Monday digest
Posted 2 October 2023
Overview: Economic resistance is about to be tested
September is rarely a great month for investors, and last month proved no exception. Broadly, both equities and bond values declined and there is increasing sentiment that the 2023 market recovery is running out of steam or may even be turning. This may seem surprising to investors as earnings have been more resilient than many economists had thought possible.
In addition, US government subsidy programmes like Creating Helpful Incentives to Produce Semiconductors (CHIPS) and the Inflation Reduction Act (IRA) have added to near-term economic activity, surprising economists and central banks and causing them to wonder whether the resilience might be all due to the time lag in the effect of their rate rising efforts, rather than lasting strength. However, the nature of lags is such that the next quarter’s US earnings are more likely to continue to show resilience than weakness. Employment has clearly remained strong through the summer and that should mean that consumer spending also remained fairly stable. This makes us expect a generally solid third quarter – but company outlooks looking further out may be less so.
While investment grade companies had recently been raising finance (at least in the earlier part of the third quarter), smaller, less credit-worthy companies decided to wait for lower rates and quite a few have been waiting since rates started to rise early last year. Now though, with rates at new highs (instead of falling as many had expected), and with the ‘higher for longer’ narrative, the cost of refinancing is likely to become more pressing for growing numbers of businesses around the developed world. All-in-all, this latest round of increased interest rate costs has the potential to have a quicker impact than previous rounds, because it has been so unexpected and because it leaves less time for those awaiting refinancing. Stress levels could reach breaking point, especially where it becomes paired with revenue weakness. None of this implies economic disaster looming over the last quarter of 2023. What it does mean though is that the ‘Goldilocks’ environment of the past two quarters is likely to end. This may result in an uptick in market volatility and a return of the same ‘between hoping and dreading’ narrative of autumn last year. It also raises the probability that long-term bonds at the yield levels they touched last week may prove rather good value for investors with a longer-term perspective.
US narrowly avoids another government shutdown
For much of last week, another US government shutdown looked inevitable. Current funding for federal operations was due to end on Sunday and federal employees were unsure when their next pay checks would come. But on Saturday night, both houses of Congress voted in favour of a last-minute measure to keep the government funded until mid-November, although they left out billions of dollars of aid for Ukraine. President Joe Biden signed the stop-gap deal just minutes before the midnight deadline. Arguably the biggest loser from the deal could be House of Representatives’ Speaker Kevin McCarthy, as working with Democrats across the floor has inflamed the Republicans on the right of his party, and look like resulting in a no confidence vote that sees McCarthy lose his job.
For investors, concerns about US finances are mostly short-term fears about politics. Shutdowns and debt scares are regular occurrences in the world’s largest economy, but capital markets do not generally move too much in response. But the threat is symptomatic of a larger problem that fraught US politics poses to its economy. Extended shutdowns in the past – most famously in 2011 – have led to measurable drags on US growth, and ratings agency Moody’s emphasised a shutdown would “underscore the weakness of US institutional and governance strength”. Of course, the agreement reached at the weekend only offers temporary respite from the political posturing. In November another deal will need to be reached, or the shutdown spectre returns. The key question is therefore, will Kevin McCarthy still be House Speaker by then, and if not, will a less conciliatory replacement make good on Republican shutdown threats?
US mega techs vs. modern antitrust law
US tech giants beware; there’s a new sheriff in town. Last week, the Federal Trade Commission (FTC) brought a long-anticipated case against Amazon, suing the e-commerce behemoth for alleged violations of antitrust law. The case is a passion project for FTC chair Lina Khan, who believes anti-competitive behaviour is about broad market influence, rather than just narrow price rises coming from provider consolidation. The FTC’s complaint against Amazon is how it treats third-party sellers – which account for around 60% of all products sold on its platforms. The platform’s algorithms promote sellers that store goods in Amazon warehouses and use Amazon delivery trucks, but the fees to do so have gone up an estimated 30% in the last three years. Research firm Marketplace Pulse estimates third-party sellers pay around half of their revenues directly to Amazon.
Of course, it can be hard to convince people that Amazon is making things more expensive for consumers when it seems cheaper than the alternatives. The company is naturally trying to argue that its preferential practices are solely based on price and ease for consumers – these being often tied to Amazon’s own logistics simply because of their wider efficiency. And while the company has around 37.6% of all US online retail, according to Insider Intelligence, this is only 3.5% of total retail. It has already started a PR campaign claiming that any of the FTC’s recommended remedies will reduce choices and harm consumers.
As Khan herself noted some years ago, the deeper problem with US antitrust law is that it is based on policing old-fashioned companies that behave nothing like the tech giants we have now. The speed of tech innovation – particularly in the age of artificial intelligence – makes it a political necessity to modernise our understanding of monopolies. It is one of the reasons that constraining the power of the big tech companies is a rare point of bipartisan agreement in Washington DC. Even if Khan fails in her latest charge, the policy tide is clearly turning against big tech – with likely longer-term implications for the willingness of investors to extrapolate their past growth rates into the future to justify extended valuations.