Global Liquidity and better-than-anticipated January data (inflation, payroll, ISM surveys) have supported markets this year so far…Will higher global liquidity offset cyclical weakness via Central/Commercial Bank tightening?
Global Liquidity/Monetary Policy: Central Bank balance sheets (reduced Quantitative Tightening pace since October/22 in the U.S.) appear to be expanding and used to maintain financial stability while slowly withdrawing support without creating significant bond market volatility/sovereign issuers and strongly rated corporates. Supporting equity markets appears to be a by-product of supporting financial stability and credit markets. Earnings multiples (P/E) are altered by liquidity/interest rates/monetary policy, which is largely what we have seen so far. Earnings expectations are coming down.
Does China’s liquidity impulse kick off restarting the global manufacturing cycle that would support corporate earnings and further global consumption and/or another wave of global inflation via higher commodity prices?
Overnight rates/tight monetary policy is being used to manage demand/inflation. The weakening of demand in end clients (U.S., Europe) via higher interest rates and inflation does not support cyclical uplift in the global manufacturing cycle. U.S. Liquidity has continued to decline close to 3% per annum. Coupled with higher interest rates, Commercial banks are also tightening credit standards, which has reduced demand as well historically as liquidity becomes scarce and some customers are not able to roll their debts and eventually default.
Leading indicators have continued to decline and have bottomed and point to a recession in H2/2023. Coincident indicators are still marginally positive, though growth is slowing. The labor market has yet to see significant stress, though there have been lower hours, less temporary staff, part-time and less job openings. These trends tend to occur before full-scale layoffs. Corporate profits expectations will need to deteriorate further before higher layoffs. An uncertain macro environment is supportive of a trend-following strategy (floating rate bonds (TFLO), Chinese Bonds (CBON) and gold (PHYS or GLD) for the current month).
The U.S. housing has yet to bottom. Home prices continue to fall and appear to have more room to fall. Usually for the economy to bottom, the housing sector will need to bottom. Jobless claims tend to follow the housing market on a 10-12 month lag. At this point, the labor market has remained tight and there may be evidence of labor hoarding, which may be partially related to the monetary illusion related to revenue in high inflationary environments. As margins erode due to higher costs and/or sales volumes decline, eventually businesses will cut labor. At this point based on leading indicators, housing and manufacturing sectors appear to be in recession (industrial production -2% on 6-mth smoothed change). We note that inventory-to-sales ratio (tends to spike during recessionary conditions) have continued to climb, which point to more disinflationary trends in forms of price discounting and lower expected future manufacturing activity.
Current corporate operating earnings for FY2022 (92% reported Q4/22) of $196/share, down 6% YoY. FY2023 earnings expectations have been lowered from $225 to $220/share, representing 12% YoY growth and projecting an earnings recession in H1/23 of (4%). We have seen signs of higher costs reducing profit margins that cannot be recouped via higher prices. Nominal revenues have held up given the monetary illusion of inflation. Inflation-adjusted revenues have remained flat since the middle of 2022. Corporate profit margins are expected to deteriorate further (with 4x companies providing negative outlooks vs positive in Q1/23). Historically, this has led to employer driven-layoffs outstripping employee-driven quits, leading to wage growth coming back closer to the trend. Current consensus 2023 S&P EPS is about 30% above the long-term trend line (earnings growth of 6%) which goes back to the 1880s. Our leading earnings indicator (1-year lead) has us back to the trend line by the end of 2023. Recessions tend to get us back to trend.
Disinflationary trends remain, but appears some service categories remain sticky into H1/23 keeping core inflation elevated at 3.5-4.0%:
Above-trend wage growth due to tightness in the labor market may keep inflation elevated above 2% target in 2023/into 2024 without a recession. Job-switchers have earned a premium of 1.5% higher than job-stayers, which is well above the long-term trend of 0.5%. Employees continue to have bargaining power, though expected to decline over the next 12 months, with wages closer to pre-COVID trend of 3.3%.
Given the pace of the rate hikes in 2022 and lagged impact on the economy, we likely have not seen the full impact of the tightening yet. Monthly coincident data (based on Jan/23) data, growth appears to be re-accelerating employment and personal income growth (though a number of restatements/seasonal adjustments), however, high-frequency data and leading data point to further deterioration. We expect that January data may be revised at a later date.