Head of Market Analysis, Janet Mui discusses triggering U.S. jobs data, while Chief Strategist, Guy Foster, adds context to the global stock sell-off and why there may still be ways to a soft landing.
It’s hard to know where to begin with the market activity of the past few days, but things have certainly been volatile, and this week kicked off with a sharp sell off.
With lots of different stories emanating from the market, we can also seek to draw a lot of them together.
Weak U.S. jobs figures fuel fears
Let’s begin with U.S. employment data. Jobs growth decelerated to 114,000 new jobs per month, which doesn’t sound too bad and indeed it isn’t, the long-term average is around 160,000 new jobs per month.
The unemployment figures have ticked up a little which may seem counterintuitive in a month in which net new jobs were created but can be explained by a couple of factors. The first is that the unemployment rate and the jobs growth metric are estimated separately so they can tell different stories. The second is that the unemployment rate can increase because people have lost their jobs, or it can increase because more people have started looking for jobs. This month it increased because more people are looking for jobs, having ceased temporary employment.
The relatively new weakness in the labour market follows some consumer facing companies reporting changing consumer behaviour, such as spending less, seeking
discounts or trading down to cheaper products. All of this has conspired to suggest the consumer might be in distress and the U.S. may be sliding into recession.
Is a recession realistic?
Of course, a recession is possible, but it does not seem likely. U.S. consumers are seeing their incomes growing even after adjusting for the impact of inflation – they have weathered the inflationary storm.
Although the labour market has loosened, it remains relatively tight – there were two jobs for every unemployed person in March 2022. That figure has declined but there are still 1.2 jobs per unemployed person even after this latest pick up in the unemployed. Before COVID-19 struck, 1.2 was the most jobs per unemployed person the U.S. had seen since it began recording these data in 2001. So, it does seem as if the U.S. labour market has loosened, but in quite a healthy way.
We are very conscious that economic data takes a while to compile and can be revised. Employment data, despite being the factor most synonymous with recession, can be quite slow to indicate one is coming. One way around this is to look at surveys. Business surveys like the purchasing managers indices were weak last month but have actually rebounded this month.
We have had a number of these rebounds over the last week. The benchmark Services ISM index revealed a rebound from a depressed level during June. It showed
new orders increasing, employment growing, inventories contracting, and the backlog of orders extending. The S&P Global U.S. Services PMI is less prestigious but has a wider participation. The message there was similar.
S&P do a series of sectoral survey reports as well. The latest edition showed six out of seven sectors reporting expanding output with only basic materials contracting.
The survey did record a slowdown in consumer demand with an expansion described as “fractional”.
Aside from surveys we can also draw insight directly from companies. We are deep into the second quarter earnings season and while the periods being reported
upon seem distant even by macroeconomic data’s standards, the messages that accompany them are very relevant indeed. Like so many earnings seasons (basically all of them) around 80% of U.S. companies have managed to exceed earnings estimates, a phenomenon which owes more to the ability of companies to massage those estimates down than it does to some unexpectedly good corporate performance.
Looking at the tone from companies, the consumer stocks have been a little downbeat (although not all of them, Proctor and Gamble saw none of the consumer
activity their peers noted). But to get a better sense of consumers’ health, the banks often have greater insight. For example, Bank of America says deposit and investment balances remain 25% above their prepandemic levels. JP Morgan said there was little to see in terms of delinquencies beyond a little behaviour that is consistent with “a little bit of weakness” amongst lower income groups. This echoes the payment companies such as Mastercard and Visa which saw more debit and less credit card activity – usually a sign that consumers are being prudent. Experian, the consumer credit monitoring company reported that delinquencies actually look to be peaking.
Overall, the consumer remains in good condition. The circumstances seem to lend themselves to the Federal Reserve cutting interest rates, and from their current
level that can provide significant support.
Why then are shares falling so fast? Interest rate cuts were allegedly what the market was looking for just a few months ago.
Understanding the stock sell-off
There is something quite technical going on in markets at the moment and it’s called the unwinding of the Japanese carry trade.
A carry trade means investing in a high yielding asset. In its purest form it means borrowing at a low rate and investing to earn a high rate. Over the last few decades
Japan has presented a lot of opportunities for carry trades because its very low interest rates made it an ideal source of borrowing. Imagine if you can borrow in yen below 1% and invest in dollars at 5% (a conservative estimate of the current interest rate differential).
Because it relies on borrowed money the trade is very attractive and can be implemented many times over, subject to the investor’s tolerance of risk.
What is that risk? Well, as investors borrow in the yen the value of the borrowing declines and the value of the U.S. asset appreciates, making the trade more valuable. However, if the yen were to appreciate then the value of the debt increases relative to the asset.
Putting this in the context of the current movements in markets, the fact that U.S. interest rates now seem set to decline, potentially quite fast, makes the carry
trade less attractive. As some investors unwind it, the yen has appreciated very fast. This puts pressure on more investors to reduce their positions and becomes
something of a vicious circle.
It seems likely that not all carry traders were invested in U.S. bonds. Some were likely invested in U.S. equities, maybe even U.S. technology equities, as the best performing asset class of the year. The selling down of those positions seems the most compelling rationale for the steep losses some tech shares faced in the early
hours of Monday.
In search of opportunities
We see much to like about several companies in the technology sphere. That does not mean there are not risks that they may be overinvesting, as they battle to lead the artificial intelligence revolution. But it does mean that when we see some investors potentially having to sell shares because they are being squeezed out of a carry trade, that provides opportunities for more prudent investors to buy shares on advantageous terms.
