Adrien Pichoud Economist
Maurice Harari Senior Portfolio Manager
Wanda Mottu Portfolio Manager
Christophe Buttigieg Portfolio Manager
01

US – Strong Q3 GDP driven by consumption

The US economy is still growing strongly. This was, in a nutshell, the message from the preliminary Q3 GDP report, posting a 3.5% annualised expansion, after a 4.2% expansion in Q2. Over the past 12 months, US real GDP has grown at 3%, its fastest expansion rate since 2015.

However, unlike in the previous quarter, the expansion was much less synchronised among various components of the economy. Business and residential investments stalled over the summer while inventories accumulated at the fastest pace in three years. Exports had their first quarterly decline in two years and imports jumped to a new record. Ultimately, only household consumption remained ‘on track’, posting another quarter of 4% annualised growth, still supported by a strong job market and lower taxes.

These discrepancies might well be temporary and will possibly be revised later. The underlying dynamics of the US expansion are powerful enough to absorb such jolts. But this Q3 GDP report possibly signals the ‘golden period’ of the past two years, where all US growth engines were positively contributing in a synchronised way, may be about to give way to a less harmonious and more volatile situation.

Household consumption fuelled strong GDP growth in Q3 but investment stalled

Sources : Factset, SYZ Asset Management. Data as at : 01 November 2018

01

Nominal wage growth is accelerating…but real purchasing power is not

Sources : Factset, SYZ Asset Management. Data as at : 02 November 2018

02
02

US – Rising wages support household spending

The unemployment rate keeps falling in the US. In October, it reached 3.7%, its lowest level in almost half a century – down from 10% in late 2009. For several years, the decline in unemployment failed to trigger a significant rebound in depressed wage growth. It seems this year it will finally happen, as labour scarcity and increases in minimum wage by several large US employers are finally driving nominal wages and employment costs higher.

Given the reliance of US growth on household consumption, this acceleration in wage increases is welcome. It compensates for the negative impact of rising energy prices on purchasing power and, more generally, the slightly higher level of inflation. In fact, real average hourly wage growth has barely accelerated this year and remains below 1%. Positive growth in household real purchasing power has to be maintained in order to sustain consumption and GDP expansion going forward.

03

Eurozone – Another quarter of soft GDP growth

Economic growth in the eurozone has once again disappointed expectations in the third quarter. The union’s GDP grew at 0.2% – lower than the 0.4% pace of growth from Q1 and Q2 and lower than the 0.7% quarterly average rate of 2017. Having grown at 1.7% over 12 month, this is the slowest growth since 2014.

Country-specific data – namely monthly activity and sentiment indicators – confirms this recent trend. Germany and Italy are still suffering from the negative impact of slower global growth on manufacturing activity. Italy has also been affected by political factors and uncertainty surrounding the budget and fiscal outlook. On the other hand, Spain remains the most dynamic of all the large European economies.

Summer weakness in activity appears to have been mostly linked to global or country-specific factors. Declining unemployment, rising wages and low rates now support domestic demand growth and should help eurozone GDP growth stabilise at a decent yearly pace of about 1.5%. But negative sentiment generated by the growth slowdown is now tilting the balance of risks to the downside.

A broad-based growth slowdown in the eurozone this year

Sources: Factset, SYZ Asset Management. Data as at: 01 November 2018

03

Higher wage growth but pressure on consumer price inflation is easing

Sources: Bloomberg, SYZ Asset Management. Data as at: 01 November 2018

04
04

UK – Weaker inflation provides some respite for the BoE

The latest inflation figures were certainly welcomed by the Bank of England, as inflation eased more than expected in September. In a UK context where uncertainty induced by the divorce from the European Union tends to undermine the economic outlook, this drop in the annual rate of inflation gives the central bank room to move slowly in raising interest rates.

While inflation pressures were weak prior to the referendum, the Brexit vote caused a sharp depreciation of sterling, which pushed up inflation. Lately, the acceleration of wage growth has been another sign of inflation picking up. The latest CPI print at 2.4%, however, gives the central bank some breathing room. On 1 November, it decided to pause interest rate normalisation. Looming Brexit continues to be a concern for the BoE, even if it expects a smooth transition.

05

FX – Chinese currency on the slide

Amid intense trade discussions between the US and China, the Chinese currency has also been under the spotlight for approaching the psychologically important level of 7 yuan per US dollar. Investors appear worried a fall below this level might trigger more volatility and capital flights, which could have a snowball effect.

But the key problem is more complex. While a weakening yuan is good for exports and indirectly alleviates the effect of US tariffs on Chinese goods, further depreciation would certainly not be good for Chinese officials and trade discussions. The US might come back with accusations the Asian giant is manipulating its currency, an accusation which was recently dropped by Secretary Mnuchin but lingers in investors’ minds.

As of late, the yuan rebounded after Trump hinted at a potential deal between both countries. The currency might remain volatile until a deal is actually confirmed.

