Slowing growth throws markets into a bind

Posted 20 January 2023

Last week we wrote that markets were rising because bad economic news was good news in terms of lessening concerns over interest rate rises beyond what is already expected and therefore priced in. This week, various economic data releases in the US painted a very clear picture of a slowing US economy, from declining Christmas retail sales to industrial production. Even though this pushed long-term bond yields down further, and had inflation expectations decline to a very benign 2%, markets this time took the bad news negatively, giving back some of the gains of the previous week.

December’s bad report card may have more to do with the exceptional cold spell that hit much of the US, then an acceleration of the growth slowdown. Even so, investors clearly began to worry that the other key variable in equity valuations (future corporate profits) was about to come under more sustained downward pressure. 

This tells us that markets may well have run out of positive momentum, and that it will be a tough ask for US markets to push higher on the back of receding rate rise fears only. In Europe and even the UK on the other hand, where macroeconomic data continues to come out ‘not as bad as feared’ but with price inflation also receding, stock markets had a much better week, even if the FTSE100 has still not managed to break through its all-time high it has neared over the past two weeks. 

There was more good news globally. China says it is past the peak in Covid-related hospitalisations. Hong Kong authorities are even telling people with asymptomatic Covid infections to return to work. Ahead of the coming week’s Lunar New Year celebrations, travelling has picked up to near normal levels. More and more research houses are pointing towards the increasing likelihood that China’s re-opening will result in a similar growth surge as the western world experienced back in the spring of 2021, except with even more pent-up demand and cumulative savings in the hands of consumers after three years of harshly restricted public life.

This is where good economic news can turn into bad news again, because for energy and input prices to continue to fall, this resurgent demand must not have more than a minor impact on energy prices (see our separate article about falling producer input prices). Expectations of a more benign impact on global energy may not be an entirely unreasonable expectation given Russia’s efforts in re-routing unsellable fossil fuels eastwards.

Turning to this week’s annual World Economic Forum gathering of the world’s movers and shakers in Davos, on Thursday, Ngozi Okonjo-Iweal, Director General of the World Trade Organisation, gave a rather downbeat assessment of global trade prospects. She warned of the problems created by “securing” supply chains. Certainly, justifying subsidies because of security concerns is a slippery slope. The US Inflation Reduction Act has myriad subsidies that concern its European trade partners. Europe’s response is likely to be more subsidies, which creates problems both internally and externally.

But before we get too worried about further deterioration in global trade, we should note that the meeting between US Treasury Secretary Janet Yellen and her Chines counterpart Liu He seemed to go well, with cordial – even friendly – dialogue. As we have commented before, China has of late performed not just a turnaround on Covid, it has also started to be a less annoying neighbour. In the vein of “no news”, there have been no Taiwan provocations in the weeks following last year’s Party Congress.

To close this week then, globally there is not very much news, which is good news in itself. We have become inured to bouts of cataclysm – natural and political – with journalists becoming celebrities themselves. It has felt rather boring of late as the economic reality outside the UK has simply plodded on. Since October, there has just been less news. This reduces the pricing of risk premia globally, and feeds back into a better investment environment. So, no news is good news….for now.