit Another All-time High
Source: Bloomberg
China – When will Data be Bad Enough to Accelerate Policy Stimulus?
Economic data out of China last week still tells a story of deterioration in economic growth momentum. We sense that the government sees the current weakness as a reflection of the pain the economy must undergo to reset. That reset will be shifting away from the old drivers, such as the emphasis on credit, that propelled the economy, to the real estate sector. However, the adjustment in the credit markets is starting to look very aggressive. Total Social funding at RMB 771 bn was around half of what the market had expected. The CNY loan component registered the first monthly decline on record. Private corporates and households appear reluctant to take on borrowing at present.
China’s economic surprise index shows us that things are bad; however, in the policymakers’ eyes the current disappointments may not be a precursor to a crisis. Indeed, a level for the index of -41.0 is not a crisis when measured against the lows of around -100, almost ordinarily seen since the recovery from COVID.
Chart 4: China’s Economic Surprise Index Not Negative Enough to Spur Authorities to React
Source: Bloomberg
In the meantime, we expect the authorities to provide some mild stimulus to the economy through further cuts in interest rates of 10bps in Q4 and a further relaxation of the required reserve ratio. Let’s not get swayed and assume that it’s all bad news. There is robust growth in the high-tech industries that the government is targeting. Aggregate high-tech manufacturing saw its growth accelerate from 8% to 10% annually, with the output of electric vehicles, microchips, and 3D printers up 25% to 30%.
A bit of a reality check here, though. Despite the good news, retail sales are still well below pre-pandemic levels, the real estate sector is deteriorating, and the private and household sectors lack confidence. Given this backdrop, we advise investors to be very cautious investing in China at this juncture.
We have found some local asset managers who have been able to beat the index by a very good measure, but the ongoing drift lower in the index is taking even these good managers off guard. One theme that keeps EM managers engaged with the market, which we need to be mindful of, is the substantial amount of cash being returned to shareholders.
Chart 5: China Sees Substantial Increase in Cash Returned to Shareholders
Source: WIND, Bloomberg, Bank of America, MSIM
