Markets last week

A quieter week in the markets and the economy, enabling us to focus on the fundamental issues at play.

In the US, most economic commentators have significantly upgraded their estimate of the probable amount of the fiscal stimulus being negotiated by Congress from US$600bn to close to US$1.5trn. Means-testing the US$1,400 cheques to Americans is one option being proposed by the Democrats now to get round any resistance to the package. Many market participants believe that President Biden’s proposed US$1.9trn is too large a fiscal stimulus relative to the current size of the output gap and that more income replacement today will result in less infrastructure spending later this year. According to the Congressional Budget Office, the output gap, that is the shortfall compared to there being no pandemic, is only US$665bn, i.e. 1/3 of the amount being sought by the US government.

Looking at corporate earnings, in Q4, the S&P 500 reporting companies are showing positive revenue growth for 8 of the 11 S&P 500 sectors, and earnings growth is positive for 9 sectors, which is an improvement over Q3. Further, the estimate for Q1-2021 earnings has been upgraded by about 4.2% this year to date. This means that, in addition to monetary and fiscal stimulus, earnings support is helping equities.

This is further supplemented by a huge savings pot accumulated by consumers, particularly in the US where personal savings are now 13% of disposable income (US$1.5trn greater today than one year ago), and which could be unleashed if the virus is thought to be under control. For the time being, however, consumers are very cautious, as can be seen by UK retail sales, the Sentix investor confidence index in the eurozone and the University of Michigan consumer sentiment index in the US, all disappointing particularly below the headline.

One important speech which went somewhat unnoticed last week, was delivered by US Federal Reserve Chair Jay Powell, where he clearly pointed out to reducing unemployment as his top priority, whilst markets seem to be concerned that the Fed might step on the brakes if inflation rises.

Last week, markets were less eventful than in previous weeks, absorbing the gains and rotating back towards energy and materials from defensive sectors. Far eastern equity markets led the pack in anticipation of the Chinese New Year of the Ox, as government bond yields and commodities resumed their ascent. Sterling also continued its upward trend against both the euro and the US dollar.

The week ahead

Tuesday: US retail sales for January

Our thoughts: after a rebound from the March-April slump, the last three months have been negative for retail sales, despite consumer confidence being strong. The US population has received significant payments from the government (US$600 cheques, pandemic unemployment insurance, etc.) and most of that cash has been saved rather than spent, leading to a higher than usual savings rate for US consumers. January could be the first month to break that losing streak for retail sales. The control group is normally less volatile than the headline number, so both readings will matter to the markets.

Wednesday: UK CPI (headline and core) and RPI inflation

Our thoughts: UK inflation has collapsed over the last 12 months, as consumption has been subdued for many services activities whether in lockdown or not. Registering below 1% since April, the CPI (consumer price index) has yet to react to vaccines, Brexit or any kind of economic recovery. The core CPI (ex energy, food, alcohol and tobacco) has been less volatile, at 1.4% for the last month, but is still on a downward trend over the same period. The RPI (retail price index) has slumped more than the CPI: it was above 4% only three years ago and is now at 1.2%. The Bank of England (BoE) has a similar target to the Fed: 2% inflation, and the current levels almost guarantee near-zero rates for very long. The January reading could start to move the needle. Brexit costs may get reflected in food prices. The question is whether the BoE will think they are one-off spikes and should be disregarded.

Wednesday: Federal Open Market Committee (FOMC) meeting minutes

Our thoughts: the Chair of the US Federal Reserve, Jay Powell, chairs the FOMC which decides on interest rates and asset purchases. Since the August Jackson Hole change in policy to Average Inflation Targeting, the market has been uncertain about how realistic the Fed’s pledge to hold rates at zero for long, really is, hence every statement by Jay Powell and his colleagues is being parsed for signs of a possible exception to that policy. Against that backdrop, the minutes from the last FOMC meeting will be scrutinised for any potential changes in language, in concerns, in direction and whether the tolerance for higher inflation will effectively continue for long. It is clear that the market is expecting higher inflation this year and the Fed’s reaction to this rise will be crucial to the market’s direction.

