Monday digest

Posted 29 January 2024

Overview: Positive growth sentiment returns
After January’s bumpy start, and the volatile two weeks that followed, it looks like investors are finding their feet again. Almost entirely across the board, regional equity markets are up another healthy amount, with even China managing another positive week. And as suspected, bond markets are having an extremely busy January.

Government debt yields have declined by around 1%, but for riskier corporate borrowers, the turn in sentiment in both markets and economies has resulted in reduced fears of defaults – which has additionally driven down the risk premium (spread), they have to pay above the government. In the US dollar bond market, the US government was paying 10-year interest of just less than 3% in September 2018. Now the yield is about 4.1%. A borrower with a credit rating just below investment grade (BB-rated) was paying just over 6% in September 2018, and now will pay interest of around 6.5%, according to Bloomberg. Only three months ago, that BB-rated borrower was looking at paying over 8%. Perhaps it is no wonder corporate borrowers feel current yield levels are reasonably attractive enough to replenish their loan capital side. The story is similar in the Eurobond market, which has already seen record issuance for January.

It is a good sign for markets and economies that more companies think this is a good time to borrow money. This rise in spirits is getting some backing from moves in the commodities markets (which we write about below) and from business sentiment surveys like the ‘flash’ purchasing managers’ index (PMI) surveys from across the world, released last week. Perhaps sentiment is not racing ahead, but the broad composite measures – which include both manufacturing and service sector companies – are now generally heading above the 50 level, which signals the difference between companies thinking they are in growth or decline. Indeed, the US, UK and even China are at or above the 52 level (which aligns with activity at a normal level and optimum capacity usage).

So, markets have returned to the frame of mind where optimism is slight and risks have been high but are falling. The European Central Bank (ECB) did its bit to keep confidence stable last week. Nobody expected a rate cut (and none was forthcoming) but President Christine Lagarde said there was “stabilisation” in some wage indicators and that companies were currently absorbing wage hikes, reducing the risk of second-round effects on prices. She also gave little pushback when asked about a spring rather than summer start to cutting rates. Next week is the turn of the US Federal Reserve and then the Bank of England. Again, nobody is expecting rate cuts, it will be all about the comments.

Will Xi allow China to profit?
Last year’s prolonged decline in Chinese stocks continued well into January, but last week, Hong Kong’s Hang Seng index rose more than 6% during midweek trading, after news that the Chinese government would step in to stop the rout. On Tuesday, Premier Li Qiang called for “more forceful and effective measures to stabilise the market and boost confidence”. On Wednesday, the People’s Bank of China (PBoC) cut bank reserve requirements, thereby unleashing a trillion Yuan of lending headroom into the banking system. Both the Hang Seng and the CSI 300 – mainland China’s benchmark stock index – rallied in response. Perhaps Beijing is willing to put its money where its mouth is and – crucially – wants markets to know it. Its words and actions are certainly a step in the right direction and, coming so soon after Premier Li’s speech, will soothe some investor concerns. Ultimately, though, attempts to support short-term confidence in the economy or financial system do not address the core reason for why businesses and investors lack confidence to begin with.

During the crackdowns of the last few years, there has been a growing sense that President Xi Jinping is against not just excesses but private sector profit altogether. He has made it clear that private power cannot be allowed to rival the state (as in the case of Alibaba founder Jack Ma) but this seems to have filtered through to profit-making in general. People are willing to take advantage of the short-term market opportunities the Party hands out, but to truly invest in long-term private sector growth investors need to know they will be allowed to profit without negative comeback. This needs consistent messaging, ideally from Xi himself. Without that, the decline will be hard to stop.

Commodities and growth
The Dow Jones Commodity Index has been virtually flat since the beginning of the year. That is either a good or bad sign, depending on how you look at it. Considering the intentional slowdown in global growth recently, a stable if unspectacular patch should be welcomed. On the other hand, this comes after a protracted downturn for the commodity sector. Dow Jones commodities have lost nearly 9% on a one-year basis at the time of writing. Staying flat is less impressive if the level is already low.

Of course, much of that downturn was about oil, but oil is no longer a great indicator of general economic conditions. Metals, in particular industrial metals, are arguably a better signal. The S&P Industrial Metal index has been flat for some time, currently at the same level it was in May last year and with only a narrow trading range since then. But metals became detached from energy prices last year, and that detachment is ongoing. Again, stable metals prices are encouraging, all things considered. Global manufacturing has been struggling for a long time, and despite improvement across the board, manufacturing PMIs still point toward contraction in the UK and Eurozone. The only exception is the US, where the manufacturing PMI unexpectedly jumped to 50.3 in January. US resilience and outperformance is nothing new, though, and is offset by weakness elsewhere – particularly the disappointing China.

The problem for metals is that they cannot sustainably rise on hope alone. Like all commodities, metals futures are subject to short-term speculation but are ultimately physical materials that need to be financed, stored, transported and used. The cost of storage has risen dramatically in recent years thanks to the massive step-up in developed market interest rates which led to a big increase in the cost of the tied-up capital. That means inventories are generally lower, which means prices are much more sensitive to final demand. As such, we are unlikely to see a sustained pick-up in metals prices until growth and demand actually come through.