The week in review – 22nd May 2023

Earnings improvements boost big tech stocks

Last week, equity markets have generally headed higher. The most notable moves were in US stocks, with the large-cap tech names doing very well in aggregate. The Q1 earnings reports have almost all been published and, on a market-cap-weighted basis, developed world stocks have seen a return to earnings growth in the forecasts for the next 12 months. That’s after six months of analysts seeing falls in earnings. In Europe, cyclical sectors have been the winner with real estate the laggard. Still, the 2023 forecast as a whole is muted at just 1%. Companies continue to be hit by higher interest rates, raising concerns that the European Central Bank (ECB) may keep tightening financial conditions through the summer. In the US, retailers have been discussing the continued softening of spending trends for big-ticket and other discretionary items. The pandemic reversal is still releasing pent-up demand for services – particularly travel and entertainment.

But for both regions, what stands out as surprising is that ‘top-line’ revenues are better than expected. In Europe margins are still under pressure, but sales are substantially improved. In the US, both sales and margins have started to improve. That tallies with a more stable economic environment, especially for Europe where energy price declines have helped greatly. The improvement in global service sector purchasing manager indices (PMIs) also helps explain the corporate positivity.

The good earnings results in the US – and especially Europe – is cause for optimism. Still, the underlying tightness of financial conditions for many companies remains, while the AI theme seems equivalent to a narrowing of profitability breadth on just a limited number of tech firms, at least for the moment. The rise in equity markets is welcome and, if caused by a general improvement in profitability, all the better, but we would feel more optimistic if central banks were less hawkish.

Emerging market currencies suffer a downdraft

The US dollar has moved quite sharply stronger, after some weeks of weakening against most currencies. Conversely, emerging market (EM) currencies – which tend to best reflect the sentiment around underlying EM economies – sunk to a three-week low last Wednesday. The reasons for this pessimism are varied. China’s slower-than-expected growth is weighing on the outlook for EM demand, while financial stress in the US has reduced available capital and hit investor risk appetite. At the individual level, Turkey’s election returned a stronger-than-expected showing for President Erdogan – an unpopular figure with international investors – while the energy crisis in South Africa has deepened. And importantly, South Africa’s geopolitical tension with the US on suspected covert arms exports to Russia has made international investors nervous.

Last week, all but one of the emerging currencies that we follow fell fallen relative to the US dollar (the Brazilian real was unchanged). This suggests the current move may not be about problems in individual nations. It may also be about the US dollar itself. Since the start of the month, the dollar has climbed against both EM and developed currencies. There are signs of a reduction in the supply of dollars held outside of the US – as evidenced by the decline in cross-currency basis swaps (signalling people are willing to pay more for dollars). The amount of dollars available worldwide has fallen, in large part thanks to the continued tightness in US financial conditions. Should this trend continue, it would likely mean the much-discussed bout of dollar weakness could be coming to an end. Indeed, the Citi forex desk has recently cut its losses on their recommendation to be short of the dollar. That would fit with the overall narrative of disappointing global growth and increased risk aversion among corporates and financials. Unfortunately, EMs may have to pay a bigger price than most for all this.

A closer look at the new wave of US bankruptcies

May has been a bumper month for US Chapter 11 bankruptcy filings so far, and this year is on track to be the busiest year for filings since 2010. Many are suggesting this is the beginning of a new wave of business failures – unlike anything seen since the Global Financial Crisis (GFC) of 2008 – with rapidly climbing interest rates, persistently high inflation and slowing consumer demand proving too much to handle. This potent combination seems to have been reinforced by the collapse of several US regional banks over the past few months, causing lenders to rein-in credit and leaving many companies without funding. As noted previously, these problems are unfortunately worst for smaller businesses, which have seen financing costs go up by significantly more than large-caps. However, Bloomberg suggests the current bankruptcy wave is also happening among large and the slew of failures two weekends ago was the biggest burst since Bloomberg started tracking this data 15 years ago.

However, while the total number of US bankruptcies is extremely high, the total amount of debt which is subject to distress is quite low (as a percentage of total outstanding corporate debt). That backs up the idea that it is mainly smaller companies facing difficulties – even if there are lots of them. However, we are certainly not at crisis levels yet, and default rates are currently below past crisis times, and especially below the 2008 level. That is quite remarkable when you consider just how rapidly interest rates have increased over the past year, and the media doom and gloom around the economy – another sign of the US economy’s surprising resilience. We are keeping a close eye on the situation and, if there is any silver lining, it will be that US interest rates will surely stop rising, perhaps falling by the end of the year. But if that does not happen, and rates keep rising, the bankruptcy wave could indeed become a tidal wave.

UK COMMENTARY

• Underlying consumer confidence has continued to recover, with people growing less pessimistic over their personal finances and the economic outlook. GfK’s Consumer Confidence Index for May rose by three points to -27 – the fourth monthly increase in a row. Although still negative, this is a significant improvement compared to January’s figure of -45.
  
• The Office for National Statistics reported a 136,000 fall in the number of payrolled employees between March and April – the first decline since February 2021. As a result, the UK’s unemployment rate increased to 3.9% from 3.8% in April.

NORTH AMERICA COMMENTARY

• US consumer spending was reported lower than forecasted in April. US retail sales rose 0.4%, missing forecasts of a 0.8% rise, after a 0.7% drop in March. Online spending rose 1.2% month-on-month and was 0.9% higher at health and personal care stores.
  
• Inflation in Canada increased for the first time in nearly 12 months. The Canadian Consumer Prices Index rose 4.4% in the year to April, up from 4.3% in the year to March, lifted by higher rent prices and mortgage interest costs.

EUROPE COMMENTARY

• Eurozone inflation for April was confirmed at 7% year-on-year, according to Eurostat. This was a 0.1% uptick from March. Given the surge in energy prices this time last year, unfavourable base effects in energy prices were the primary reason for the increase, while core inflation – which strips out food and energy costs – eased slightly.
  
• Eurostat reported Eurozone industrial production declined 4.1% month-on-month in March, to its lowest level since November 2021. The fall exceeded the consensus for a 2.5% contraction. Although the decline was worsened by a very large fall in volatile Irish industrial production, contractions were reported across three of the four largest Eurozone economies in March, signalling broad-based weakness across the bloc.

ASIA COMMENTARY

• Japanese nominal goods exports rose 2.6% year-on-year in April, slowing from a 4.3% rise in March. Despite continued gains in the auto and shipping sectors, overall exports were weighed down by weak global economic momentum.