The numbers for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

Fed focusing on employment

Speaking at the Economic Club of New York last week, US Federal Reserve (Fed) Chair Jay Powell made a very strong case for the reduction of unemployment in the US: “A strong labour market that is sustained for an extended period can deliver substantial economic and social benefits, including higher employment and income levels, improved and expanded job opportunities, narrower economic disparities, and healing of the entrenched damage inflicted by past recessions on individuals’ economic and personal well-being.”

United States

Drop in University of Michigan expectations

Surveys: the NFIB small business optimism survey eased from 95.9 to 95.0. The University of Michigan consumer sentiment index fell further from 79.0 to 76.2 with most of the slump coming from the expectations component, down from 74.0 to 69.8. The index was above 100 before COVID-19 and has had trouble staying above 80 since. The 1-year inflation expectation within that index rose from 3.0% to 3.3%.

Inflation: the CPI (consumer price index) remained at a subdued 1.4% for both the headline and core (ex food and energy) readings, below estimates. Real average earnings continued to move up, as low-paying jobs are being lost and the average gets pulled up: real average weekly earnings rose from 5.3% to 6.1% whereas real average hourly earnings eased from 4.1% to 4.0%.

Employment: the JOLTS job openings number rose from 6,572K to 6,642K, a sign of optimism on the employment front. Jobless claims fell but less than expected. Initial claims fell from 812K (although revised up from 779K) to 793K and continuing claims from 4690K (also revised up from 4592K) to 4545K.

Housing: MBA mortgage applications fell 4.1% during the week ending 5 February. Mortgage delinquencies for Q4 fell to 6.73% from 7.65% the previous quarter and MBA mortgage foreclosures were also down to 0.56% from 0.59%.

United Kingdom

Recovery in Q4 growth masks poor retail sales and a peaking housing market

Sales: the British Retail Consortium (BRC) like-for-like year-on-year sales rose 7.1% in January, but behind the headline number, it looks worse. Clothing and footwear stores fared particularly badly. A separate Barclaycard survey showed consumer spending falling sharply and Britons more worried about their jobs. In January, online sales surged and the closure of schools led parents to buy laptops and printers. Alcohol sales also did well, but holiday bookings were hit.

Housing: the RICS house price balance fell from 63% to 50%. It peaked in November at 65.9%, the high since 1999.

Growth: UK GDP rose an expectedly high 1% during Q4, mostly driven by government spending, up 6.4%, and investment (known as gross fixed capital formation), up 2.1%, but private consumption was down -0.2%.

In December, industrial production rose 0.2% but construction output fell 2.9% and the index of services was up a strong 1.7%. As mentioned last week, this rebalancing of the economy in favour of services is a hopeful sign for 2021.

The trade balance in December narrowed from £6.6bn deficit to £6.2bn.

Europe

Eurozone economy flat to weak

Surveys: in the eurozone, the Sentix investor confidence index fell 0.2% after being up 1.3% last month. The Bank of France industrial sentiment indicator was unchanged at 98.

Industry: German industrial production was flat in December. French industrial production fell 0.8% in December, exhausting its strong run from May to September.

China/India/Japan/Asia

It’s official, China no longer exports deflation

China: the CPI (consumer price index) fell to -0.3% but, more crucially for the rest of the world, the PPI (producer price index) rose into positive territory from -0.4% to +0.3%, the first positive number since last January. Together with the rise in the value of the Renminbi, this clearly means that China is no longer exporting manufacturing deflation abroad.

Foreign direct investment was up 4.6% year-on-year in January.

Japan: preliminary January machine tool orders rose 9.7% year-on-year. Domestic surveys were less buoyant with the Eco Watchers survey (current) falling from 34.3 to 31.2, but the outlook rising from 36.1 to 39.9.

Oil/Commodities/Emerging Markets

Copper and oil still on an upward trend

Saudi Arabia’s production cut of 1.0 million bbls/ day in February and March is likely to provide yet another tailwind for the sector.

Copper traded at an 8-year high last week.