The long-awaited US interest rate cut finally arrived!
After all the angst, markets (sort of) decided that the whole thing was more or less discounted. The bigger than expected cut emerged from the narrative of a structural counting problem creeping into nonfarm payrolls. However, a glance at the Atlanta Fed “nowcasting” data suggests that US GDP is not ready to fall into a funk just yet.
Additionally, previous important components in housing that looked fatigued perked up again — though housing is probably the wobbliest one to watch, for the time being. Goldilocks seems to have dodged the three bears with a soft landing.
Meanwhile, in equity markets, highly valued index tech companies that were beneficiaries of the AI froth need all the help they can get from lower rates. It will be some time before the industrial-scale building blocks of the AI boom really show profitability, so how markets tolerate or discount this start-up angst could be important for some time. Earnings drive markets!
In terms of tech, it goes further than the US; Dutch chip giant ASML also reported disappointing results. The restrictions by US politicians in terms of exports to China are obviously going to lean on US chipmakers the hardest, but we can see that it’s a broader issue. It’s worth noting that the companies that make up the big US indices are not necessarily reflective of the entire US economy, so pressure in tech doesn’t necessarily mean problems for the US economy as a whole. Still, it’s a potentially very noisy background risk.
Earnings are the key reason China continues to look unwell. The (long-overdue) rate cuts are coming through, and huge stimulus has been announced, which may prove a game-changer. President Xi Jinping putting a stop to his antibusiness commentary of recent years would be a definite plus.
Europe came to the party with a rate cut of its own, but expect nothing from Japan, which has desynced from everyone else for the time being — it is on rate-hiking cycle for now. However, watching for the peak in its interest rate cycle could prove profitable.
It’s worth noting the companies that make up the big US indices are not necessarily reflective of the entire US economy
The Reserve Bank, of course, watches the US Federal Reserve like a hawk! After the Fed announced 50 basis points (bp) in cuts, the Bank leapt with Jabba the Hutt-type reflexes to cut rates 25bp. Well, at least it’s in the right direction, and the latest inflation readings look encouraging.
South Africa avoided further slippage in its credit rating after Fitch Ratings retained a stable outlook on the nation’s debt, citing a moderate improvement in economic reforms and slower growth in its debt.
“We expect the government of national unity, in which the ANC is the largest party, to continue the reform programme, which will contribute to a modestly increasing real GDP growth,” Fitch says.
“However, we do not think the reforms will significantly raise South Africa’s low growth potential, which we estimate at 1%.”
The agency kept the country’s foreign currency long-term rating at BB-, three notches below investment grade.
Even after the cut, South Africa’s real interest rate is at the highest level in 18 years, which means that the Bank really should consider lowering borrowing costs further. Some positive comments coming from the Bank recently are that it sees CPI in the bottom half of the 3%-6% range within the next three quarters. Furthermore, the Bank notes that markets are pricing in more than 125bp cuts to come.
What we need is a promising report card from the medium-term budget; we don’t need ridiculous tariff hikes or more load-shedding from Eskom. Overall the rate cycle will dominate, though excessively bearish news for China would be our problem too.
The summary for equity and bond markets? Despite ructions and noise, the direction for the cost of capital is positive in most markets. Stay long of most risk assets. Otherwise, this advice is known as: “Don’t fight the Fed.”
Where are market returns coming from in the world right now? Remember that most equity returns come from a mix of earnings growth, dividend coupon, stock market rerating or derating, and currency movements. I am indebted to Piet Viljoen for alerting me to the graphic included here, which provides a number of useful conclusions.
It’s no surprise that the US has had good stock market gains, because it has provided good earnings growth. Similarly, it’s no surprise that China has underperformed, because thanks to Xi’s mini-Mao project, Chinese earnings have been atrocious.
In constant currency terms, over the past 15 years Japanese companies have grown their earnings at a higher rate than US companies in the aggregate. The weaker yen, especially in the expectation of running negative real rates, has led to Japanese equity performances underperforming the US. Japanese companies have derated — in other words, investors have placed a progressively lower multiple on their earnings over time. However, this does tee up the Japanese for a rerating.
By contrast, the US may struggle with equity earnings in aggregate, given the preponderance of the dominating Magnificent 7 stocks (which are spending vast amounts on research & development) in its indices (about one-third of the S&P 500). Of course, in the longer term it’s great that US investment is up to date, but will markets look far enough through the cycle? It’s a risk …
Europe doesn’t seem competitive in terms of earnings growth in almost any period. It’s a low-growth, closed-shop nanny state that recently had its constraints worsened significantly as the war in Ukraine destroyed its energy cost profile. It has to be said that we are not seeing an awful lot of benefit accrue to the UK from its Brexit, which has leant hard on sterling, but given that its markets have digested the consequences, the UK is almost certainly a better value play than Europe, which seems pretty expensive for the limited rewards available.
Overall the US deserves its outperformance over the years, but that doesn’t mean it’s sustainable. Remember what hedge fund manager Cliff Asness said about doing the right thing? You can be wrong for the right reasons for a very long time. I am OK to be underweight the US in equity indices, even though I am constructive on most markets.
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