20 Nov 2023
The strength and direction of corporate earnings forecasts are an important guide to where investors think the economy is heading.
Recent evidence of ongoing disinflation and the growing likelihood that the Fed is done with its tightening cycle has provided markets a respite.
After a dramatic reversal last year, cryptocurrencies have rebounded strongly in 2023, with momentum accelerating since October.
This week’s US CPI data saw headline inflation fall to 3.2% y-o-y in October, down from 3.7% in September and lower than consensus expectations of 3.3%. ‘Core’ inflation – which ignores volatile measures like energy and food – fell to 4.0% in October from 4.1% previously.
This was very clearly good news for risk assets, with further rate hikes this year essentially ruled out by the market. It also heightened hopes that the Fed is moving closer to ‘pivoting’ its policy towards rate cuts. That was a key driver of a rally in bonds that saw yields fall by around 20 basis points to 4.45% before backing up later in the week. Equities also rallied, with the Russell 2000 index enjoying its best day in over a year.
As in other western economies, we see US disinflation continuing in 2024. Goods inflation has already fallen back quickly. Even though energy prices could be volatile, we expect that trend to continue. Meanwhile, central bankers are more focused on services inflation – and how ‘sticky’ that might be. Nonetheless, after a rapid tightening of financial conditions, evidence points to services inflation continuing to slow through 2024.
Last week, Moody’s lowered its outlook on the US credit rating to “negative” from “stable” citing large fiscal deficits and a decline in debt sustainability. However, credit rating agencies are in cheerier mood when it comes to emerging market sovereign debt. For the hard currency Emerging Market Bond Index (EMBI), the ratio of positive to negative outlooks has turned positive for the first time in a decade.
What’s driving the improving outlook? EM countries generally ran lower fiscal deficits during the Covid pandemic and consolidated quicker in the recovery with an emphasis on spending discipline. Many EMs have also pursued a strategy of local currency debt issuance while there has been limited supply from quasi sovereigns, which are pursuing alternative funding avenues. There are macro tailwinds too. With many EMs acting early to raise interest rates to fight inflation and defend currencies post-pandemic, they are better positioned to ease rates over the coming quarters, and ahead of DM economies.
The value of investments and any income from them can go down as well as up and investors may not get back the amount originally invested. Past performance does not predict future returns. The level of yield is not guaranteed and may rise or fall in the future.
Source: HSBC Asset Management. Macrobond, Bloomberg. Data as at 12PM UK time 18 November 2023.
There is truth in the old saying that “the stock market is not the economy”. Yet, it’s also true that the strength and direction of corporate earnings forecasts are an important guide to where investors think the economy is heading.
With the Q3 earnings season winding down, S&P 500 earnings per share (EPS) is set to grow by 3.4% y-o-y, falling to 2.7% in Q4. Yet, further out, the picture is much more upbeat. Analysts expect around 11% EPS growth in 2024. What is this consensus view pricing in?
In the US, periods when earnings grow at more than three times nominal GDP tend to happen mid-cycle. Based on forecasts of 3.7% nominal GDP in 2024, the EPS/GDP ratio stands at around 3 – meaning that analysts are assuming an economic soft landing and no recession. Some EPS optimism may be warranted. Productivity growth and limited corporate retrenchment may help avert a major downturn. Higher rates benefit cash-rich large-caps, and declines in sequential wage growth are helpful for cost control.
For investors, year-to-date market returns continue to look reasonable, and better than many expected at the beginning of 2023. A typical 60-40 portfolio is up 12%, with most gains coming from the performance of US equities, helping to offset losses in DM government bonds.
But scratching below the surface shows an interesting shift in market trends occurring around the time the S&P 500 reached its year-to-date peak on 31 July. Up until that point, year-to-date performance was characterised by outsized gains in tech and growth stocks – fuelled by AI enthusiasm and as peak Fed rate expectations stabilised – with relatively little action elsewhere.
Since then, market performance has been more lacklustre. Tech continues to outperform. But rising bond yields in H2 have weighed on broad market performance.
Recent evidence of ongoing disinflation and the growing likelihood that the Fed is done with its tightening cycle has provided markets a respite.
After a dramatic reversal last year, cryptocurrencies have rebounded strongly in 2023, with momentum accelerating since October. In US dollar terms, the price of Bitcoin – by far the biggest crypto coin - has risen by around 30% in the past month. Bloomberg’s broad basket of currencies, the Galaxy Crypto index, is up by more than 40%.
That’s impressive in the context of struggling returns elsewhere in the investment universe, and given some of the negative news flow this year centred on FTX episode. But this was arguably reflected in this summer’s period of relative underperformance versus tech stocks – which typically move in tandem with crypto.
Investors have moved on and crypto has caught up. News that a spot Bitcoin ETF could soon get the regulatory green light has probably helped repair investor sentiment. But perhaps a more intriguing view of recent Bitcoin price trends is the impact of rising bond yields on investor portfolio construction.
Past performance does not predict future returns. The level of yield is not guaranteed and may rise or fall in the future.
Source: HSBC Asset Management, Refinitiv, Macrobond, Bloomberg. Data as at 12PM UK time 18 November 2023.
| This week |
Past performance does not predict future returns. Source: HSBC Asset Management. Data as at 12PM UK time 20 November 2023.
| This week |
A downside surprise in US inflation and weak US labour market data spurred a broad-based rally in risk markets on rising expectations of a Fed easing by mid-2024. Short-dated US Treasuries outperformed, bull flattening the yield curve. Euro area and UK sovereign bonds moved higher in tandem. Global equities posted decent gains, including both developed and EM stocks. The S&P 500 was bolstered by improving US rate sentiment, with the “magnificent seven” outperforming. European stocks followed suit. In Japan, the Nikkei saws strong gains, shrugging off weaker than expected Q3 GDP data. Meanwhile, commodities were mixed. Oil prices weakened further with Brent crude dipping below $80 per barrel amid ongoing demand pressures. In contrast, gold moved higher, aided by falling US real yields.
Related Insights
The UK government’s Autumn Statement gave us a timely reminder of the fiscal constraints...[27 Nov]
US stock and Treasury markets were closed for Thanksgiving. [24 Nov]
US stocks rose as Treasuries edged slightly lower. [23 Nov]
European inflation remains too high for central banks…[14 Jun]
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