Monday Digest
Posted 19 August 2024
Tornado rather than hurricane
The market storm looked like it would become a hurricane in early August, but it ended as fast as whirlwind: stocks climbed last week without hesitation. Positivity is good, but a little unnerving. Our medium-term outlook is bright, but there might be further storms ahead.
Last week’s recovery was helped by surprisingly good economic data – including 0.6% Q2 growth for the UK. Markets mainly got excited about US retail sales, which grew 1% month-on-month in July. US consumers are still proving the doubters wrong – counter to the recession fears in recent weeks. If unemployment was about to spiral, consumption would be the weakest part of US data, but in fact it’s the strongest.
We shouldn’t get ahead of ourselves though. A ‘soft landing’ (growth slows without going negative) is on the cards, but not a ‘no landing’ (growth doesn’t slow at all) scenario. Markets reacted like July’s figure was great news, but month-to-month data is noisy and next quarter’s profit growth still looks likely to be a little soggy. We can’t tell yet if market optimism is justified – but should get a better idea after central bankers’ Jackson Hole conference.
In other news, a US judge ruled that Google illegally monopolised the search engine market, and the Justice Department is reportedly considering breaking up the tech giant. That would be terrible news for US tech – a signal that regulators will tackle their market power. We suspect a Harris administration would be tougher on them than a Trump one, but anti-tech sentiment is a rare point of bipartisanship in Washington.
Finally, there is talk that the Bank of Japan might be able to cut rates in December after all. That would add to yen strength, which would benefit neighbours China. Maintaining a renminbi-dollar peg amid a falling yen has forced China into tight policy, so if the yen strengthens authorities will be able to loosen their grip.
Would ‘Kamalanomics’ mean US fiscal expansion?
Vice-President Kamala Harris is now the slight favourite to win the US presidential election, across polls, betting markets and most forecasts. She has begun to announce policy measures – mostly focused on support for children and families. But the market implications of a Harris presidency are unclear, largely because she had been tactically vague on the big issues. Neither party is likely to win a clean sweep (the House, Senate and Presidency), so we will probably see a degree of policy gridlock and status quo anyway.
It isn’t a given that Harris would continue President Biden’s economic agenda, given Americans’ disapproval of his handling of the economy. If she wants to distance herself from unpopular parts of his record, she will likely focus on lowering inflation. That could make her administration more fiscally disciplined than either Biden or Trump. However, she will likely extend time-limited Trump-era tax cuts that are set to expire, which could push Trump to promise more tax giveaways (he has already suggested making the time-limited cuts permanent).
US fiscal metrics have deteriorated under Trump and Biden, but there has been no ‘Liz Truss moment’ in treasury bonds, thanks to America’s status as the world’s leading market. This invulnerability is harder to maintain the worse debt metrics become, particularly if coupled with tariffs that limit capital inflow. External observers have warned there is not much capacity to expand US fiscal policy further – but that is unlikely to stop Trump from trying.
While neither party will be fiscally conservative, we suspect Harris will be less willing or able to run the risk of a ‘Liz Truss moment’. Both candidates will probably be tempted to offer ‘giveaways’, given the lack of public concern over the budget. Just like in the UK, opposition to fiscal expansion will come from bond markets, if at all. And just like here, any turmoil would probably be a short-lived buying opportunity.
The long-term case for Japan
Despite an intense market shakeout, the long-term case for Japanese assets is strong. Profitability has improved, thanks to corporate reforms. These should help companies’ capital efficiency – which is much worse in Japan than the US or Europe. Firms have become less averse to foreign ownership, and shareholders appear more willing to vote against company directors. The shakeout of speculative investors this month should actually help here, aligning incentives more toward long-term profitability.
The yen is still cheap, despite sharp recent gains (it was ¥100 to the dollar at the start of 2021, and it is ¥148 at the time of writing). That, together with comparatively low inflation, means Japanese labour (among the world’s most highly skilled) is highly competitive in dollar terms. Exporters seem to be reaping the benefit, as shown by Honda’s recent earnings. Many company outlooks assume a ¥140-to-the-dollar rate, and the Bank of Japan’s structural dovishness means it is likely to stay there or weaker.
Growth has been disappointing, but the comprehensive picture is arguably better than individual indicators. Export growth should feed through into stronger domestic demand, which Goldman Sachs note has been decent. Exporters will get a profit boost even if domestic demand is lethargic, and in any case Japan’s equity valuations are very cheap (a reflection of weaker growth). To stay that cheap, you would have to assume that growth will be as weak as it has been recently.
We have little reason to be that pessimistic. Japan is not suddenly seeing a ‘new dawn’ or an end to its long-term malaise, but its long-term profit outlook is improving. Since stock values are based on those earnings, and Japan remains cheap in terms of currency and valuations, the long-term case for Japan still looks solid.