In collaboration with The Global CIO Office (Bill O’Neill, Gary Dugan)
Singapore, Dubai and London, 18th February 2019
- Global markets rally on good geopolitical news
- Poor economic data overwhelmed by a hope the Fed may cut rates
- US retail spending disappoints; economists cut GDP forecasts
- Brexit outcome no clearer, but sterling supported by better UK economic news
- Oil and oil stocks helped by OPEC production cuts and possible restraint from US producers
- Technology stocks seeing creeping regulation
Global risk assets remain supported by the drip feed of good headline news. The re-opening of the US government and the hopes that China and the US may find a way forward on the trade talks is good for the markets. However, in the absence of these news stories the backdrop remains challenging. GDP growth forecasts continue to slip, and the Brexit problem is far from resolved. The market is in one of those moods where bad news is good news. Market logic is that weaker growth means the Fed could even cut interest rates; the market is pricing a 20% chance of a rate cut from the Fed by January 2020 – so good news right!
While President Trump is calling a national emergency to enable him to fund his Mexican Wall, he seems to be oblivious to the building challenges in the economy. The President would have hoped that by generating conditions of near-record low unemployment that the US consumer would have led growth; however, that is far from the case. The economic expansion was built on debt-funded narrow tax cuts. One hopes his new wall has better foundations!
Consumer spending at around 68% of the US economy is clearly important. Hence, is it was worrying last week when the retail sales report for December came in at -1.2% month-on-month much worse than the +0.1% expected by the consensus. The news was all the more surprising when you consider that unemployment is close to record lows, real wage growth is robust and consumer confidence generally quite upbeat.
For sure US householders have more money in their pockets, but the worry is that good news has not been evenly distributed. Real average earnings for US workers are growing at around 1.9% year-on-year. However, averages can give a false impression of how the majority of householders are faring. A recent study showed that over 80% of US workers are living from paycheck to paycheck and can barely muster $400 of spare liquidity. Also, the percentage of all auto loans where borrowers are more than 90 days behind on their repayments is now higher than it was in 2010.
Typically, with labour markets so tight you would have expected even higher real wage growth. The latest job openings report was stronger than expected. New job openings came in at 7.33 million versus 6.85 million expected. The number of job openings is now above the number of people making themselves available for work. Economists argue that wage inflation has not materially taken off partly because these past two years have seen ongoing fear amongst workers about job security. A New York Fed survey, for example, shows that most age groups believe that unemployment will be higher in the next year- hence many people are probably put off demanding a sizeable wage increase.
US consumer stocks have rallied ever since President Trump’s tax cut was announced in the first quarter of last year. However more recently the performance has become more mixed. The performance of the sector remains complicated by the demise of shopping malls. Although some commentators believe that that the worst is behind us, Payless last week went bankrupt (again). Wal Mart announces its full-year 2018 results this coming week which will be a good bellwether stock of an old retail store model of a company trying to diversify into online rapidly. Wal Mart had indicated that it wanted to see its online sales improved by 40% in 2018.
Last week’s much weaker than expected December retail sales figures had economists rushing to downgrade their fourth-quarter GDP forecasts from around 2.5% to 2.0%. In aggregate, the US economy is not quite as robust as many had thought/hoped. The Citibank economic surprise index has fallen from a recent peak of 27.3 to -15 indicative of quite a sharp weakening of economic data relative to expectations in past weeks.
We have almost given up trying to say anything sensible about Brexit. The political muddle continues with a seeming game of poker between the EU, the UK Prime Minister and the UK Parliament. Prime Minister May despite being voted down by Parliament over and over again continues to battle on for some compromise with the EU on the backstop. In the EU there appears to be little hope of a majority let alone a unanimous consensus to give Prime Minister May a compromise. The UK Parliament meanwhile is waiting to take over the process should May not win her concessions from the EU.
The only consensus view on Brexit is that very few people even in continental Europe want a hard Brexit. Europe is verging on recession. The last thing the continent needs is another factor such as hard Brexit that damages growth. The recent news that German fourth quarter GDP growth was at zero was far too close to recession.
Sterling remains the bellwether of Brexit, and at $1.29 it’s sitting in the middle of a range of $1.15 to $1.45 of possible outcomes for sterling from hard and soft scenarios. Last week the pound gained some confidence from stronger than expected retail sales figures for January. Retail sales rose 1.0% month-on-month led by a 2.1% surge in clothing sales. It’s not all bad news in the UK, and maybe the numbers demonstrate that if you could just take away the uncertainty of Brexit, the UK could start to respond to some of the positives. Wage growth has picked up, and the government’s tax changes will be putting more money in the pockets of households.
The oil sector and oil stocks could be set for further reasonable performance given the attempts by OPEC to cut production to support prices. Oil prices rose every day last week. OPEC cut production by 800,000 bpd in January. They look set to reduce bearing mind that they have lowered their global oil demand estimate by 240,000 bpd due to slower global growth. Also, OPEC has to continue to accommodate US production which the EIA now believes could surpass 13 m b/d by 2020 (currently 11.8 m b/d). One might have thought that US production could keep increasing rapidly. However, US producers are coming under pressure to rein in their capital investment and focus on profitability and not only oil production growth. Interestingly the US is going a bit soft again on sanctions on Iran for fear of allowing oil prices to spike. The catastrophic drop in Venezuelan output is leading to some fear of material shortages of oil.
As a last thought, there are further signs of efforts by governments to rein in the power of companies who have used technology to dominate their industries potentially. In December last year, the Indian government announced that it was banning from February 1st online companies selling the goods of businesses that they have an equity interest in. Amazon’s Indian web site has mostly the products of companies it has equity stakes in. In some quarters the announcement was seen as politicking, particularly given that the Indian Competition Commission had previously declared there was no issue. In our view there will be increasing pressure on the large tech companies as governments investigate whether they are abusing their often-dominant market positions. Investors in Big tech beware.