As growth drives the outlook, what next for equities?

There was plenty to celebrate in the closing months of 2023. The S&P 500 index was up by around 14%, while rally in rates enabled bond indices to post a total return of more than 9%. This year has started under less favorable auspices, and economists and analysts alike seem to think the rally is behind us. In this weekly edition of Simply put, we ask: if the drop in rates has done its bit, how can equities continue to rise now?

Earnings growth as a deciding factor

What happens next largely depends on the direction of earnings growth. Earnings growth can be broken down into margin growth and sales growth: the latter is showing only half-hearted expectations. However, our margin growth indicators are starting to pick up again.

How should we interpret this and, more importantly, what are the implications for markets?

A more optimistic outlook

The pace of US economic activity was exceptionally high in the second half of 2023, despite high interest rates. However, with the earnings season just around the corner, it is worth noting that analysts revised their expectations downwards considerably in December. Although the rise in US growth in Q3 surprised to some extent, there were many warning signs - not least the diffusion index of our growth nowcaster.

In the summer of 2023, more than 60% of US growth data were improving. This percentage then fell back during Q4, and it is only very recently that it has started to rise again. Today, more than 70% of the data show an improvement, and whereas in the summer of 2023 consumption was the main vector for improvement, this rally is now spread across a broader range of components. 

We were cautious in interpreting this signal in Q4, but it is a second sign of improvement and is accompanied by a material uptick in the growth indicator itself - so watch out for positive surprises in terms of growth in the first quarter of 2024. This upturn in growth in the middle of such a pivotal period could work in favour of equities, particularly value stocks, emerging market equities and, more generally, the laggards of 2023, with growth underpinning sales and corporate earnings.

FIG 1: Diffusion index of the US growth nowcaster (% improvement in economic data)

Source: Bloomberg, LOIM. Past performance is not a guarantee of future results. For illustrative purposes only.

But rather pessimistic expectations

Is the potentially improved growth outlook already reflected in market prices and in analysts' scenarios? There seems to be a consensus among market players that a soft landing is coming, and the Federal Reserve’s (Fed’s) recent pivot has increased the likelihood of such a scenario.

Figure 2 illustrates the current expectations of analysts and economists, who are forecasting a period of weaker nominal growth than previously, in terms of both sales and GDP, for 2024 and 2025. This medium-term outlook is therefore rather pessimistic. Lower interest rates and the continued strength of global demand could provide some positive surprises for growth – our growth signal and its rise only point in the same direction, that of a cyclical recovery without any real contraction beforehand. Welcome to monetary policy 2.0.

FIG 2: World GDP growth and sales growth (Bloomberg forecasts to 29 December 2023)

Source: Bloomberg, LOIM. Past performance is not a guarantee of future results. For illustrative purposes only.

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 continued to increase over the week, bringing our US signal to higher levels.
• Inflation continues to rise from negative territories, and has now started to do so in Europe.
• Monetary policy is stabilising at lower levels, explained by the stronger-than-expected macro data.
   

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 indicator 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).

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