Head of Equity Strategy
Summary: It's been a stellar month for equities, though some regions have been markedly more successful than others. Looking ahead, we take a look at MMT (Modern Monetary Theory) and its implications for global assets.
Emerging Markets were weak relative to the world due to a strong USD and surprisingly weaker than expected macro numbers out of China except for total social financing. The biggest gainer was South Africa, which extended its impressive gains since December despite weaker manufacturing PMI figures and the worst leading indicators since 2010. South African equities have typically been a late business cycle market so the current developments are not fitting past patterns.
The OECD’s leading indicators declined as of February to the lowest levels since 2009 and continue to suggest a weak economy. Asia is leading the world and on the positive side leading indicators on the South Korea economy turned higher in February. Macro forecasts are filled with false positives and it’s still too early to say whether South Korea has turned a corner.
China’s recent negative PMI surprise for April indicated that things have stabilised but a sharp rebound is maybe in the making. The current business cycle phase, measured on OECD’s leading indicators, is what we call Recession which sees elevated risk of recession unless policymakers address issues in the economy and financial system. Until further data present itself we expect the economy to remain weak. The Chicago Fed National Activity Index (tracking 85 indicators on the US economy) also suggests that the US economy is slowing rapidly to the lowest levels since May 2016 when the global economy was beginning to heal from the rout in emerging markets/China.
While equities were clear in their message during April the macro data were confusing. China surprised negatively on their PMI figures and the noise around the US-China trade deal continues to linger. The South Korean won has been under pressure due presumably a shortage of USD and the weaker Chinese numbers. But tonight, South Korea published April export numbers including exports to China which is the most important series to track. While South Korea exports to China are still down 4.5% y/y the slowing is slowing, in other words things are stabilising, which leads to the next question.
Will the policy change in Q1, more dovish central banks and Chinese stimulus, deliver more positive change and kick the economy into the Upswing phase of the business cycle? The economy will for sure shift into the Upswing phase but the question is whether it will be a short period before returning to Recession phase.
Judging from the incoming data we believe OECD’s leading indicators on the global economy may have turned positive in April, but we will not know this until early June. The Eurocoin Growth Indicator released by Bank of Italy is the best real-time GDP tracker on the euro area, slowed again in April to 0.18, indicating annualised growth of around 0.8% in the euro area. While still slowing down, the indicator is definitely stabilizing, confirming the stabilisation in Asia. The next couple of months will be about whether this is a fragile stability or it is a turning point for a firmer upswing.
Earnings season takeaways
The earnings season is unfolding as predicted. US and European earnings are slowing down to the worst earnings season in three years. US earnings are relatively stronger than Europe due 1) larger technology and media segment, 2) higher growth and 3) more buybacks, pushing down the index divisor. But this earnings season is much more than the aggregates. There were two earnings releases that stand out. providing clear signals to investors.
1) Google’s miss on advertising revenue was more an Amazon story than a Google story. For the first time ever, Google has finally got a competitor that is taking market share in online advertising on products and that’s Amazon. Our channel checks suggest that this trend is real and that has implications for Google. Advertisers will love a choice so Amazon will see more allocation by advertising agencies and the bigger question is whether Amazon has a better value proposition because advertising on their platform is better integrated with actual products (on Amazon.com) and buying behaviour. We believe the Amazon vs Google story will drive sentiment on Google over the coming years and Alphabet (Google’s parent company) will be forced to step up monetisation across its other digital assets such as YouTube.
2) Intel’s big miss, driven by lower than estimated revenue from Datacentres and their negative revenue forecast for that segment this year, was a big surprise. Some interpreted the news as demand weakness for datacentres tying it to recent macro weakness, but Nvidia’s data suggest that Intel is merely losing market share to Nvidia. Demand for datacenters is still very strong judging by Amazon’s Q1 figures for AWS revenue.
What is MMT and is it coming?
Everyone engaged in financial markets will have to understand MMT (Modern Monetary Theory), because the subject could take center stage during the 2020 election in the US. But elsewhere the conversation is also heating up with the CEO Hans Sterte of the Swedish pension giant Alecta giving ammunition as he has criticised the current Swedish policy framework on monetary affairs.
From the papers we have read it seems MMT is better at explaining what we actually observe on the economy. MMT will most likely increase nominal GDP growth but the question is whether it will raise real GDP growth as well, or inflation will just eat up the increase in nominal growth.
If inflation rises meaningfully this will most likely help changing the income and wealth distribution (which has worsened due to financial asset QE in many countries) without raising direct taxes. Another big question still remains around inflation as the real constraint on fiscal spending. The proponents of MMT are still adequately addressing how the government should be able to forecast when inflation is accelerating out of control. History shows that inflation dynamics are conditional and thus after a certain point it may not easily be tamed again.
Below are a couple of links to articles about MMT that are worth reading.
- A Swedish Investing Giant Is Sick of His Country's Policy Misses
- The Macro Tourist Presents: A Practitioner’s Guide To MMT
- How government deficits fund private savings