Monthly Market Outlook
Ebullient equity markets don’t guarantee a fairy-tale ending
March 2023 (Click here to download)
Financial markets have enjoyed a Goldilocks scenario in recent months, characterised by buoyant equities and falling inflation. Can it last, or will we soon find ourselves in Baby Bear’s chair?
We’re coming off an encouraging winter: equity markets have risen, inflation has retreated, and Central Bankers have lessened their appetite for rate rises. The question we need to ask now is: can this continue?
The hope is for a lasting Goldilocks scenario where inflation falls fast which allows policymakers to cut rates which, in turn, keeps growth healthy enough to support the equity market gains and earnings we saw in the first quarter.
But, on the other side of the coin, is a ‘heads, you win/tails, I lose’ scenario in which one of these factors takes a wrong turn. Along one path, inflation doesn’t fall fast enough to allow policymakers to cut rates which would have a negative effect on demand. This would, in turn, discount companies’ stock prices, causing earnings to fall. Down another road is even higher interest rates; while inflation would fall, this situation would also be bad for equity markets, as, on the business side, costs wouldn’t fall as quickly as revenues.
So, what happens if the dark side wins: if inflation doesn’t necessarily retreat and policy rates stay high? In this situation, demand would fall, but businesses would be bogged down by sticky cost pressures which would have a dampening effect on their earnings. Unfortunately, if unsurprisingly, the most recent earnings season featured signs that this less encouraging scenario may be most likely.
If costs stay high, companies will experience a squeeze on margins which will, in turn, drive profits down; businesses may begin to see lower share prices and more challenging forecasts. Despite a positive start to the year and inflation beginning to weaken, there’s tentative evidence that it’s not falling fast enough; this creates upward pressure on Central Bankers, the gatekeepers of interest rates, and downward pressure on the equity markets, where the jubilance of January and the post-Covid era may prove short-lived.
Chart 1: Q1 earnings showed profit margins are declining
For now, many market participants seem to think things look just right: growth has been surprisingly robust stateside and European equity markets are up, the region having largely avoided the predicted energy crisis thanks to forgiving winter weather. Positive macroeconomic data has sent markets rallying. But these statistics are a reflection of the past. The job of the Manager as investors is to adopt a global perspective and take a spherical view of the story unfolding: that is, to consider the data and consensus expectations, but fortify its portfolios just in case the porridge is eaten while its back is turned.
“There is no magic bullet, no single indicator that will tell us what’s happening with growth or inflation. However, using multiple sources and expert judgement, it’s possible to extract the signal from the noise.”
Head of Investments, atomos
The number of people employed by the US technology sector.
Investment View: Decoding the clues in data releases
Mapping the way forward via macroeconomic data isn’t as straightforward as it seems.
Knowing what economic indicators to heed and what they’re trying to tell us is challenging at the best of times. Throw in a pandemic, hawkish Central Banks, rampant inflation and implausibly high employment data, and the picture becomes downright indecipherable.
Currently, policymakers are trying to glean a clearer picture of where we’re at. As discussed previously, the global economy appears to be approaching an inflection point at which things will either go swimmingly or start looking shaky. But an individual nugget of data taken in isolation does not tell a story.
The US technology sector is a perfect illustration of this. With large-scale lay-offs, often an early feature of lasting recessions (see: the tech bubble bursting in 2001, the shuttering of Bear Stearns), the public would be forgiven for feeling uneasy about headlines detailing mass job losses at the likes of Microsoft and Twitter. The latter laying off a tenth of its workforce seems a stat worth fretting about.
Big Tech isn’t as big as you think
Here’s where the figures can be misleading. It’s true US tech is shedding jobs – but there are record vacancies in other industries. This is because, despite the press the sector garners and the influence it has on our everyday lives, the tech sector isn’t a massive employer; of 160 million employed Americans, only 12.2 million – or 7.9% – make a living in IT. It’s a very important sector in equity-market terms, but, in labour-market terms, it’s not. The size of the tech sector as an employer pales in comparison with the breadth of its market cap (it generally comprises 20–30% of the S&P 500), which can make for misleading newsflow. Eleven thousand job losses at Meta is undoubtedly a startling headline, but, in truth, it does not dent employment data as a whole. (Additionally, the company’s specialised workforce is likely to find other work and quickly).
Chart 2: The tech sector’s portion of the employment market is much smaller than its market cap
Further muddying the waters of recent economic data is the lasting effect of the Covid pandemic. Big Tech boomed as employees established home offices to the benefit of businesses like Zoom. Amazon doubled its headcount while consumers stuck at home spent money on its wares, but in February announced it would eliminate 18,000 jobs of the 1.6 million on its books. Employers cut back on tech spending as workers returned to offices, which caused revenues to fall and tech companies to scale back significantly expanded workforces.
No stat is an island
Plucked from the statistical soup on its own, no fact or figure will tell the future. Consider each data release but commit to reserving judgement: numbers have been highly volatile in the post-pandemic era. Late 2022 saw floundering figures; weeks into 2023, they were up. Policymakers have to depend on this data and, so, they’ll wait for a clearer picture; one that, the Manager believes, will probably show figures somewhere in the middle.
So, despite what’s happening in Silicon Valley, the labour market is likely to remain strong, which, to take it back to our earlier point, decreases the likelihood of a Goldilocks scenario as a healthy job market and steady wage growth could keep inflation elevated. The Manager’s read of the US labour market, based on sometimes conflicting data, is that it’s humming along nicely – too nicely for the Federal Reserve’s taste. The final battle in the fight against inflation may yet be upon us.
atomos is the trading name of Atomos Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Atomos Investments Limited is registered in England and Wales, No: 2041819. Registered office: Monument Place, 24 Monument Street, London EC3R 8AJ.
The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice.
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