Markets last week 9/08/2021

Markets last week

A quieter political backdrop in China helped trigger a small recovery in Asian equities, with Chinese state media tempering an attack on gaming companies. The action was mostly in western equities, though, with economic sentiment surveys at a very high point globally. Interestingly, the Citi US economic surprise index turned negative for the first time since Q2 of 2020, as most of the high numbers have been broadly expected.

The earnings season for Q2 is coming to an end and close to 80% of companies have reported their earnings. Anywhere from 70% to 90% of reporting companies have beaten estimates and the frequency and magnitude of such positive surprises is nothing short of astounding, averaging 20% both in the US and Europe. This is the fourth quarter of such earnings beats, which has never been seen before and undoubtedly is a large part of the reason why markets have been so strong throughout the reporting season.

Equities and the US dollar received a boost and bonds sold off on Friday due to a strong payroll number in the US. All eyes are now on the US Federal Reserve (Fed) for its end of August Jackson Hole retreat where traditionally new ideas and policies get mooted and leaked.

At the end of the week, government bond yields surged, with US 10-year bond yields up 7 bps and gilts up 5 bps, underscoring the ongoing risk-on mood in the markets. Equities did well, with fairly even returns across markets. Among sectors, the best performing were financials and the worst materials and consumer staples.

Commodities were generally weak, with oil falling to just above US$70/bbl despite tensions in the Persian Gulf and copper settling back down below US$9,500/metric tonne. Gold was relatively unchanged until Friday when it dropped 2.5% to US$1,763/oz.

The week ahead

Tuesday: ZEW survey for eurozone (expectations only) and for Germany (expectations and current situation)

Our thoughts: Europe is lagging the US, the UK and Asia in the cycle recovery, due to flip-flopping on the lockdowns and hence reopening steps. Further, many of the eurozone’s exports are cyclical and depend on global economic growth, with China and emerging markets featuring prominently among export markets. This explains why eurozone PMIs have risen recently when other parts of the world were starting a descent. Surveys therefore matter enormously in highlighting the specific point in the cycle where Europe is. The ZEW (Zentrum für Europäische Wirtschaftsforschung) has often been dismissed as a survey of economists, as opposed to purchasing managers or real economic agents, but in this case having an indication of trends would matter. The ZEW for the eurozone looks to have peaked two months ago at 84 and the most recent level was 61.2. The German ZEW expectations component is expected to fall from 63.3 to the 50s, although the current situation is tipped to be improving. Given the strength in manufacturing PMIs, it would not be surprising if these numbers were beaten and they may give some direction to European markets for the rest of the summer.

Wednesday: US CPI (consumer price index) and core CPI (ex food and energy)

Our thoughts: once again, US inflation will be in the headlines after the strong employment growth on Friday, although the shock value of the first eye-watering data has passed. The important thing about the US CPI won’t be the absolute level, but the details underneath. Will the main increases still come from rental cars, hotel rooms and other obvious reopening activities or will inflation seep into rents and wages, which would make it more worrying? Is energy still a main element, given relative stability in prices over the last quarter? How are specific components moving from month to month?

Thursday: UK June GDP with sector growth data

Our thoughts: the UK has suffered from quite a bit of a stop-and-go throughout the lockdowns and reopening. The reaction of various parts of the economy has been somewhat erratic from month to month. Now that the country is reopening more steadily, the relative performance of different sectors could be a good guide as to the overall health of the economy. Construction has just had a good run but seems to be toppy, whereas services are picking up and manufacturing has been quite flat recently. It should give markets a good clue as to which areas of the market behave better towards the end of the year.

Markets for the week

Central banks/fiscal policy

Does the market buy the Bank of England’s ’modest tightening’?

The Vice-Chair of the US Federal Reserve (Fed) Richard Clarida said the Fed was on track to begin increasing interest rates in 2023, if the economy performs as expected.

The Bank of England (BoE) mentioned the need for some ’modest tightening‘ in due course. The BoE will probably begin to unwind its quantitative easing programme (asset purchases) when its benchmark rate is at 0.5%, a threshold that used to be 1.5% and is therefore likely to be reached faster after this announcement. This comment is showing the BoE the exit door for its current monetary policy, although the market is flagging that the 0.5% rate threshold won’t be reached until 2024 at the earliest.

As to economic forecasts, the BoE updated them as follows: inflation should hit 4% in Q4 but then will fall back close to the 2% target. The jobless rate is expected at 4.75% this year and 4.25% next year. GDP is forecast at 7.25% this year, 6% next and 1.5% in 2023.

