Most recent data has pointed to steady or improving growth, but therefore steady or deteriorating inflation. This has been a drag on equity markets.
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US core inflation for April as measured by the personal consumption expenditures (PCE) index confirmed what markets had learned from the earlier consumer price index (CPI) data: inflation has remained sticky. The monthly change in prices fell from 4.1% (annualised) in March to 3.0% in April, still well above the US Federal Reserve’s (Fed) 2% target.
The next Fed policy meeting on 11-12 June may well see it increase its forecast for inflation this year (currently at 2.6%). Services inflation has remained the key area where prices are still rising at a rapid clip. This strength reflects a robust labour market, with low unemployment and rising wages. The upcoming non-farm payrolls data, due on 7 June, will be examined closely for any clues that the labour market is finally slowing.
In addition to, and perhaps despite, higher inflation, US consumer confidence jumped in May, though it was a rebound from what had been the lowest reading in two years in April.
A mixed message from China
In contrast to the broadly robust US data, purchasing manager indices (PMIs) out of China painted a more mixed picture, with data coming in below expectations.
The Caixin manufacturing index showed a modest improvement, but the broader official index fell back into contractionary territory (below 50). This was almost entirely due to ongoing weakness in the property sector. The official services index was marginally lower (see Exhibit 1).
The MSCI China index reacted poorly to the news, dropping by almost 3% for the week. We expect the government to continue to support the economy if it wishes to reach its 5% real GDP growth target for this year.
Our multi-asset team has recently cut its overweight to Chinese equities back to neutral.
And what about Europe?
The outlook for growth remains good in the US, and is improving in Europe. The latest country purchasing manager indices (PMIs) for Europe show five out of eight indices better in May than in April.
Along with the resulting sticky inflation, government bond yields have risen. While 10-year US Treasury yields have risen towards the top of the range they have been in over the last two months (between 4.3-4.7%), Bund yields have broken out, reaching 2.67% on 30 May 2024. This marks the highest level since last November.
Equity markets did not react particularly well, with declines across most country indices and sectors. Not surprisingly, the sector most sensitive to changes in (real) interest rates – technology – was the worst performer. The weakness we believe will likely prove temporary. Valuations may suffer in the short term due to higher discount rates, but the positive earnings trend should eventually dominate.
The trend has been positive across most markets for quite a while. The notable exceptions have been Europe and China (see Exhibit 2).
Earnings expectations diverge
Stable (as opposed to rising) forward earnings expectations are not so surprising for Europe given that growth was slowing for much of last year. Now that the data is improving and the market is anticipating rate cuts from the ECB, analysts’ expectations are moving up.
The pattern for China, however, is more unusual. The economy is still recovering from the Covid lockdowns; in the US and Europe, the recovery corresponded with strong earnings growth. Beijing has been providing various forms of stimulus.
Until recently, however, earnings expectations did not improve. The latest increase has mostly been limited to PDD (the holding company for Temu) and Tencent, suggesting a broad-based improvement in the outlook for corporate profits is yet to come.