Yuan drops, flirting with the 7 level

Sources: Bloomberg, SYZ Asset Management. Data as at: 01 November 2018

05

Domestic indicators of credit growth and activity have recently stabilised

Sources: Factset, SYZ Asset Management. Data as at: 01 November 2018

06
06

China – Tentative stabilisation in domestic activity

Aside from the ongoing dispute with the US on trade, the Chinese economy has also been struggling with domestic headwinds this year – namely the politically-driven crackdown on credit announced right after the Party Congress in October 2017. By abruptedly cooling lending growth, this dampened internal demand and amplified the economy’s growth slowdown.

The Chinese authorities’ plan to reign in credit expansion, however well-intentioned in the context of an increasingly-leveraged economy, proved to be ill-timed, as it was conducted in parallel to rising US tariffs. Incidentally, the move was rapidly reversed, with a gradual easing in monetary conditions in the spring of this year later complemented by supportive fiscal measures. As the negative impact of US tariffs progressively filters through to economic activity, so are the positive monetary and fiscal stimuli supporting domestic demand.

Tentative signs of a stabilisation have recently appeared. Domestic credit has rebounded from a three-year low and domestic manufacturing activity appears to have stabilised just above the limit between expansion and contraction. It is too early to point to a decisive reversal in trend, but this is an encouraging sign on the domestic front.

07

Mexico – MXN under pressure after the cancellation of airport project

Mexican president-elect Andrés Manuel López Obrador (AMLO) announced the cancellation of the $13.3bn airport project in Mexico City, following the result of a consultation he initiated. Nearly 70% of participants voted against the project, choosing instead to recondition and expand existing facilities. Following AMLO’s announcement, Fitch cut Mexico’s sovereign rating outlook from stable to negative. The decision to abandon the project raises further concerns on the cancellation of existing contracts, especially in the energy sector, and will certainly affect investor confidence.

With Mexican assets under pressure, the peso lost 8.0% versus the dollar over the month, compared to the MSCI emerging markets currency index, which only lost 1.1%. AMLO will take office on 1 December and there is no doubt his inauguration speech will be closely watched, as well as the government budget, which must be passed by 15 December.

MXN underperformed emerging markets currencies in October

Sources: Bloomberg, SYZ Asset Management. Data as at: 31 October 2018

07

US 10Y real yields and Gold spot price evolution

Sources: Bloomberg, SYZ Asset Management. Data as at: 01 November 2018

08
08

Commodities – Gold’s negative correlation with real interest rates

In October, the price of gold edged up nearly 2% above $1200 per ounce, in a month where only a few asset classes finished positive. Gold finally acted as a safe haven asset, in volatile markets which were also under pressure due to fears of stronger-than-expected interest rates hikes from the Federal Reserve.

In parallel, real rates have also recently readjusted above the 1% threshold, from 0.42% at the end of last year. This kept the gold price range bounded in the last three months at about $1200 per ounce. Moreover, the US dollar got stronger this year, up 5.4%, which kept a lid on gold prices.

Lately, it seems investors are regaining faith in the precious metal historically deemed a safe haven. Two of the biggest threats to gold are higher interest rates and a stronger greenback but the market has probably already priced these in, putting less of a drag on gold going forward.

09

Rates – Rise in US yields without higher inflation expectations

US 10-year nominal treasury yields climbed above 3.2% in October for the first time since 2011. Unexpectedly strong activity data and comments from Federal Reserve president Jerome Powell on the fact the Fed is not anywhere near the end of its rate hike cycle led to a sudden jump in yields.

However, this movement was peculiar in the sense it was almost exclusively caused by the rise in real long-term rates rates, while the inflation expectation component barely moved – even droping later in the month. Nominal long-term rates are a combination of expectations on future inflation and future short-term rates.

The fact only real rates rose in October suggests investors remain firmly convinced inflation will remain under control over the long run. This may be because if the Fed keeps hiking short-term rates, the US economy will not be allowed to overheat to the point where it finally generates inflationary pressures. This impression is reinforced by the fact inflation still has to appear in the US, despite strong economic growth and low unemployment.

Inflation expectations edged lower in October while nominal rates jumped

Sources: Factset, SYZ Asset Management. Data as at: 01 November 2018

09

Relative performance of the Russell 2000 (small caps) over the S&P 500

Sources: Bloomberg, SYZ Asset Management. Data as at: 02 November 2018

10
10

Equities – Underperformance of US small caps

In October, US small caps, measured by the Russell 2000 Index, continued to underperform and have been lagging the broad US equity market – the S&P 500 – by 8% since the end of June.

Recently, with the change in monetary policy environment, equity markets have started to adjust. For example, US small caps are underperforming and the growth/momentum style being challenged by value investing.

A few months ago, when trade war discussions started between the United States and China, US small caps rallied over US large caps on the back of sanctions which will probably hurt smaller companies less than larger ones.

Investors are now focusing on the US economy, with economic indicators pointing to late-cycle conditions, which generally favor large caps over small caps. Moreover, with the Federal Reserve continuing to normalise its monetary policy, small caps with high levels of debt – often floating – could be hurt.

The small-cap bounces seen earlier this year on tax cuts or trade concerns are slowly fading, while new trade deals, such as a revamped NAFTA, will again benefit large companies.