Correction in stock markets, but no downward trend

Monthly report from MAPFRE Gestión Patrimonial

The onset of the second quarter bids farewell to the festive and leisurely period that characterized the first three months of the year. Now it’s time to get back to work, but that's not necessarily a bad thing. The poor performance of assets throughout April reflects a necessary correction, with no significant shifts observed in the macroeconomic landscape. Nonetheless, minor fluctuations have raised investors’ concerns regarding a trend that seemed a lot clearer only a few months ago.

In broad strokes, the United States’ growth trajectory yielded a disappointing surprise, registering a 1.6% annualized growth rate in the first quarter instead of the anticipated 2.5% consensus. A closer examination reveals that this subdued growth was the result of adverse contributions from the external sector and underwhelming inventory data. However, given the robust demand (+2.5%), it’s likely that these trends will reverse in subsequent readings.

Hence, it wasn’t the growth data that derailed the upward momentum in asset prices in April, but rather the unexpected rise in inflation. March saw prices increase by 3.5%, up from 3.2%, and we received readings on other significant macroeconomic data concerning inflation expectations, which exceeded expectations, along with the wage cost index.

These fresh insights reignited investors’ fears of stagflation (low growth and high inflation), which exerts a profoundly negative impact on asset prices, as we observed throughout April. Only Asian stock markets managed to escape losses, driven by a resurgence in growth in China and more lenient financial conditions that are helping to redirect flows back towards the Asian giant. Whether this marks a temporary shift or a sustained recovery remains to be seen in the upcoming months, but it undeniably bodes well for the macroeconomic situation in Europe.

Trending toward growth convergence

Despite the extensive discussions triggered over the past month by various macroeconomic data releases indicating weakness in US growth, the reality is that GDP estimates for the entirety of 2024 in the United States have improved by two tenths and now stand at 2.4%. However, there is a possibility that the country’s economy might begin to decelerate following a notably robust and unusual boost in growth expectations.

With interest rates at their highest in nearly a year, savings at low levels, and prices stubbornly high, there could be a dent in domestic consumption. Nevertheless, this hinges on the evolution of a job market that’s starting to go back to normal after dropping to historically low unemployment levels. It’s challenging to go against the grain of the US economy and consumption trends, so we differ from those who firmly believe in an abrupt economic slowdown (barring any financial or geopolitical misfortunes).

Another noteworthy development in April was the upward revision in expected growth for the entire Eurozone, following months of stagnation at notably low levels. This marks a mere one-tenth increase to 0.6%, yet it’s an undeniably positive outcome driven by the strong performance of economic activity in Spain, among other factors. When coupled with the widely anticipated interest rate cut by the European Central Bank (ECB) at its June meeting and potential support from Chinese growth, it seems reasonable to expect the European economy to begin to close some of the growth disparity with the United States.

This divergence in sentiment has been aptly reflected in the macro surprise index, as the US reference has turned negative for the first time in over a year (indicating more data points falling below expectations), while the European and Chinese references comfortably remain above 0 (with more data points surpassing expectations).

Yet, volatility persists in interest rates

The unexpected rise in inflation in the United States and the potential response from the Fed at its meeting in the first week of May have once again increased volatility in interest rates. In fact, bond price variability (as measured by the MOVE Index) has remained higher than that of equities (as measured by the VIX Index) since mid-2022, a situation that is unusual and difficult to navigate, given that interest rates essentially represent the “price of money.”

One explanation for this circumstance may lie in the monetary policy of the major central banks (e.g., the Fed and the ECB), as they have linked their future decisions to the trajectory of macroeconomic data. While this strategy would make sense in a stable environment, the present macroeconomic and geopolitical landscape is anything but stable. Consequently, every release of significant economic activity data leads to heightened volatility in asset prices.

The data released throughout April triggered a notable surge in both short and long segments of the German and US yield curves, sparking speculation about the number of rate cuts the Fed might implement for the remainder of the year, especially after Federal Reserve Chairman Jerome Powell dismissed the possibility of a rate hike.

In our opinion, it’s concerning that expectations regarding future interest rates are so volatile and subject to so many fluctuations, as seen recently, over the course of a single week, in response to two conflicting publications (wage costs and the jobs report). However, what is reassuring is that while the evolution of central bank liquidity remains negative, the market demonstrates an ability to generate liquidity independently, largely due to the continued lax financial conditions.

Positive surprises in corporate earnings

Because markets don’t only “drink” from the macroeconomic data, we cannot overlook the ongoing earnings season corresponding to the first quarter of the current year. Overall, we can assert that a positive trend is evident, as profit growth expectations are surpassing by +9% for US companies and +6.5% for European companies. Sales are also improving for the fourth consecutive quarter, which means that business margins may even be increasing, contrary to what one might expect.

What's more, as we mentioned in this article, CEO of listed companies are increasingly optimistic about the future performance of the companies they represent; even expected earnings growth is projected to rise in the coming months. What may seem counterintuitive is investors’ response after the financial reports are released, as the typical pattern has been to see drops in stock prices whether the results exceeded or fell short of expectations (a sign that the market needed a break).

Conclusions: cautious, but optimistic

The macroeconomic outlook hasn’t shifted as dramatically as some recent headlines might imply. Instead, we see the recent movements in asset prices over the past month as a healthy correction rather than the start of a prolonged downturn. While growth in the United States could begin to slow down, it’s important to note it won’t come to a complete halt, and any deceleration may be offset by improved growth in Europe and China.

The ongoing debate about the trajectory of inflation remains lively, and we maintain our belief that economies will need to adjust to higher neutral interest rates—rates that neither excessively stimulate nor hinder growth—compared to those of the past decade. The ability of companies to adapt to this environment, alongside the significant volatility observed in both interest rates and currencies, will play a pivotal role in shaping the performance of risk assets in the months ahead.