What if everything turns out just okay?
Greetings my esteemed readers and fellow investors! Stock markets are off to a cautiously green start to the year.
As you could see from the forecasts in the latest post, the majority of investors expect a recession this year and a further downturn in equities before better times. As an added curiosity, I saw on Bloomberg a compilation of 500 different market forecasts for the current year, where the tone was mostly negative.
But what if everything turns out okay? The theme of this post is positive signs from the economy that challenge the gloomy and grimy thinking.
China's economy should recover strongly in 2023
China's economy should recover in 2023. China made a U-turn on its strict COVID policy and is now literally in the middle of a COVID mayhem. At the same time, the real estate sector's problems continue as what is reportedly the largest asset bubble in world history slowly unravels. But the clouds have a silver lining. Although there are now more COVID cases than the statisticians can count, the epidemic is expected to sweep across the country early in the year.
In some metropolises, metro transport, which can be seen as a measure of economic activity, is already recovering.
Fresh data on purchasing managers' sentiment came out of the country, and index readings came in below expectations. This is understandable given the COVID crisis and weakening demand in the rest of the world for Chinese products. But there were positive signs in this data too, as expectations for future output jumped to their highest level since February 2022. The end of the zero-tolerance line therefore seems to be boosting business confidence in the future.
As the country's economy opens up, economic growth could be strong, especially in the second half of the year. Goldman Sachs, for example, expects economic growth to accelerate to 10% annualized by the end of the year. This graph shows GS’s and the consensus forecast for China's economic growth.
Despite the opening-up spurt, it’s worth remembering that the long-term economic growth outlook in China is subdued as the working-age population shrinks. This graph shows the country's long-term economic growth projections, which are trending towards 3% annual growth. It will probably take years to digest the real estate bubble, but the Communist Party doesn’t seem to have any interest in letting the situation get out of hand, judging by the support packages that are constantly being put together for the sector.
This depends a lot on the preferences of the political elite in the country, but I think it will also help to rebalance the country's economy towards a consumption-driven economic model, when people don't have to sit in lockdown. After all, in recent years China's domestic consumption has been hit hard by the zero-tolerance policy and the country's economy crawled forward through exporting all the more goods abroad. This graph shows how the gap between exports and imports, measured in Chinese dollars, has widened in recent years. Domestic consumption can be encouraged, for example by improving citizens' weak safety nets. However, there has been talk about this change for more than a decade already, with little concrete action so far.
Europe is holding up
Let's take a look at Europe, which is still holding up better than expected. Europe struggled to get off Russian natural gas without having to crush economic activity.
In Germany, the Eurozone's largest economy, the unemployment rate unexpectedly fell to 5.5%, as the consensus of economists expected unemployment to rise. Given fears earlier in the fall that the winter energy crisis would bring the entire energy-sucking German economy to a standstill, things are looking much better so far.
The negative effects of the energy crisis have been partly offset by the easing of the semiconductor shortage in Germany. This Goldman Sachs graph shows the development of German industrial output relative to December 2019. Gas-intensive sectors are suffering, but at the same time semiconductor-intensive sectors have been growing as bottlenecks have been resolved. The massive car industry is back on the growth curve.
Natural gas prices have plummeted in Europe as winter temperatures have been mild, households are frugal and gas stocks are bulging. The price of gas to be delivered in a month's time has plummeted from a peak of over €300 to less than €80.
Of course, the real test for Europe will be next winter, when countries won't be able to stockpile gas from Russia in the summer, but so far the situation has developed better than feared.
In early January, electricity prices briefly hit zero or negative levels in countries such as Spain, Germany and France.
It’s also good to be aware that energy prices are a major driver of inflation in Europe. Inflation measures the change in prices. If energy prices do not rise, or even fall, this will contribute to pushing inflation towards zero, or even negative.
Of course, this in itself is still not enough, as central banks specifically monitor core inflation, which doesn’t take energy into account.
Last year, inflation consistently surprised negatively with its abundance, but it’s not impossible that it will surprise positively this year, when expectations have hit a ceiling and inflation is going against a strong comparison period. Investors have a bad habit of extrapolating recent developments.
Earlier this week, inflation rates in the major Eurozone economies of Germany, France and Spain came in below forecasts. Inflation peak is here.
However, the inflation figures are confounded by different energy subsidies in Germany and France, and inflation in both countries is still expected to accelerate in the early part of the year. So, let’s not count our chicks before they hatch.
More inflation data from the Eurozone is due tomorrow, and we'll see if it continues on the same note.
A significant easing of inflation would let the European Central Bank off the hook for interest rate hikes, and that would give a big boost to equities.
The rise in interest rates is not just a negative thing, by the way. Finns have a lot of variable-rate mortgages, which is why people are terrified of rising interest rates and ballooning mortgage bills. But at European level the picture is much better. Swedish-style super mortgage indebtedness is more the exception than the rule. In Italy and Germany, for example, less than a fifth of households have a mortgage, as shown in this J.P. Morgan graph. Instead, Europeans actually have a lot of savings from which they are starting to earn interest income. Rising interest rates are therefore not necessarily disastrous for the basic household but, on the contrary, help to achieve savings targets and thus support consumption.
Observations on the US economy
Finally, let's turn our attention to the world's largest economy, the United States. After all, the central argument of the bears is that economies go into recession when central banks raise interest rates too high. After that, we face uncontrollable free fall.
However, the economic cycle during the pandemic reached different heat levels compared to previous ones. J.P. Morgan's strategists had a good point about how pandemic-era business investment, and housing investment in particular, was more subdued relative to GDP than in previous peaks of the cycle. In general, a recession is prolonged and deepened by massive over-investment in optimistic glasses, which isn’t the case now. The banks also didn’t overstretch their lending criteria and their balance sheets are strong. Banks are the arteries of the economy, so their good health is a relief.
To sum up the theme of the post, economies around the world don’t have to go into a deep recession. The stock market was in a bubble during the pandemic, but that bubble has now been deflated. Many investors confuse the melancholy of the stock market with the real economy, which seems to be doing reasonably well. There is no massive boom on the horizon as economies cool between tight monetary policy and the energy crisis, but not a worse economic bust either. And the stock market should soon start to look for better fundamentals and monetary conditions in 2024.
Thank you for reading the post! Read analysis and make good stock picks!