It has been a very good start to the year for (most) equity markets worldwide.
Japan posted its best six months in a long time, US equities have returned more than 20 per cent in sterling terms, and even core European markets have been quite strong. The only laggards have been emerging markets.
But we have been extremely surprised at the resilience of developed market equities in the latter stages of the first quarter, but even more surprised – and also hurt, to be honest – by the relative strength of US equities.
There can be no doubting the global economy is slowing down. Both Chinese and US exports showed a noticeable decrease at the last reading, while the US recovery seems to be taking a small breather – or maybe a big one.
Perhaps more disconcerting is that Chinese officials are now happy to state they are moving away from the past decade’s obsession with growth and are allegedly more concerned with achieving popular wellbeing through a much more balanced economy.
If we are witnessing a real slowdown of what has been a rather fragile recovery, then I believe this is not yet priced in by most equity markets. The S&P 500 is still very close to an all-time high.
Notwithstanding global cooling, there are also a few domestic issues in the US that appear to have been overlooked by the eager bulls.
More than 70 per cent of US economic output is made up of consumption: for quite a while now the consumer has been the nearly unstoppable engine that has helped the US to reach its place at the top of the food chain.
If you read the headlines, with markets having been so strong, unemployment dropping and the housing market strongly established in an uptrend, there should be no stopping the mighty American machine.
We believe that, quite to the contrary, there are early signs of more potential trouble ahead in the US.
What drives consumers to spend – and they will need to spend a lot if the recovery is to have more legs – is the feelgood factor triggered by wealth increases. Ways to increase wealth are pay rises, investment performance and house-price appreciation.
Wage inflation has yet to happen in the US and is unlikely to occur unless unemployment drops to much lower levels. House prices have indeed risen a bit in the past 12 months, but as the end of QE looms we can expect mortgage rates to rise fast and therefore affordability to plummet.
Since April the index representative of US mortgage interest rates has risen from 3.4 per cent to nearly 4.4 per cent – an increase of roughly 35 per cent of your monthly repayment.
With this in mind it is not surprising that the last GDP figure pointed towards a slowdown in consumption. The last employment figures were not so rosy either.