MARCH 2024
The global economy seems to be perking up.
Last year was dominated by concerns that a recession would take hold in the face of surging borrowing costs and lingering inflation pressures. Yet despite significant weakness in the manufacturing and trade sectors, headline GDP rates managed to grind higher thanks to robust consumer spending.
Encouragingly, manufacturing data has come in stronger-than-expected in recent months with a pickup in the inventory cycle pointing to a sustained recovery in 2024.
The chart below measures the ratio of new goods orders to inventories in the US manufacturing sector. When it’s rising, order books are expanding faster than inventories, meaning firms need to increase production and employment to satisfy demand. This typically means the economy is in a healthy phase of growth.
The converse is true when the ratio is falling, like it did between its summer 2021 peak and late last year. This decline reflected the unwinding of the surge in demand for “stay at home” goods during the pandemic and left many firms needing to bleed down their excess stockpiles. Faced with such a demand shortfall, many manufacturing firms were forced to shut down production lines and cull their workforce; hence why a recession became the consensus call in 2023.
The good news is that manufacturing activity is finally recovering. Indeed, the recent spike in this ratio suggests firms are struggling to keep up with the increase in new orders so inventories are being depleted. That means production lines will need to be reactivated and workers rehired. In short, the manufacturing sector looks set to be a positive contributor to global growth this year.
Manufacturing and trade activity tend to be intrinsically linked because many of the goods produced in any given country are transported across international borders. This means trade data is still positively correlated to global growth, despite all the talk of deglobalisation.
The chart below shows the annual rate of South Korean export growth, going back 20 years. It also highlights the two official US recessions during this period; 2008 and 2020. As you can see, some of the more extreme declines in South Korean trade have coincided with a major US downturn.
South Korean trade data is usually deemed a good barometer of the global trend because its economy is so open with exports often driving at least 40% of the country’s GDP. Furthermore, it trades in a wide variety of goods and industries so is deeply integrated into global supply chains, especially for advanced technological goods like semiconductors and other electronics.
Therefore, the recent pickup in South Korean export growth suggests global trade levels are improving which, in turn, reduces the risk of a major economic downturn. At least in the near-term.
Most equity markets have rebounded strongly since their late 2022 lows, but for the bull market to persist this year we believe corporate earnings need to deliver. The chart below is encouraging in this regard.
The blue line shows the annual growth in S&P 500 aggregate earnings, dating back to 1985. The red line shows the year-on-year change in the ISM Manufacturing New Orders sub-index, but it is lagged by 1 year. This is because the new orders trend typically leads S&P 500 profits growth by around 12 months.
The recent acceleration in new orders growth thus augurs well for corporate earnings in 2024. Based on this measure alone there is little reason to doubt the consensus forecast for an 11% increase in S&P 500 profits this year (source: Factset). That said, equity indices are likely to come under pressure if earnings disappoint.
A notable feature of the recent gains in global equities has been the dominance of the so-called “Magnificent Seven” US tech stocks. As the Financial Times notes, over the past 12 months they are collectively up around 80% and account for more than half of all US stock market gains. Indeed, the median stock (out of almost 5,000 listed) is nursing a loss.
This trend is captured in the chart below, which shows the ratio of the equal-weighted S&P 500 index (in which all stocks share the same % allocation) versus the market-cap equivalent. The latter is heavily dominated by “big tech” with the Magnificent Seven representing around 30% of the S&P 500 market cap index.
So when they outperform this line falls and vice versa. The scale of the decline in this ratio since late 2022 shows just how dominant their performance has been.
Given the recent improvement in economic news flow we have been surprised that the more cyclical stocks have continued to lag; as shown in the ongoing decline in this ratio since the turn of the year.
However, if the manufacturing and trade data continues to perk up over the coming months we expect this trend to reverse and the likes of the resource, financial and industrial names to outperform their “Big Tech” counterparts.
The content of this document is for information purposes only. The authors believe that, at the time of publication the views expressed and opinions given are correct. No guarantee in performance of investment can be given to readers intending to take action based upon the content of this document. It is reminded that this document is a matter of opinion and any person wanting to invest in this market should first consult with the professional who can advise on their financial affairs. Any such investment will see your capital at risk, and you may get back less than you invest. Any companies cited in this report are used to support the view of the authors and should not be construed as recommendations to purchase or sell the underlying securities. Neither the publisher nor any of its subsidiaries or connected parties accepts responsibility of any direct or indirect or consequential loss suffered by a reader or any related person as a result of any action taken, or not taken in reliance upon the content of this document.
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