Written by Kristina Hooper, Chief Global Market Strategist, Invesco
Key Takeaways:
- US stagflation?
Google searches of the term “stagflation” went up dramatically last week, but I don’t believe we’re seeing stagflation in the US.
- Eurozone services?
The recovery in eurozone services appears to have legs, in my opinion, as we are finally seeing better activity in the eurozone’s two largest economies, Germany and France.
- Republic First Bank
We saw a small bank failure with the seizure and sale of Republic First Bank, but I don’t see any contagion stemming from this failure.
The big news last week, given that the world is waiting to see when the US Federal Reserve (Fed) will begin cutting rates, was the US gross domestic product (GDP) report for the first quarter. Not only was growth lower than expected, but inflation was higher than expected. This was followed by the March Personal Consumption Expenditures (PCE) Price Index, showing both headline and core inflation for March were higher than expected. This data calls into question how sticky inflation is going to be — and how long the Fed will have to wait before it cuts rates. As a result, there was a big increase in fear — Google searches of the term “stagflation” went up dramatically, and some even argued that the next Fed action will be a hike, not a cut. In addition, we saw a small bank failure last week with the seizure and sale of Republic First Bank. But despite these concerns, I do see several reasons for investors to be positive.
1. The US is not experiencing stagflation
Stagflation (combining the words “stagnant” and “inflation”) is characterized by slow economic growth, high unemployment, and high inflation. This is not stagflation! The March PCE Price Index is below 3% with year-over-year headline inflation at 2.7% and core PCE inflation at 2.8%. And don’t forget, PCE is the Fed’s preferred measure of inflation.
The US Consumer Price Index (CPI) has been higher, although we can point to idiosyncratic reasons for this, especially lagging components such as automobile insurance (which is reflecting an earlier increase in auto prices) and shelter, which is reflecting an earlier rise in housing costs as higher market prices established by new leases take time to show up in shelter data.
In short, I still believe disinflation has continued although progress has slowed — but that slowdown could be very temporary. There is more data to come between now and the Fed’s upcoming meetings. (It’s also worth noting that while Google searches in the US for “stagflation” have risen significantly, they are still below previous peaks in February 2008 and May 2022.)
2. The eurozone economy appears to be experiencing a solid recovery
Flash Purchasing Managers’ Index (PMI) readings for the eurozone for April indicate the eurozone economy is improving. Eurozone manufacturing PMI weakened a bit, but services PMI reached an 11-month high. And this recovery appears to have legs, in my opinion, as we are finally seeing better activity in the eurozone’s two largest economies, Germany and France, which had shown signs of real weakness for some time.
Additionally, the economy may be poised to get a boost from the start of European Central Bank (ECB) cuts, which still appear very likely to begin in June, which could provide a significant boost to European equities.
3. The UK economy has upside potential
Despite weaker manufacturing activity, services activity has shown real strength. The flash S&P Global UK Services PMI was far better than expected and is helping to power the overall economy. With disinflationary progress being made in many components, I think the Bank of England is closer to rate cuts than many expect.
4. No contagion expected from last week’s bank failure
As stated earlier, we saw a small bank failure last week with the seizure and sale of Republic First Bank. This was the first FDIC-insured bank failure of 2024. As I said back in December, I wouldn’t be surprised to see a few isolated bank failures going forward. However, I believe that in assessing situations like this, the key is to determine whether it is contained or contagious. In my view, based on information available, this appears to be an isolated situation with issues that were largely idiosyncratic. I don’t see any contagion stemming from this failure.
5. Corporate earnings have been stronger than expected
Markets performed well in the past week despite higher-than-expected PCE inflation and talk about stagflation. Helping stocks is that earnings growth has been stronger than expected — and isn’t that what we want driving price gains?
As of Friday, with nearly 50% of S&P 500 companies reporting, we saw 77% register a positive earnings surprise and 60% register a positive revenue surprise.3 Earnings growth for the S&P 500 in the first quarter is estimated to be 3.5%, which would be the third consecutive quarter of year-over-year earnings growth.
And it’s not just the US. With 33% of Stoxx Europe 600 companies having reported, 54% have beaten earnings expectations. And in Japan, with 14% of Topix companies reporting, 59% have beaten earnings expectations. As global growth improves, this should translate into improved earnings growth in coming quarters.
As one multinational consumer company shared on its earnings call, “…the consumer globally, we think is very resilient. And we see it in, as you saw, from our international business performance. And it’s basically supported by two facts, very low unemployment or quite low unemployment globally and wages growing at a good pace in a majority of the countries where we participate.”
Perhaps we are returning to a more normal world where monetary policy expectations don’t have such an outsized impact on assets.
6. European stock buybacks have accelerated
European companies have ramped up their stock buybacks, and now more closely resemble US companies. For example, the Stoxx 600’s buyback yield has risen to 1.8%, which is the same as that of the S&P 500.6 We are seeing similar behavior in the UK. These companies have significant cash on balance sheets, giving them the potential to further increase buybacks. I believe this should provide material support for European and UK stocks.
7. Cash remains on the sidelines
We don’t need rate cuts to drive stocks higher — as I’ve said before, there is excess investor cash on the sidelines that could easily return to capital markets. And the catalyst doesn’t have to be imminent rate cuts — it could simply be improved earnings growth or just “dip buying.”.
Looking ahead: An important week for markets
This week will be an important one for markets — absolutely chock full of data, and with a Fed meeting to boot. We will be getting eurozone CPI, the US Job Openings and Labor Turnover Survey (JOLTS), the US Employment Cost Index, China PMIs, and the US Employment Situation Summary jobs report.
When it comes to the US, I will be most focused on the labor market, especially wage growth. When it comes to the Fed, I wouldn’t be surprised to hear hawkish language from Chair Jay Powell given the recent data, but I will not be rattled by it (I’m looking ahead to the data between now and the next two Fed meetings). And we will be getting more earnings reports, which I think will be very helpful in providing macro and industry-specific insights.
