Marlborough Monday Espresso - 10th July 2023

[00:00:00] Sheldon MacDonald: It is the 10th of July today. Weaker undertone to markets last week, pretty much across the board, certainly on the equity side, well, the bond side as well, we'll speak about that in a minute.

[00:00:10] But a continuation of the themes that we've been seeing for the last couple of months, which is this balance between expectations for higher rates versus the expectations for recession.

[00:00:22] Nathan, last week, the news dominated by the jobs data.

[00:00:26] Nathan Sweeney: Yeah, so we had jobs data out in the us so basically this is an unemployment report, so how many people are working, and there's lots of elements to this.

[00:00:34] Now what we've seen is that there were two jobs reports last week, and both of them highlighted strength in the jobs market.

[00:00:44] So as a result of that, the market reaction was negative. Why is that? Because if you have lots of people working, isn't that good for the economy?

[00:00:52] Yes, it is, but the expectation is that that will lead to inflation persisting for a prolonged period, which means Central Banks may have to act as in raise interest rates further.

[00:01:05] Sheldon MacDonald: We also had the release of the Fed minutes from their previous meeting last week, and that certainly indicated or underscored the fact that several of those governors that vote in that meeting are supportive of further interest rate hikes going forward.

[00:01:19] Of course, the question mark is, yeah, all these rate hikes that we've had is the effect of them still rarely to be felt?

[00:01:25] Nathan Sweeney: Yeah, so it's interesting because what we have out this week is we have inflation figures and you know, that's been the key to all of this.

[00:01:33] Now if we look at inflation in the US, inflation is currently 4%. Now I'm gonna repeat that 4% because you might have expected that it's actually higher and the market is expecting that figure to come in at 3.2%.

[00:01:48] So I'm not necessarily convinced that inflation is going to be a continued problem specifically in the US, even in the face of low unemployment.

[00:01:59] Because if you remember pre-COVID we had a period of over a decade where we had low unemployment and no inflation, but the market seems to be latching onto that at this moment in time.

[00:02:11] Sheldon MacDonald: So further indications last week that inflation is coming down this side of the pond. In Europe, we saw the PPI turning negative, now the PPI is a secondary measure of inflation.

[00:02:22] It's producer price inflation prices received by producers of goods. As I said, that turning negative and that then typically would lead to expectations of consumer prices coming down in the weeks and months ahead.

[00:02:36] Now, changing tack, we've got earning seasons starting this week, so indications perhaps gonna come from companies this week around what has all this inflation and interest rate moves, what has it done to, to companies on the ground?

[00:02:49] Nathan Sweeney: Yeah, so this is a big one actually, because really, how are companies doing?

[00:02:53] Now, we've looked at some preliminary data and it suggests that companies earnings will contract by about 7% as they release those earnings this quarter from a year ago or over the last year.

[00:03:07] Now, is that good or bad? Actually, in the wider scheme of things, it's actually good because we expected earnings to be much worse and what we do know is that companies like to deliver surprises.

[00:03:19] So they like to say, actually, we think we're gonna earn this, but actually the earnings were better than we thought they would be.

[00:03:25] And on average, those earnings surprises tend to be. In the range of about 5%.

[00:03:30] So earnings tend to be about 5% better than expected, which would mean that company earnings are likely to only be down around 2%.

[00:03:38] One other interesting piece is that we know that technology companies have been really driving market performance this year. But we also know, looking at some of that preliminary data, that other sectors are likely to deliver better earnings in this quarter.

[00:03:54] So we're expecting a broader participation from other sectors in the market.

[00:03:58] So again, that's good news from an investment perspective.

[00:04:01] Sheldon MacDonald: Yeah, so as we see the earnings come through, people will be examining those reports really to get a sense of whether companies can maintain the margins in the face of these interest rate hikes.

[00:04:12] There'll be clues on whether the bank stress, remember those regional bank stresses that we had a couple of months ago?

[00:04:18] Has that had an impact on credit and lending to companies? Clues for the health of the US consumer, the consumer in the US driving more than 70% of the economy.

[00:04:29] And of course, people are looking for how companies might be able to harness AI in the months ahead.

[00:04:36] Now, I said at the beginning we'd returned to interest rates here in the uk.

[00:04:40] A lot of news, a lot of talk last week around interest rates, and we saw short term rates spiking up quite high.

[00:04:46] A lot of this leading to concerns around what might happen in the mortgage and housing market?

[00:04:52] Nathan Sweeney: Yeah, so the real concern here is that higher interest rates will lead to higher mortgages, and if people have higher mortgage costs, then they'll have less money to spend elsewhere.

[00:05:01] And what does that mean?

[00:05:03] Slower growth for the economy. Now, the reality is only a small fraction of the total population have mortgages and only a small subset of that have mortgages up for renewal.

[00:05:16] So, It actually is unlikely to have the impact on the economy, on spending that people expect.

[00:05:24] So we've looked at some data and it suggests there's about 1.4 million people who have to renew at those higher rates over the course of the next year or so.

[00:05:33] We don't ultimately think that that will have the negative impact on economic growth that markets are currently expecting.

[00:05:42] Let's hope that's the case. We look forward to speaking to you again next week.