As we enter June, equity markets globally have become even more data dependent than usual.
US Federal Reserve Chair Jerome Powell has often stated that the timing and extent of interest rate cuts will depend on the data. We now know what this looks like, with markets adjusting to every economic release in accordance with its implication for the rate cut outlook.
At the beginning of 2024 the market was anticipating seven rate cuts over the calendar year in the US, whereas we were expecting four, and today we are looking for two.
We mentioned last month that markets were overdue for a pullback and in April, US equity markets experienced their first 5% plus pullback this year. We often remind our readers that “markets rarely go up in a straight line” and the US stock market has historically experienced over four and a half 5% pullbacks in any one year.
In May, bad news became good news, as softer retail sales data (down 0.3 per cent) and slightly more favourable CPI data (up 0.3 per cent for April and up 3.4 per cent for the year), renewed the market’s faith that the economy was slowing and that rate cuts would eventually come.
The fact is that interest rates are at or near their peak and offshore you will see cuts in 2024. Inflation is below 2021 and 2022 levels, but it is still higher than what both the Federal Reserve and investors want to see, as the “last mile” for inflation has become sticky.
It is important to put the inflationary pulse of the last few years into context. More than half of the US population feel like they are in a recession, even though they are not. The reason for this is that, after adjusting for inflation, US equities are only just approaching their 2021 peaks, US house prices are still below their prior peaks and US real incomes have gone sideways, as shown in the following chart.
In Australia there is currently little independent market direction – the US data each night provides the US markets with direction and the Australian market mimics this direction the following day.
We are nonetheless confident that US inflation will fall over the remainder of the calendar year and that you will see two rate cuts in the US in 2024 (however no rate cuts in Australia).
The charts below illustrate where US shelter and wages costs are likely to head, with both leading indicators now back at levels last seen prior to the COVID outbreak in 2019. Wages and shelter costs are two of the stickier components of US services inflation that have delayed the disinflationary process in recent months, however we believe these trends will diminish and allow US inflation to drift close to target by the end of this year.
During the month Nvidia released their sales results for the three months to end April. The results were stunning – USD26Billion against consensus estimates (according to the Financial Times) of USD24.7Billion, a year-on-year increase almost as big as the prior quarter, when growth hit 265 Per cent. A 10 for 1 stock split was also announced. At the time of writing, Nvidia has a market capitalization of USD2.6Trillion. To put this into perspective the Australian Equity Market is capitalized at approximately USD1.9Trillion.
The Nvidia result did not fuel a broad rally for the market, possibly a sign that markets are tiring, but as we head into June, US tech stocks are starting to rally again.
To reinforce this view the chart below shows that sentiment is near an all-time high, and with sentiment at these levels comes complacency.
Further to this, the debate over a ‘soft landing’ versus a ‘no landing’ scenario has become the focus. We have robust growth now with persistent inflation, but above trend economic growth cannot last while central banks continue to pursue restrictive policy.
At some stage we will see unemployment rise and a softening labour market. In the United States, shelter as a component of inflation is looking likely to decline with rental price data falling sharply.
We are entering a traditionally quiet period as traders square their books for the northern summer and market expectations drift. After the extreme optimism this is not a bad thing and can set the remainder of 2024 up for a reason to remain optimistic.
What does all this mean? Capital Economics summarise the outlook from here as “We expect government bond yields to fall back this year as central banks, including the Fed, cut interest rates by more than investors are currently discounting. Our expectation that ‘safe’ asset yields will fall, alongside our view that global growth will pick up, informs our forecasts for good returns from ‘risky’ assets over 2024-25. We expect equity returns to be particularly strong as an AI bubble continues to inflate, with the US stock market remaining around the front of the pack.”
As such equity investors will be able to look back at the end of 2024 having been rewarded for being overweight in both Developed Markets (ex -Australia) and Emerging Markets but in the meantime, we could well see a pullback which would be healthy.
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