Financial Update from Brewin Dolphin - 27 January 2023
The Weekly Round-up
Friday 27 January 2023
In his latest weekly round-up, Guy Foster, our Chief Strategist, discusses what the latest US GDP figures and corporate results statements tell us about the state of the economy and markets.
This is a good week to assess the state of the economy and the market. The week brought the release of US economic growth data for the final quarter of 2022, a timelier impression of the momentum in the economy via the latest purchasing managers’ indices, and comments from corporate leaders about their performance and outlook.
Just over a quarter of S&P 500 companies have reported their fourth quarter profits and the headline characteristics are familiar. Around 70% of companies have issued better-than-expected earnings which, in truth, seems a bit lower than the 80% ratio of a really solid earnings season. As ever, reported earnings provide only part of the story and can often be less important than the outlook companies give.
Earnings estimates from analysts continue to be trimmed. Notably, the pace of declines is slowing in the US and Asia and accelerating in Europe, which had hitherto been relatively resilient. Ironically, this comes at a time when the economic outlook for Europe is brightening somewhat due to the collapse in natural gas prices and resulting easing of the inflationary burden.
In the final quarter of 2022, US growth was very resilient. Although we expected it to be strong, the final numbers were a little above estimates. However, the make-up of GDP was less encouraging. GDP can be inflated by companies building inventories which must be sold in future periods – therefore bringing growth forward. Around half of the Q4 GDP increase related to this build-up of stocks. It’s not too worrying as this only partially offset inventory declines in the second and third quarters, so inventories are more likely to be a reduced tailwind than an outright headwind at the start of 2023.
The more important component of the GDP increase related to personal consumption expenditure, which again formed about half of the total increase. Personal consumption expenditure has remained consistently positive over the course of the year but, being reported in inflation-adjusted terms, particularly benefitted in the final quarter from the easing of price pressures. To maintain spending at times when wages weren’t rising as fast as prices, consumers were forced to draw down upon their savings and in some cases increase debt. However, in this final quarter real incomes rose due to the decline in energy and food prices.
The tone from companies continues to be that consumers are in good shape, echoing the message from banks. Most companies, however, are cautious on the outlook. One theme that seems to be emerging is that companies faced raw material cost pressures during 2022, which are easing, and they anticipate labour cost pressures during 2023. Wages usually lag consumer prices and, although the Federal Reserve has been able to take comfort from the decline in the rate of wage growth, it would be unwise to be too complacent given the tightness of the labour market. The number of new unemployment claimants has dropped to the lowest level since April 2022 and is equal to pre-lockdown levels, which suggests workers still have the ability to demand higher wages if prices start rising again.
Going forward, much will depend upon the consumer’s ability to grow incomes in real terms. This, in turn, will depend a lot on the progression of inflation, with oil prices having turned from tailwind to headwind, rising 13% so far this year. That headwind will likely intensify if Chinese demand for oil increases as air travel returns to historic levels.
A further concern for many forecasters going into 2023 was the very weak levels of economic activity indicated by business surveys such as the purchasing managers’ indices (PMIs). These seemed to show a pretty synchronous economic downturn at the end of last year, offering a poor omen for 2023. However, these data tend to follow something of a natural mini cycle of three years or so, which would imply that the downward momentum is ready to turn. Indeed, of the seven economies which S&P Global issue preliminary PMIs for, all but Australia saw their manufacturing PMIs improve in January. Some of the improvements were marginal and all imply that companies are seeing orders declining at a slower pace rather than increasing outright but, nevertheless, they were consistent with a small improvement in economic momentum.
The main drag on US GDP in the fourth quarter was residential investment (housebuilding). In fact, residential investment has been a drag all year and has not contributed positively since the first quarter of 2021. Residential investment has declined because Homebuilders anticipate consumers not being able to afford new homes at profitable prices. That’s partly because construction costs have risen sharply and partly because mortgage rates limit the amount that prospective homebuyers are able to afford.
Homebuilder sentiment finally improved during January. Since then, though, the data has been mixed. Many building costs have fallen, most notably lumber, while mortgage rates have dropped from the very high levels seen in November but remain close to their highs of the last decade. Nevertheless, there is strong underlying demand for housing once prices come down, as evidenced by the fact that prices remain close to their all-time highs and the speed with which new houses sell once completed is close to its all-time low.
Markets made further progress this week with some of the trends we observed last week continuing. This week saw bonds generally weaker whilst stocks moved higher – this is in contrast to last year’s highly correlated moves in stocks and bonds. So while the chances of a soft landing (slowing inflation while avoiding a recession) seem higher, this was seen as bad news for bonds and good news for stocks.
It was also a second week in which the Nasdaq outperformed the S&P 500; this is significant because of the very consistent trend of weaker Nasdaq / growth stock performance throughout 2022. It was also significant because this week saw the first big tech company results for the fourth quarter and there will be more big technology companies reporting next week.
The value of investments can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.
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