Strong US data con­firm un­der­weight

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Data re­leased on Fri­day reaf­firmed the ro­bust health of the US do­mes­tic sec­tor. Para­dox­i­cally, this only strength­ened our con­vic­tion that in­vestors should un­der­weight US eq­ui­ties in favour of other mar­kets.

The July pay­roll re­port did not spring any sur­prises, but it did con­firm the sta­tus quo—that the US labour mar­ket, while still grow­ing, is look­ing in­creas­ingly tight. July pay­roll growth was sta­ble at just over 200,000; un­em­ploy­ment was steady at just 5.3%; hours ticked up by a hair, and pri­vate hourly earn­ings growth inched up from 2.0% to 2.1% yearon-year. Fol­low­ing re­cent con­flict­ing sig­nals on wage growth, Fri­day’s data fit in with our ex­pec­ta­tions that tighter sup­plies of la­bor will lead to a ris­ing trend in wage growth.

Al­most two years ago, we claimed that US house­holds had largely re­paired their bal­ance sheets and that they were likely to start adding debt again, fur­ther en­cour­aged by low in­ter­est rates. This re­newed ap­petite is now show­ing up in credit card and auto loans. So far, house­hold mort­gage debt has only sta­bilised, but we ex­pect growth there soon as well. Even­tu­ally, debt in­creases will lead to trou­ble, but for now they boost con­sumers’ power, which has also been juiced up by the fall in energy prices.

So, why does all this ap­par­ently pos­i­tive news lead us to re­it­er­ate our un­der­weight view on US eq­ui­ties rel­a­tive to other eq­uity mar­kets? A few rea­sons:

1. So long as the largest con­sum­ing block in the world is show­ing strength, the chances of a global re­ces­sion are

lim­ited.

If we were to see a US re­ces­sion in the mak­ing, we would not want to be over­weight non-US eq­ui­ties, but in­stead over­weight US long bonds. How­ever, this is not (yet) the core sce­nario for some of our col­leagues, such as Tan Kai Xian.

2. A in­ter­est stronger US con­sumer rate “lift-off” this year.

in­creases

the odds

of

The lack of any ma­jor de­te­ri­o­ra­tion in July’s labour data keeps the door open for the Fed­eral Re­serve to do as it wishes. And it wishes to start hik­ing rates—how­ever timidly—be­fore the end of 2015, and per­haps as soon as the Septem­ber 17 meet­ing. His­tor­i­cally, rate hikes have weighed on eq­uity mul­ti­ples. And while it is pos­si­ble that earn­ings growth could more than com­pen­sate for the mul­ti­ple con­trac­tion, this could be dif­fi­cult given our next fac­tor...

3. Strong do­mes­tic data sup­ports the US dol­lar at lofty lev­els.

Con­sid­er­ing that the US dol­lar is now clearly over­val­ued against al­most ev­ery cur­rency out there, ex­cept for the Chi­nese ren­minbi, we are neg­a­tive on the US dol­lar over the long-term. How­ever, it could be some time be­fore the US dol­lar cor­rects. So long as do­mes­tic data is sup­port­ive of Fed rate hikes, while most other coun­tries re­main miles away from even think­ing about rais­ing rates, the US dol­lar is likely to re­main strong. The US dol­lar’s rise has al­ready hurt the profit num­bers of multi­na­tion­als, be­cause of the trans­la­tion ef­fect. If the cur­rency now stalls at these un­com­pet­i­tive lev­els, fu­ture profit pains will be felt most keenly by US ex­porters, and by do­mes­tic pro­duc­ers who com­pete with for­eign mak­ers of trad­able goods. So, while bad news for US pro­duc­ers, a strong US con­sumer and a strong US dol­lar are great news for for­eign pro­duc­ers.

More­over, with the strong US dol­lar en­cour­ag­ing a widen­ing of the US cur­rent ac­count deficit, more US dol­lars will flow abroad—which usu­ally leads to the out­per­for­mance of non-US mar­kets.

This is not to say that the prob­a­bil­ity of a US and global re­ces­sion in the next 12-18 months is zero. As Charles Gave has high­lighted re­cently, there are some wor­ry­ing signs that need to be as­sessed along­side all the pos­i­tives (man­u­fac­tur­ing is weak, profit growth is weak, and while cor­po­rate in­ter­est rates are still low, they have ticked up some re­cently). Ap­pro­pri­ate port­fo­lio pro­tec­tions should be in place. Charles says he is get­ting very close to call­ing for re­ces­sion—and that he will do so if his in­di­ca­tors de­te­ri­o­rate any more. How­ever, we do not yet see a re­ces­sion in the mak­ing. As a re­sult, we con­tinue to ex­pect su­pe­rior re­turns from non-US mar­kets, such as Ja­pan and Europe.

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