Monday Espresso Podcast - 17th July 2023

[00:00:00] Sheldon MacDonald: It is the 17th of July today. We had a pretty strong week across markets, equities, and bonds, the biggest news last week was the decline in US inflation rates. Nathan, take us through that.

[00:00:12] Nathan Sweeney: Yeah, so markets were definitely buoyed last week by the improvement in the inflation data. We saw US inflation falling to 3%.

[00:00:22] Nathan Sweeney: Now, if we remember a central bank's target is 2%. So we're really moving nicely towards that. And if you look at US inflation specifically, it peaked at about 9.1% last year, it's been falling ever since, and that continued fall inflation is really being cheered by markets so we saw some really strong returns coming through last week for UK markets, US markets, pretty much equity markets across the globe.

[00:00:47] Nathan Sweeney: And also bond markets like that too, because it means that there is the potential for central banks to get to that peak in interest rates sooner.

[00:00:57] Sheldon MacDonald: Now that inflation figure, that's the lowest we've seen for over two years. March, 2021 was the last time we got as low as this. Markets though still expecting a 25 basis point hike in the Fed funds rate in their meeting next week.

[00:01:11] Sheldon MacDonald: Why is that if inflation's coming down so nicely?

[00:01:13] Nathan Sweeney: Yeah, so this is an interesting one. I think from a central bank's perspective, they're really looking to ensure that they get inflation down and that inflation stays down. So basically they're looking to slay inflation. So the reason they're looking to continue to raise interest rates is because there is the potential for inflation to reassert itself, because historically, when they've got inflation down back in the seventies, inflation then came back with a vengeance.

[00:01:42] Nathan Sweeney: And because of that, central banks are just very cautious. They're looking at those textbooks from history and wanting to make sure that actually when we get inflation down, it stays down. So from a US perspective, one more rate rise is on the cards, and after that it looks like we're done.

[00:01:59] Sheldon MacDonald: That view of ultimately falling interest rates is leading to some weakness in USD, so across the board, the dollar was weaker last week.

[00:02:08] Sheldon MacDonald: Of course, the flip side of that is Sterling's strength. Now that is a double-edged sword really for us. When you translate returns that generally are based in US dollars back into a stronger dollar, that means those figures are lower.

[00:02:23] Sheldon MacDonald: So while we see US equities, were up three or 4% in dollar terms, in sterling terms that translated last week only to a couple of percent. Of course the other thing, is the how it impacts, we've mentioned this before, how it impacts companies. So UK companies, the majority of their earnings earned offshore translate those earnings back at a stronger sterling rate that equals lower earnings.

[00:02:47] Sheldon MacDonald: Now, earnings clearly a focus at the moment. We've got Q2 earnings season starting off this week. What are the expectations there, Nathan?

[00:02:56] Nathan Sweeney: Yeah, so if we look at what companies are expected to deliver it's earnings decline of around 7%. Now, that may sound bad, but in historical standards, when you've had a big recession or risk of periods, earnings tend to fall by more.

[00:03:12] Nathan Sweeney: So even though it sounds bad, it's not that bad. We've seen a couple of companies report already and those companies are reporting earnings ahead of expectations. So they're beating that number or you know, earning down 7%, they're delivering ahead of that. And on average, companies tend to deliver earnings, which are about 8% better than expected, so that's what we're expecting to see.

[00:03:36] Nathan Sweeney: We've got some big companies reporting this week, so we'll have the likes of Goldman Sachs and a couple of the big banks. I think Netflix is also on the cards as well this week. So we get a clearer picture over the course of the next few weeks.

[00:03:47] Nathan Sweeney: But I think that the real focus now is going to be on earnings because inflation has come down then the market is definitely gonna be looking at companies earnings to see are they delivering, because that will be the driver of growth from here.

[00:04:01] Sheldon MacDonald: Valuations are a little bit stretched at the moment, so we do need the earnings growth to really validate the current levels. Another area though, that gives us a little bit of confidence though, is credit markets.

[00:04:13] Sheldon MacDonald: Now we've seen pretty tight credit spreads, we're pretty close to the lows, the tightest credit spreads that we've seen this year.

[00:04:21] Sheldon MacDonald: Now, the credit market doesn't have the strong tailwind that we've seen in the tech market, and therefore the fact that overall credit spreads, even despite this tech tailwind, are pretty close to the years lows mean that it's a validation of the equity bull market perhaps credit spreads really indicating confidence in future earnings, confidence in future cash flows, and so that gives us a bit of reason to be cheerful that perhaps this bull market that we've been seeing might have some legs yet.

[00:04:50] Sheldon MacDonald: Now we focused on the US so far today, just to mention for Asia, China, that was up about 6% last week in local terms, and that's on expectations there for policy easing.

[00:05:01] Sheldon MacDonald: They've had a disappointing rebound post covid and the central banks expected to provide some support measures there. And also some data on the political front for the US, Foreign Minister Blinken has been meeting his counterpart, also we had Janet Yellen there last week. So on the political front, perhaps an easing of some of the tensions.

[00:05:21] Sheldon MacDonald: So again, something to be positive about there. Just briefly, Nathan, what are we expecting this week?

[00:05:26] Nathan Sweeney: So we've got UK inflation data, so all eyes will be on that number. As you remember, UK inflation is currently at 8.7%. That number's expected to come in at 8%. Anything lower the market like that?

[00:05:38] Sheldon MacDonald: Excellent. Lots to look forward to, and we look forward to speaking to you again next week.