Market Insights – March 12th, 2018

Weekly financial & economic analysis.

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Essentials

Citing national security considerations, Donald Trump has imposed tariffs on steel and aluminium imports. But these measures will have a limited impact, since Mexico and especially Canada – the main exporter of these metals to the USA – will be temporarily spared the impending tariffs owing to the renegotiation of NAFTA.

North Korea’s strongman, Kim Jong-Un, sent a conciliatory message to his country’s southern neighbour by offering to meet with Donald Trump. There are still no guarantees, but the Seoul Stock Exchange rose sharply on the news, led by stocks that had been weighed down by fears of a deteriorating political climate and those exposed to Pyongyang’s ally China.

At its latest meeting, the European Central Bank adopted a more constructive tone with regard to economic growth in the eurozone. The markets took this as a further step towards winding up the asset purchase programme before the end of the year.

Goldilocks – season two?

We have often talked about the ideal scenario for the USA, in which strong growth is coupled with a lack of inflation – a virtuous circle that various pundits refer to as a Goldilocks economy. But this scenario has been put to the test recently as investors have started to worry that inflation might be creeping back through wages. These concerns were what triggered the market turbulence in recent weeks. The February jobs figures, which have just been published, probably came as a relief to worried investors. The USA added more than 300,000 new jobs over the month, which was well above economists’ expectations. Such a solid figure at this stage in the macro cycle nevertheless comes as something of a surprise, since the USA has been creating jobs non-stop for more than nine years now. Unemployment held steady over the month, at 4.1%, but this is linked to a rise in the labour force participation rate, which was probably prompted by more long-term unemployed people returning to the job market. In the past, such developments would have been enough to justify an immediate tightening of monetary policy. Yet investors were reassured by the very reasonable uptrend in wages (+2.6%), as well as the downward revision in the previous month’s figure, which had initially sparked an inflation-related panic. Structural changes brought about by the digitisation of the economy seem to be behind the slow rise in wages in a labour market that is close to full employment. The financial markets reacted well to the latest jobs figures. Stock markets made gains over the week, while bond markets remained flat. But these indicators won’t be all that encouraging for the Federal Reserve, which is on the lookout for signs of overheating. The Fed will probably continue to tighten monetary policy very gradually if job creation drops to a more sustainable pace and especially if productivity picks up. And increasing productivity will most likely involve a rise in capex as companies seek to modernise their production equipment. This may be why tech stocks are doing so well across the globe – but especially in the USA, where the Nasdaq has just reached a new record high.

Oil prices still on a firm track

Oil prices, which have fared very well over the last two years, could have some more surprises in store. After peaking, investor sentiment relative to crude oil has started to wane. But investors are not excessively bearish. In the short term, a further consolidation of price cannot be ruled out, but that’s without factoring in current inventory levels in the USA, which are at their lowest in recent years. That said, the risk of a sharp rise in output in the USA is real. According to some estimates, growth in global demand combined with oil companies’ limited spare capacity following investment cuts in recent years should help prevent any market imbalance.  

If robust demand keeps oil prices firm, this would be an excellent opportunity for companies to ramp up their capex programmes. After all, it takes about four years for the impact of an investment decision to be felt. So the consequences of the capex reduction should soon be upon us. Energy stocks have lagged behind in the recent stock-market rally and still have some catching up to do.

 

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