Monday digest

Posted 30 October 2023

Overview: The resilience narrative comes under pressure
In recent times, a fall in bond yields (and therefore a rise in bond prices) would go alongside rises in equity prices, particularly the mega-cap growth consumer-related techs like Amazon, Alphabet (Google), Microsoft and Apple. However, last Thursday, US Treasury long maturity bond yields started to retreat from highs but US stocks carried on lower. In the credit markets, despite the higher government bond prices, corporate bonds were flat to weaker, especially among the more indebted companies. If this new dynamic continues, it may signal a change in investor expectations about the resilience of US sales and earnings growth.

In particular, concerns are building that the US consumer is running out of steam. The third quarter corporate results at Alphabet, Amazon and Meta were seen as good as they will be for the foreseeable future. Investors are worried the digital ad market is slowing. Meta disappointed (shares dropped more than 4%) after its executives warned of softer advertising spending, Alphabet slumped 9.5% last Wednesday, and despite a healthy quarter, Amazon stock was still down on the week and -17.5% below its 13 September high for the year.

To us, this seems to indicate waning investor confidence in US consumption. As a consequence, the stock market leadership of just a handful of darlings is waning.  This is not necessarily a bad thing, but the risk is that it leads to a more significant correction beyond those names. US consumers could suddenly feel a lot less well-off, slowing demand much too quickly. This would force central banks into slashing rates much earlier than anticipated. The European Central Bank (ECB) met on Thursday and left rates unchanged (more on this below). The other global rate setters of the Federal Open Markets Committee and the Bank of England (BoE) meet next week. The stalling of the oil price and other energy price rises also should allow the rate pause to continue. All ears will be on the respective statements and press conferences. We expect dovishness from the BoE given the slowing inflation environment, the easing of employment tightness and the weak house market.

The oil majors double down
October has seen two of the biggest acquisitions in the history of the oil and gas industry. Last Monday, Chevron announced it will purchase fossil fuel producer Hess for $53 billion, less than two weeks after rival ExxonMobil agreed a whopping $59.5 billion deal for Pioneer Natural Resources. The megadeals have naturally caused stirs in the industry, suggesting anyone that thinks the world will soon wean itself off fossil fuels is kidding themselves. Clearly, corporates do not commit tens of billions without a plan that can withstand shareholder scrutiny. But, megadeals are not always a sign of confidence; rather than expansion, Chevron and Exxon might be consolidating ahead of an uncertain future.

This defensive interpretation is backed up by the fact that stock valuation premiums for recent oil and gas deals have been extremely small by historical standards. Pioneer sold for 9% above its market share price, while Hess Corporation accepted a 10% premium. There is probably a combination of motivations for these megadeals – partly defensive and partly bullish. This mixture has a lot to do with the particular environment that US oil majors find themselves in, certainly compared to global rivals. In the post-pandemic world, amid intense wars in Europe and the Middle East, energy security has become one of the top political priorities for every nation.

Europe’s quest for energy independence is inescapably tilted towards renewables: it has lots of capacity for solar, wind and hydro power (and relatively smaller distances for electric grids to cover) but little capacity to mine its own fossil fuels. The US has plenty of oil and gas, and its consumers are hesitant to change, particularly if that comes with higher short-term costs. For the world, we can hope that European reasoning wins out. Or that at least fossil fuel rich countries don’t lose track of alternatives and CO2 neutralisation technology development in parallel.

Is the ECB turning dovish?
Economic ills have put pressure on the ECB to slow, stop or even reverse its aggressive monetary tightening. Like most developed world central banks, the ECB is very worried about tightness in the labour market and the potential of the dreaded wage-price-spiral leading to persistent inflation (wages, profits and prices all increasing in response to each other). Wage rises in particular have been far outpaced by inflation in the Eurozone over the last year, meaning a sharp deterioration in household spending power, along with higher borrowing costs and a general dwindling of economic prospects. Speaking after the meeting, ECB President Christine Lagarde said growth is “likely to remain weak over the remainder of the year”. Policymakers are reasonably confident that price increases are coming under control, but – as the recent shift up in commodity prices and outbreak of another Middle Eastern war have shown – they are wary that externalities could turn for the worse, providing yet another input cost shock. Lagarde specifically mentioned the Israel-Hamas war’s potential effects on energy.

Over the last few years, the ECB has also made clear its concern for inflationary profit expansion – the flipside of the wage-price spiral, often ignored in British and US discussion. That being said, Europe is clearly in a different place to the US, where growth, jobs and consumer sentiment have been incredibly resilient despite a barrage of global pressures. We wrote last week that this was largely down to Americans’ willingness to draw on excess savings built up during the pandemic (though these are arguably dwindling, perhaps supporting the Fed’s recent decision to keep rates on hold). In Europe – and the UK for that matter – wage growth is moderating and consumers are clearly not feeling too confident.

The monetary impetus for inflation in Europe has fallen away, and there is no real economic impetus to replace it. A similar dynamic is taking hold in the UK – even if the Bank of England still has its hawks and hence might yet raise rates again. The US is not seeing this yet but, as we wrote last week, this is likely to change the more that excess savings come down. This side of the Atlantic, however, central bankers have every reason to turn dovish, and the evidence from last week’s meeting is that the ECB already has.