Japan’s share market index, the Nikkei, had a particularly strong month (+8.4%) but the US S&P 500 (+1.6%) was only moderately strong – largely because of the big sell-off on the last day of January following the Fed’s press conference. China (-6.3%) and Emerging Markets (-3.1%) went backwards.
A lot might depend on whether the Artificial Intelligence (AI)-led rally of 2023 continues or, indeed, retraces. Without the so-called Magnificent Seven (big technology stocks), the S&P 500 index would not have been impressive at all in 2023.
However, the consensus eoy 2024 forecast we have gleaned for the S&P 500 from published reports (made at 1 January) was 5,000 points or just above the closing value on 31 January (4,846). While we are not expecting a bumper 2024, our analysis of broker forecasts suggests that this consensus is somewhat pessimistic.
Bonds and Interest Rates
At the end of January the Fed funds interest rate was on hold at a range 5.25% to 5.5%. The CME Fedwatch tool is pricing in about a 35% chance of a 0.25% interest rate cut at the Fed’s March meeting. The same source is predicting that there is only about a 10% chance of the Fed funds interest rate being unchanged by June. The prospect of two or three 0.25% interest rate cuts by June being about the same and collectively by far the most likely outcome.
The European Central Banks (ECB) and the Bank of England (BoE) also kept interest rates on hold in January in spite of their slightly improving inflation outlooks.
The RBA kept our interest rates ‘on hold’ on their meeting on the first Tuesday in February. In our opinion, there is evidence that the Australia economy is in need of some rate relief, as the surging immigration levels are masking the cost-of-living pressures on the average household.
Since company earnings from selling to Australians are determined by aggregate demand – and not by per capita (household) demand – the ASX 200 can grow while a per capita recession takes place.
The 10-year Treasury yield in the US fell from just on 5% in October to a recent low of 3.8%, since then it drifted up a fraction to 4.1%. After the latest Fed meeting this yield retraced to just under 4.0%. The Australian 10-year yield ended January at 4.01%.
We expect some more visibility on Australian monetary policy from the RBA from here onwards, as the new committee appears to be charged with the task of improving communications.
The price of oil bounced back sharply from December’s lows. Both West Texas Intermediate (WTI) and Brent Crude oil were up by about +8% largely on the impact of the Middle East conflict and more recently issues with shipping in the Red Sea.
The prices copper and gold were largely flat over January. The price of iron ore fell by -6.3%.
The Australian dollar – against the US dollar – depreciated by -3.9% which will not help our inflation cause through import prices increases.
Australian November retail sales (in value terms) published at the start of January surprised at +2.0% for the month – but they grew only +2.2% for the year. This growth becomes negative when inflation is taken into account. In addition, population growth running at about +2.5% p.a. suggests the average citizen was consuming a lot less in inflation and population-adjusted terms.
The monthly retail value data for December were published at the end of January. The seasonally adjusted monthly growth for December was 2.3% (not annualised) wiping out the November gain. But, just as with the change in employment data, retail sales as collected by the ABS were up +14.3% on the month in ‘original terms’. It was the seasonal adjustment process that converted +14.3% into -2.3%.
Non-specialists might ask if the ABS is competent at performing the task at hand. While we think the ABS is world class, their task is very difficult when seasonal patterns are changing. In due course, we believe that the data will be revised. They will still likely not be good but not as bad as we see at first sight.
There were also two reads on the monthly Consumer Price Index (CPI) inflation gauge published in January owing to the delay in reporting November data because of our holiday season.
Both the headline and the core monthly variants for November were +0.3%. The 12-month gains were +4.3% for the headline and +4.8% for the core variant that excludes volatile energy, food and holiday travel. Our rolling quarterly estimates which we produce each month was +3.0% p.a. for both the headline and core variants. That puts these inflation estimates at the top of the RBA target range.
At the end of January, quarterly CPI data were released. The monthly data, in order to be more timely, has only about 70% coverage of the quarterly basket of goods and services.
The official read for the Quarterly index series was +0.6% for the quarter and +4.1% for the year (expected +4.3%). Note that +0.6% for the quarter, if annualised, becomes +2.4% p.a. and is within the RBA target range.
