It’s been the first five-day week for a little while so congratulations for making it this far!
While it’s been longer it has been quiet in financial markets with the US debt ceiling yet to be concluded but the ‘mood music’ improving somewhat with both sides suggesting there is potential for a deal to be reached in the near future.
In terms of the debt ceiling, the brinkmanship has continued but markets, outside of short-dated Treasury bonds, have appeared to be untroubled. Indeed, with more encouraging headlines in the last couple of days, US equities have seen some positive momentum. President Biden met with House Speaker Kevin McCarthy on Tuesday and the headlines after the meeting were more positive than we have seen previously. McCarthy described the meeting as “a little more productive” but said the sides were still some way apart. That said, he did comment that “I think it is possible to get a deal by the end of the week” adding on Wednesday that a deal was “doable”. That would be a very positive outcome, but we should remember any deal will need approval of the House and Senate ahead of early June when Treasury Secretary Janet Yellen has said the money will “run out”. It appears that Congress is being lined up to vote on a deal at some point next week. Biden said there was some “consensus, I think, among Congressional leaders that defaulting on the debt is simply not an option”. Talks are ongoing and, and President Biden will keep in touch during his trip to Japan for the G7 summit, before returning early to the US to be on the ground for further negotiations.
The economic news has seen China issue their monthly ‘data dump’ with the theme of an unbalanced recovery post-Covid continuing. Retail sales showed growth of 18.4% year on year; this was some way below expectations, as were industrial production, up 5.6% and fixed asset investment, up 4.7%. China’s recovery has been led by consumers, while the other data points suggest that the manufacturing side of the economy remains sluggish, likely not helped by weak demand from western economies. After the first quarter GDP data there was optimism that China would see growth of 6% this year, but if the data continues to disappoint, we will likely see an expectation that China’s authorities may feel the need loosen monetary and fiscal policy along with other measures not least around the struggling property sector. Japan published solid first quarter growth data, with GDP advancing by 1.6% on an annualised basis, a market improvement from the decline of 0.1% in Q4 2023 and led by the services sector on the back of post-Covid reopening.
In the UK we’ve seen the employment data take a slight turn for the worse, with the unemployment rate rising from 3.8% to 3.9% and payrolls falling by 136,000 in March – the first decline since February 2021. Wage data showed earnings growing by 6.7% year on year, an increasing pace. Bank of England governor Andrew Bailey noted for the first time the UK was dealing with a wage-price spiral while pledging to raise interest rates “as far as necessary” to get inflation back to the bank’s 2% target. Bailey observed that “second round” effects of inflation reflected the spread of price rises in energy and food into generalised wage and price setting by companies. Bailey sees the outlook for inflation as dependent on the “extent and persistence in wage and price setting”. While base effects will bring inflation lower in the coming months, the Bank’s 2% target is, for now, a long way away.
Our asset allocation meeting this week saw no major changes to our overall positioning, but we did adjust our regional biases. We remain underweight equities and alternatives and continue to favour bonds and cash; we’re also moving some of our cash allocation to hold some gold. The change in our regional positioning is to pare back slightly our overweight in Asia to allow us to add to Japan, taking the portfolios overweight. Our Japan review has recently concluded and while there are perpetual unknowns around Bank of Japan policy, the top-down view is supported by fiscal stimulus. What is most compelling is from the bottom up, where companies, encouraged by the Tokyo stock exchange, appear to be in another wave of trying to be more shareholder friendly, seeking to improve profitability and shareholder value along with stronger corporate governance. If nothing else, the TSE’s strategy has heralded a new wave of international focus on Japan, and highlighted that valuations are compelling.
We remain underweight in the UK, US and Europe, where the impact of rate hikes is yet to be fully felt but it already having consequences, as we have seen with the bank failures and data highlighting contracting credit conditions. Markets appear somewhat range bound for now, awaiting what must be the most anticipated recession in history to begin. In the short term we need to be cognisant of US politics and the noise around the debt ceiling, but our longer-term concerns remain around the prospects for economic growth and corporate profits in an environment of higher rates and sticky inflation.
