investment viewpoints
Will European consumers drive a SMID resurgence?
After a period of strong US growth, the global economy is likely to be in the early stages of a slowdown. At first sight, this natural phase of normalisation is good news for the medium-term prospects of financial markets: without this deceleration, monetary tightening would persist and make a successful soft landing unlikely.
Such moderation also allows the dominant engine of growth – consumption – to achieve a better balance between the world's three major economic zones: the US, China and Europe. This week in Simply put, we ask: what are conditions like in each of them, and how should equity investors approach this rebalancing phase? To find an answer, we look at both nowcasting indicators and market performance.
| Need to know:
|
|---|
A tale of three consumers
About 65% of global consumption takes place in three regions: the US (30%), Europe (20%) and China (15%). Over time, consumption has grown in importance and has been influenced by the major rebalancing of Chinese growth from an investment-driven model to one based more on consumption and services. Tracking and analysing the dynamics of these major consumption zones is essential for any market economist.
Our nowcasting indicators incorporate consumption components for three regions. Their ups and downs, and combined average, since the early 1990s are shown in figure 1. We can see that each recession features a consumption slump in at least two of these zones – take the 1990, 2001 and 2008 downturns, for example.
In the past year, the time lags between the consumption upswings in each region support the case for a soft landing. First, Chinese consumers hit the shops after Covid-19 restrictions ended, followed by Europeans and then Americans. Even though all zones are improving, consumption in Europe is weakest, which probably contributes to the collective pessimism about the economy’s prospects. But could European consumers simply be recovering more slowly, with further strength to come? If this is the case, which markets could benefit from the coming improvement?
FIG 1. The consumption component of our nowcasting growth indicator
Source: Bloomberg, LOIM at March 2024. For illustrative purposes only.
Look to small- and mid-caps
In equity markets, small- and mid-cap stocks usually benefit the most from strengthening consumption. There are various ways for us to assess this dynamic, but the simplest is probably to calculate the correlation between the returns of different equity indices and these consumption components of our growth nowcaster. The results are presented in figure 2, with the left chart focusing on small- and mid-cap indices and the right showing the earnings for large caps. There are three messages:
- The link between consumption and stock performance seems clear: improving consumption across the US, Europe and China is positively linked to the performance of stocks of all sizes
- The performance of small- and mid-caps are more closely linked to European consumers than the others. Chinese small caps are more closely linked to Chinese consumers
- In the US, the situation is different: European consumer spending appears to be the most correlated with the performance of US small- and mid-caps
These charts convey a simple message: gradually improving European consumption could well support the valuations of US and European small- and mid-caps. The recent rally in indices such as the Russell 2000 may be the first sign of this.
FIG 2. Correlation between equity index returns and consumption indicators
Source: Bloomberg, LOIM at March 2024. Past performance is not a reliable guarantee of future results. For illustrative purposes only.
‘Size’ matters
The academic literature is full of it: the 'size' factor that leads small- and medium-sized companies to outperform the stocks of larger companies. This has long been a key driver of many asset-allocation decisions. But in the last few years, this track record has fallen on hard times as US large caps rode over everything in their path.
Figure 3 provides further evidence for those who still believe that the size factor is not dead. It contains three graphs showing the correlations of the large- and small-cap indices with our consumption indicators, organised by region. It shows a clear trend: the strength of the local consumer matters more to smaller caps and large companies.
This finding, combined with the view that European consumption is improving, paints a positive picture for European small- and mid-caps. It could well be a key macro trade in 2024.
Figure 3: Correlation between equity index returns and consumption indicators
Source: Bloomberg, LOIM. Past performance is not a reliable guarantee of future results. For illustrative purposes only.
| Simply put, as European consumption gains strength, small- and mid-cap equities in the region could stand up to large companies. |
Macro/nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises are designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
- Growth has declined recently, mainly due to US data
- Inflation is rising in the US, the eurozone and China
- Monetary policy, led by the US and China central banks, is taking a dovish lean
World growth nowcaster: long-term (left) and recent evolution (right)
World inflation nowcaster: long-term (left) and recent evolution (right)
World monetary policy nowcaster: long-term (left) and recent evolution (right)
Reading note: LOIM’s nowcasting indicators gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).
important information.
For professional investors only
This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393. This document is approved at the date of publication.
Lombard Odier Investment Managers (“LOIM”) is a trade name.
This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
UK regulation for the protection of retail clients in the UK and the compensation available under the UK Financial Services Compensation scheme does not apply in respect of any investment or services provided by an overseas person. A summary of investor rights and information on the integration of sustainability risks are available at: https://am.lombardodier.com/home/asset-management-regulatory-disc.html.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited which is authorized and regulated by the FCA. ©2024 Lombard Odier IM. All rights reserved.