The monthly series official reads over the year for December were +3.4% from +4.3% for the headline and +4.0% from +4.6% for the core. Our in-house rolling quarterly estimates (annualised) were +1.3% p.a. for the headline and +2.4% p.a. for the core. The RBA has over-achieved! +1.3% is below the target range.
The core measures over the last five months have been +5.5%, +5.1%, +4.1%, +2.7% and +2.4%. We think that is a stable downward trend and indicative of the RBA may have gone too far, and at a minimum, far enough, given the lags in the system for interest rate hikes to work through. With the RBA target range being 2-3% the RBA needs to act in a timely manner with rate cuts to prevent overshooting on core inflation.
The jobs data for December showed that the participation rate had fallen from 67.3% to 66.8% reflecting a strong discouraged worker effect. In essence, 41,400 full-time jobs were converted to part-time while, in addition, 65,100 full-time jobs were lost from the workforce. The unemployment rate remained at 3.9%.
China’s GDP growth came in at +5.2% against an expected +5.3% but the market seemed to interpret this result as being very weak. Retail sales also missed at +7.4% compared to +8.0% expected but industrial output at +6.8% beat the +6.6% forecast.
The Purchasing Managers Index (PMI) a measure of industrial demand was 49.0 for December which was down from the 49.4 read in November. At the end of January the PMI for January rose slightly to 49.2.
The big problem in China still relates to the debt burden mainly of property developers. The Hong Kong government recently ruled that Evergrande the formally very large mainland property developer should be placed into liquidation. The government is reportedly trying to ring-fence a few of the big developers to stop a spread of the problem. At the end of the January, China noted that it had merged ‘hundreds of rural banks’ to reduce risks of failure.
US CPI inflation came in at +0.3% for both the headline and the core variants of the measure.
Over the year, headline inflation has come down to +3.4% and the core to +3.9%. While these numbers are far from the Fed target of 2% the market seemed to breathe a sigh of relief that substantial progress had been made.
Our rolling quarterly estimates (annualised) were +1.8% p.a. and +3.3% p.a. for the headline and core variants, respectively. The headline rate was below the Fed target of 2%! There should be two more releases of the US CPI before the next Fed meeting to make the next interest rate call.
The Fed’s preferred Personal Consumption Expenditure (PCE) inflation data painted an even better picture. The monthly core and headline rates were each +0.2% while for the year they were +2.9% and +2.6% respectively.
The Fed fears a resurgence in inflation if it starts to cut too soon. Supply-side shocks such as higher oil prices and disrupted supply chains due to restricted access to the Suez Canal due to the conflict in the Middle East, are almost unpredictable and inflation expectations data do not support a demand-side surge in inflation.
The US consumer appeared to be somewhat resilient in January. Retail sales (for December) grew by +0.6% – well ahead of inflation. The December quarter GDP growth was +3.3% when only +2.0% had been expected. The household savings ratio fell to +4.0% from +4.2% indicating some pressure on budgets.
Over 2023, economic growth was +2.5% following +1.9% for the previous year. The University of Michigan consumer sentiment survey showed that 28% of Americans thought the economy is in excellent or good shape. The corresponding figure for April 2022 was only 19% but, in January 2020, just prior to the onset of the pandemic, the Michigan figure was 57%.
While some reported that the current 28% figure showed some resilience, we think it would at least be equally plausible to state that the consumer is not as pessimistic as they were but nowhere near as optimistic as they were before the interest rate-hiking cycle began.
Existing home sales were the lowest since 1995 but, that is to be expected when mortgage rates are historically high and expected to fall in the coming months.
German inflation rose to +3.8% while, for the eurozone, it was +2.9%. The UK recorded +4.6% inflation and its retail sales fell -3.2% when a fall of only -0.5% had been expected.
The Europe economy is clearly in a worse position than the US and it has been paying the price for once becoming so dependent on energy/fuel from Russia.
Rest of the World
The conflict in the Middle East has certainly escalated and the deaths of US soldiers has seen a retaliatory military action against specific targets in the region, in particular to stem the terrorist attacks from inside Yemen on ships in and around the Red Sea and other military targets. To date, the economic consequences of the conflict seem less than that from the Ukraine war as there is a simple, but costlier, option to avoid the Red Sea shipping lanes by diverting round the Cape of Good Hope in southern Africa to access Europe and the US particularly with crude oil sourced from the Middle East.