Stock markets have entered a busy earnings season week with cautious optimism.
In this post, we briefly talk about the development of liquidity, which has been favorable for equities. We also make a quick visit to China. Then we look at the market's preparation for the US becoming insolvent if the debt ceiling debate continues. Finally, I'll highlight a few takeaways from the poor earnings season and how wage growth could emerge as a growth driver in the US.
Brief overview of liquidity
Liquidity, or the amount of money and credit floating around in the financial system, has continued to recover here and there. Of course, if there is more money floating around in the system, it will support different asset classes, such as equities.
This graph, familiar to my active readers, shows the Fed's net liquidity in blue and the S&P 500's performance in red. Those two have gone quite nicely hand in hand in recent years. In practice, liquidity developments have remained at elevated levels since the small bank bailouts. Liquidity has been significantly improved by the rapid depletion of the federal current account, which has put money into circulation. We'll talk more about the federal current account running low in a moment.
If you're confused about liquidity as a concept, you should read this post from December, where I talk about liquidity in more detail.
The improvement is also well reflected in liquidity-sensitive speculative asset classes such as Bitcoin and the gold price. Both have performed favorably since last fall, while the US dollar has weakened. The dollar index is shown in this graph on an inverted scale. The weaker the dollar, the better for other assets. It helps monetary conditions in the rest of the world, as the dollar is a major trade currency.
After a short delay, growing liquidity should support the economy, in addition to keeping the creaking financial system together. If you think about the kind of earnings recovery expectations that have been loaded into equities for next fall, this is nice news.
In China, the world's second largest economy, the credit impulse is also showing signs of recovery. The amount of debt in the country is growing rapidly, even though only a moment ago there was talk of putting a bridle on the galloping debt horse. This graph shows the absolute amount of credit growth (social financing) on a monthly basis, which was 5.4 trillion yuan in March, or about 700 billion euros. The cooling housing market is also showing signs of recovery, with prices rising for the third month in a row in March.
And the vast amounts of debt hasn’t been wasted. The Chinese economy grew by a better-than-expected 4.5% in the first quarter, according to fresh data reported in the early hours of this morning. Even better news is the strong recovery in domestic consumption, with growth rates of over 10%, meaning that economic growth didn’t rely on infrastructure alone. Exports also recovered strongly in March, reflecting improved demand in the rest of the world. The Chinese economy as a whole is expected to rebound by just over 5% after a weak last year. However, it’s worth remembering that as the population ages rapidly and the economy matures, the longer-term growth picture is more subdued.
Federal insolvency looms
Let's come back to that draining federal account before the next topic. The federal government has hit a debt ceiling that the US Congress should raise again. If the debt ceiling won't be raised, the federal government can’t borrow money, it will have to cut its spending and will default on its loans. It would be a big hiccup in the world's most important financial market, but politicians are crazy enough to use this nuclear weapon of the financial world to push their own agenda.
The risk of a momentary US default is already reflected in the yield curve. This shows the market interest rates for bonds of different maturities. Short-term rates get more than 5% because they move more or less in line with the Fed policy rate. The yield curve has inverted, meaning that funnily enough, longer paper yields less interest. But you can also get a lower interest rate on 1- and 2-month bonds. This is because investors who fear default are parking their money in bonds, which will pay them back anyway, before the federal government potentially runs out of money. For big players such as pension funds and companies, hiding money under the mattress is not an option, which is why the money is stuffed into these bonds, which are considered safe.
In the coming months, as this quiet struggle continues, it will be interesting to see where the yield curve settles. In 2011, stocks plummeted 20% and economic growth took a brief hit as the US entered a gray area of default. Usually, politicians on a collision course have given way at the last minute and compromised, but until then the world can hold its breath. We'll find out in a couple of months.
Highlights of the earnings season
Here are a few highlights from the earnings season that has just commenced. Firstly, it’s good to remind you again that the market doesn’t expect a good performance and bad results should not be news, unless they are even worse than expected. This graph shows the forecast performance of the S&P 500 index for the first quarter. Earnings are now expected to fall by 7.5%, compared to 8% last week.
