Strategy: PMIs highlight developed markets’ lead

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Emerging markets lag, but there is relief over the slowdown in China

With the main central banks remaining in stimulative mode and the US and eurozone economies improving, we stuck to our overweight in equities. We do not see enough signs of improving growth in emerging markets to go overweight there to benefit from attractive valuations, so we remain neutral. We closed our overweight US small caps versus large caps since we believe the earnings outlook has worsened. Furthermore, this position had moved against us.

  • US labour data points to solid income gains
  • ECB sticks to words, but is ready for fresh action
  • Emerging market PMIs weaker than developed market indicators
  • Overweight US small caps versus large caps close

With the main central banks remaining in stimulative mode and the US and eurozone economies improving, we stuck to our overweight in equities. We do not see enough signs of improving growth in emerging markets to go overweight there to benefit from attractive valuations, so we remain neutral. We closed our overweight US small caps versus large caps since we believe the earnings outlook has worsened. Furthermore, this position had moved against us.

US: a solid labour market report

You could say this report disappointed financial markets. Equity markets and bond yields fell after the news. But payrolls rose by 192 000 in March and the previous two months’ data was revised up, taking employment growth close to the 200 000 trend seen in most of 2013. The jobless rate was stable at 6.7%.

The increase in the average workweek from 33.4 hours to 33.7 hours – the strongest monthly gain since 1996 – was also positive. Average hourly earnings fell by a notch, but the participation rate rose. It looks like household income rose solidly. So for me, there is no reason to be negative about this report. Market participants may just have got ahead of themselves, with the ‘whisper number’ for employment growth higher than the actual outcome.

The forward-looking ISM non-manufacturing index and the NFIB index of confidence among small business owners both rose. New orders and employment improved. This does not point to solid GDP growth though since there may be some drag from the harsh winter. The situation is not much different for small business owners. Interestingly, the number of owners raising pay has climbed to its highest since 2008.

ISM & US hours

ECB sticks to words for now

Verbal intervention can be powerful. In its early April policy meeting, as expected, the ECB stopped short of taking additional action to stimulate growth, but president Draghi clearly left the door open to new measures, reiterating the ECB’s readiness to use non-standard measures. He implied that next to deflation, even a long period of low inflation may be enough to trigger action. We expect the ECB to try a small cut in the refi rate, a negative deposit rate or a halt to the sterilisation of earlier bond purchases first. Credit easing, under which the ECB buys asset-backed securities, is also possible since this could lower interest rates more directly and improve banks’ willingness and ability to extend new loans.

Steady retail sales, gains in consumer confidence, improving German industrial production and an uptick in French business sentiment point to a brighter outlook for the eurozone, which could keep the ECB from unconventional action.

Eurozone consumer222

PMIs slow almost globally

The drop in PMIs was more pronounced in emerging markets than in developed economies with improvements in the US, Canada, France, Italy and Spain. Japan, Germany, the UK and the Netherlands recorded declines. Emerging market PMIs fell almost across the board, except for South Korea and Vietnam. In China, the manufacturing PMIs held steady, but the services PMIs improved. To some extent, the data alleviated market fears of a sharp slowdown in Chinese growth.

In Brazil, where the PMI rose slightly, the central bank hiked interest rates by 25bp to 11%. With annual inflation easing since the middle of last year, it looks to us like the tightening cycle in Brazil is ending.

Japan’s latest Economy Watchers Survey confirmed the recent optimism on current conditions, but a less bright outlook due to the 1 April sales tax hike. It will be important to look for signs of a rebound in the third quarter, possibly helped by further quantitative easing by the Bank of Japan amid persistent strength in the Japanese yen.

Manufacturing555

Joost van Leenders

Chief economist, Multi Asset Solutions, CFA charterholder

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