United States

Excellent surveys and strong payroll numbers

Surveys: the Markit manufacturing PMI rose from 63.1 to 63.4, whereas the ISM (Institute for Supply Management) manufacturing PMI fell from 60.6 to 59.5, with ISM prices paid dropping from a nosebleed 92.1 level to ’merely‘ 85.7, new orders also easing from 66.0 to 64.9 and ISM employment actually rising from 49.9 to 52.9. As customer inventories hit a new low of 25 down from 30.8, there is significant room to replenish supply chains. 17 of the 18 manufacturing industries reported growth last month.

The ISM services index improved 4.0 points in July to 64.1, above estimates, with a pickup in business activity, employment, new orders, but also input costs at extreme levels (82.3 vs. 79.5), inventory contraction, staffing shortages and supply chain disruptions. Here again, 17 of 18 industries reported growth.

Industry: US factory orders rose 1.5% in June, above estimates, also 1.4% ex transport. US durable goods rose 0.9% and 0.5% ex transport. All better than expected with previous numbers revised up.

Housing: MBA mortgage applications declined 1.7% for the week and 8.1% year-on-year despite mortgage rates falling to 2.97%, the lowest level since February. US construction spending missed estimates of 0.4% in June, at only 0.1%.

Employment: initial jobless claims fell from 399K to 385K, roughly in line with estimates but continuing claims collapsed from 3296K to 2930K. The Challenger, Gray & Christmas job cuts fell 92.8% year-on-year to the lowest in 21 years. Non-farm payrolls were very strong for July, rising 943K for the second strong month in a row and exceeding forecasts. The last two-month payrolls were revised up 119K, adding to a very positive picture on new jobs. Most jobs were created in the private sector (703K vs. 240K for the public sector) with leisure and hospitality and education as the main job creators. The unemployment rate (U-3) fell sharply from 5.9% to 5.4% and the underemployment rate (U-6) from 9.8% to 9.2%, with a slightly higher labour participation rate at 61.7%.

Lastly, average hourly earnings year-on-year rose from 3.7% to 4.0%.

United Kingdom

The housing slowdown is offset by a buoyant services sector

Surveys: the Markit/CIPS services PMI unexpectedly rose from 57.8 to 59.6, almost in line with the eurozone. The construction PMI dropped to 58.7 in July, well below the 24-year high of 66.3 in June.

Autos: new car registrations fell 29.5% year-on-year in July after a strong bounce in previous months.

Housing: house prices grew at the slowest pace in four months, as the value of homes rose 7.6% from a year ago in July, slower than the 8.7% pace recorded the previous month, according to Halifax. The average value of properties stood at £261,221.

Europe

Strong surveys across the board

Surveys: the Markit eurozone manufacturing PMI was slightly higher than the previous month and estimates at 62.8. The leader was Germany at 65.9. The eurozone services PMI fell from 60.4 to 59.8, with every major country slightly below expectations but still at a very high level.

Inflation: the eurozone PPI (producer price index) rose from 9.6% year-on-year to 10.2% in June whereas the CPI (consumer price index) is only 1.9%. This is not so unusual today, as we saw Chinese PPI at 9% and CPI at 1.1%.

Sales: eurozone retail sales rose 1.5% in June, down from 4.1% the previous month, rising 5% year-on-year.

Industry: German factory orders rose 4.1% in June, way above estimates and a rebound from -3.2% last month. French industrial production rose 0.5% in June or 7.1% year-on-year, but German industrial production fell 1.3% for a 5.1% year-on-year rate.

China/India/Japan/Asia

Surprise in China

China: surprisingly, the unofficial Chinese Caixin services PMI soared from 50.3 to 54.9. Exports, however, slowed down, rising 19.3% year-on-year in July down from 32.2% the previous month. Import growth also eased to 28.1% from 36.7%, resulting in a higher trade surplus of US$56.6bn vs. US$51.5bn. The total foreign exchange reserves in China rose to US$3,235bn, by far the largest number anywhere in the world.

The CPI (consumer price index) fell to 1.0% from 1.1% previously whereas the PPI (producer price index) rose to 9.0% from 8.8%, both readings above estimates.

Japan: consumer confidence index moved a smidge higher from 37.4 to 37.5. Household spending fell 5.1% in June year-on-year, with labour cash earnings a weak -0.1%. The Leading Index CI rose from 102.6 to 104.1 and the Coincident Index from 92.1 to 94.0.

Other Far-East: the ISM manufacturing PMI for South Korea stands at 53, but Taiwan is much stronger at 65.2 due to the semi-conductor industry.

Oil/Commodities/Emerging Markets

Despite tension in the Persian Gulf with the hijack of a tanker, oil prices were pointing downward for most of the week. On Friday, the strong US payroll numbers dragged most commodities down, with Brent crude down to near US$70, copper below US$9,500 and gold below US$1,800.