Luxury companies Moët Hennessy Louis Vuitton (Europe's most valuable listed company) and Hermes, reported stronger than expected growth. Hermes grew by 23% and LVMH by 17%. Luxury brands are particularly benefiting from the opening up of the Chinese economy. They are also resilient even in downturns, as the more difficult economic environment is barely catching up with the spending habits of the rich. Currently, LVMH has a market capitalization of €450 billion and Hermes around €200 billion. These two are a bit like the FANGs of Europe. We may not have the technology, but taste and style beat the Americans.
On the other side of the Atlantic, Fastenal, a wholesaler of nails, fasteners, and other hardware, especially for industry, reported virtually record first-quarter results. However, March sales were already showing signs of weakening. This reflects well the story of the slowdown in industry told by the purchasing managers' indices.
Fastenal is a high-quality company that offers an interesting window on what's happening in the industry. The company's return on investment has been hovering steadily around 25% for years, which is an excellent level. It's worth checking out the company if you're interested in quality steady growth.
Delta Airlines' results missed expectations, but the company reiterated its expectations for a strong summer season, with no signs of a slowdown in consumer travel for the time being. The same message of a strong spring was echoed earlier this year when United Airlines lowered its first-quarter outlook. The major US airlines are trading well below their pre-pandemic peaks. The aviation sector in general has been very challenging in terms of value creation, with fierce competition quickly eating away at extra profits.
Turning to the banking sector, JP Morgan, the largest US bank with a balance sheet of just under 4,000 billion dollars, posted better-than-expected numbers. The Bank raised its net interest income to $81 billion from $73 billion. Loan-loss provisions were slightly higher, as the bank says the economic outlook is showing signs of souring, even though things are quite good right now. Consumers spend and businesses are in good shape, which pleases the bank that finances them. The bank's long-time CEO Jamie Dimon said the bank sees higher inflation on the horizon for longer. (Of course, a bank benefiting from higher interest rates won’t mind this prospect.)
Big banks Citi and Wells Fargo also posted better-than-expected results.
Of course, the most important news for investors is that there is hardly any sign of the March banking crisis in the big banks' results. In fact, according to the Fed data, deposits in the banking sector in general started flowing back as early as April 5th, which is where this data ends. In contrast, smaller banks that have reported, such as State Street or financial services house Charles Schwab, saw a larger outflow of deposits and banks' interest costs are rising rapidly as customers move their money to more lucrative accounts. This will flatten banks' net interest income. No wonder, then, why the US small bank index has continued to slide in recent weeks.
So far this earnings season, one could generally say that the situation is, in the words of HBO's brilliant Chernobyl series, "Not great, not terrible."
Wage growth as an economic driver?
Let's talk briefly about how bank lending actually slowed down even before the March banking crisis and how wage growth is becoming a driver for the economy.
This graph by Bob Elliot shows annualized bank lending as a 4-week moving average of GDP. In this respect, the banking crisis hasn’t changed much, as lending slowed dramatically already in December. This is in line with the tightened credit criteria for banks, which I have shown in previous posts.
Despite this tightening of borrowing, the US economy seems to be holding its own, at least for now. The Atlanta Fed's GDP Now gauge, which is like a real-time GDP forecasting tool and works just as well as the best analysts' guesses about the economy, shows no signs of slowing down.
Elliot points out that the consumer-driven US economy seems to be driven by strong wage growth. The recently updated Atlanta Fed wage gauge shows the median wage rising at an annual rate of 6.4%, and the recent slight easing has been reversed. Wage rises will be helped by a tight labor market and a shortage of workers. I have shown this gauge in many of these posts and disguised in a bearish cloak, because a hard rise in wages can feed sustainably higher inflation.
On the other hand, at present, median wage growth is above the rate of inflation. Thus, real earnings are already rising, which in turn supports consumption. If inflation cools off quietly despite good wage developments, this will give a major boost to US consumption-led growth, with repercussions for the rest of the world. For equities, the scenario would be a real nirvana. This data can therefore be seen from two different angles. If the labor market really started to crumble, it would be worse, but so far it has remained strong.
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