“Is America Exceptional? Who Cuts First?”
Below is a round-up of Longview related views/research & trade ideas – this is published most Fridays, and updates key themes and highlights key pieces of (often contrarian) research.
Key Central Bank Quotes This Week
ECB Governor and President comments this week (our bolding):
“We are data-dependent, not Fed-dependent" Lagarde added.
“If our updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase our confidence that inflation is converging to our target in a sustained manner, then it would be appropriate to reduce the current level of monetary policy restriction”
Source: Christine Lagarde, 16th April 2024
“Even if the near-term inflation outlook is somewhat bumpy, the projected convergence of inflation to the target in 2025 will be underpinned by: the lowering of labour cost pressures; some additional compression of unit profits; the dissipation of the adverse effects of past energy shocks, supply bottlenecks and the pandemic re-opening; and the further unfolding of the disinflationary impact of the restrictive monetary policy stance”
Source: Philip Lane, University College Dublin, 15th April 2024
“The risk would be to be behind the curve and to pay a too high cost in terms of economic activity.”; "It is time to take an insurance against risk of being behind the curve.”; "Barring a major surprise, we should cut rates. We are increasingly confident about the disinflation path in the euro area”
Source: ECB’s Governor Villeroy, April 18, 2024 speech/comments
Fed Chair Powell comments this week:
“More recent data shows solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal,” the Fed chief said during a panel talk.”
Source: Federal Reserve Chair Jerome Powell speaking at the Wilson Center’s Washington Forum on the Canadian Economy, 17th April 2024 – CNBC write-up
America vs. Europe (& the UK)
There’s much chatter about ‘American Exceptionalism’ of late in markets. According to Wikipedia, this is the belief that the “United States is either distinctive, unique, or exemplary compared to other nations”.
Obama landed in hot water in 2011 for suggesting that:
“while he believed in "American exceptionalism," it was no different from "British exceptionalism," "Greek exceptionalism," or any other country's brand of patriotic chest-thumping.”
Source: Foreign Policy Magazine, October 2011
Part of the current resurgence of interest in markets about that topic has been driven by the differing economic performances. The Eurozone has essentially stagnated in 2023. At the end of the year, its economy was roughly the same size as it was at the start (FIG 1). That is, Q1 2023 saw good growth (0.5% q-o-q; 2% annualised); Q2’s growth was modest (+0.1% q-o-q); while Q3 and Q4 were quarters of economic contraction (albeit modest ones). The UK’s performance is similar to that of the Eurozone but worse. The UK economy has stagnated since the start of 2022 – no cumulative growth over two years (and has contracted in recent quarters; i.e. -0.1% q-o-q in Q3; & -0.3% in Q4).
The US, in contrast, has seen rapid economic growth, consistently surpassing expectations (and defying the calls for a US recession). The economy has grown at 3.4% (annualised, q-o-q) in Q4 after +4.9% in Q3 and +2.1% (Q2) and +2.2% (Q1).
FIG 1: US, UK & EZ real GDP level (rebased to 100 at start of 2022)
Further highlighting the America’s exceptionalism, the US stock market has considerably outperformed the European market in recent years, mostly driven by its large and diverse tech sector (something which is largely absent from the European market). The S&P500, for example, is over 3x higher than its 2000 and 2007 major highs (at around 1,500 versus current price of ~5,000). In Europe, meanwhile, the broad Euro Stoxx 600 index is a mere 11% above its March 2000 highs1.
Interestingly, while part of that is an upward re-rating of the US stock market, much of it is the result of notably faster earnings growth over that time (FIG 2). As the chart shows, the UK & Europe didn’t deliver any earnings growth in the decade post the global financial crisis, while the US & Japan have fared much better. Equally since mid-2022, the US earnings outlook has moved to record new highs (after a brief slowdown in late 2022), while the UK & European earnings outlooks have languished (or indeed shrunk in Europe).
Reflecting that, while almost everyone around the world owns some/all of the main US tech stocks (& the US market), most don’t own any European equities – at least not directly (even those that live in Europe).
FIG 2: Consensus rolling 12m forward EPS – for key global regions/markets
Those different post pandemic economic growth paths have, not surprisingly, driven different expectations for their respective policy rates. Contrasting comments from the ECB & Fed heads (& Governors) this week have highlighted those differences.
President Lagarde made it clear that the ECB is ‘not Fed dependent, but data dependent’ while hinting, along with many other ECB members (see quotes above), that June is likely to see the first ECB rate cut.
We updated our thinking on the outlook for European inflation (and therefore rates) in a piece published on Wednesday (see below). Inflation pressures look set to dissipate rapidly in the Euro area, even in the services sector (given that labour market pressures are softening, while forward looking indicators suggest that trend will continue). Contact Nick Beazley at nick@longvieweconomics.com for a copy of the full report.
“Eurozone services inflation, despite recent ‘stickiness’, should fall sharply over the next 6 – 12 months. In particular: (1.) both monetary and fiscal policy in Europe are ‘tight’ and should increasingly put downward pressure on service sector prices (see point 1 below); and (2.) Europe’s labour market is loosening, with wage growth likely to fall further in coming quarters. As we highlight below, weaker wage growth should result in lower service sector inflation (point 2).”
Source: Longview Economics’ Monthly Asset Allocation, 17th April 2024, “Eurozone Services Inflation: How Worried Should We Be?”
In the UK, meanwhile, those pressures are falling away even faster. Harry’s calculations last week highlighted the real possibility that UK headline inflation will be between 0 – 1% by year-end (FIG 3 below). If that is the case, and given a stagnant/contracting economy, the case for multiple rate cuts (over and above what is priced) is strong. Bailey’s comments this week demonstrated the BoE’s growing understanding that they need to start cutting:
“[there is more] demand-led inflation pressure [in the US, than seen in the UK]… [there is] strong evidence of UK price pressures retreating”
Source: BoE Governor, Andrew Bailey, 16th April 2024
Extract from Longview research:
“In two of our three scenarios, headline CPI readings fall to between ZERO and 1% by year end. That would put significant pressure on the BoE to cut rates (by more than is currently priced). Our third scenario puts headline at target by year end. That, if it materialised, would still put pressure on the BoE to cut (just not as much).”
Source: Longview Economics’ Monthly Asset Allocation, 10th April 2024, “UK Rates: More Cuts Need to be Priced”
NB Key chart below from the 10th April 2024 UK inflation analysis:
FIG 3: UK headline CPI (Y-o-Y %), with key scenarios
In contrast, Chair Powell (as was widely publicised this week) pushed back further on the timing of the first rate cut, and by implication, the number of cuts (see quote above). The 2025 Fed fund rates curve illustrates the point with 16bps priced out of the curve since early April (FIG 4).
FIG 4: US Fed funds implied rate cuts for 2025 (bps)
Is America Exceptional?
All of which raises the question: Is America Exceptional? Is the market correct to price the US stock market at a 52% premium to Europe, with the S&P500 on 20.7x forward consensus EPS and Europe trading on 13.6x. As a result, Europe is trading at its steepest discount to the US on record (FIG 5).
FIG 5: PE ratio – Europe relative to the US (both based on forward 12m rolling consensus EPS)
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