Macro

Last week, we discussed hot payroll numbers with cool wages and a strong but perhaps moderating economy. This week, we have received another hotter-than-expected inflation print, but investors still expect three rate cuts this year, with the first one starting in either June or July.

As the outlook on the US economy is relatively stable from last week, it’s worth discussing two important but contrasting emerging markets: India and China.

India has invested in infrastructure, reduced its deficits, and decreased subsidies while allowing the organic growth of the private sector. It is now the middle of the biggest infrastructure investment in history, focused on the local and regional road system. They are also rebuilding their internet infrastructure with the aim of making internet connections available across the entire country, including rural areas. These capes and investments in banking systems and technology have significantly improved labour productivity.

The government is looking to move $4B to $5B worth of infrastructure projects from public to private hands. These projects are mostly related to energy transition, telecommunication infrastructure, and toll roads. Expectations are that with such a great demographic and rapid digitization, technology and telecommunication will be the winning areas out of those supported by government plans.

India’s economy is growing, not only due to an increase in exports but also through an increase in internal consumption driven by the fast-growing middle class. This is a major difference compared to China, which overstresses savings. India’s GDP is 65% consumption, whereas China’s GDP is only 37% consumption. From an income perspective, India has about a quarter of China’s GDP per capita.

Inflationary concerns made many investors shy away from India in the past. India’s government must increase fiscal discipline and capital transparency and focus on price stability and support for the productivity growth. Although inflation risk is still there, India’s government is revising bankruptcy laws, which will not only bring downside cushion for investors but also rejuvenate credit markets and, over time, allow companies to access liquidity. India is also benefiting from inflows from emerging market investors, who were overly focused on China before and are now moving to India as a more politically stable frontier.

This week, China made a headline by announcing its economic plans at the 14th National Congress. Congress provided little information about reopening for foreign investors and focused on consumers. NFC was dominated by state-directed investments, state control over the economy, and more empowerment of the internal security apparatus.

As China increases its production capacity but fails to kindle domestic consumption, it must rely on exports. International partners are concerned that they will try to increase exports by unfair competitive practices such as significant state support and subsidies to further exacerbate trade imbalances.

China wants to achieve its 5% GDP growth target through investment in technology and manufacturing. More specifically, it will focus on AI (the AI+ initiative to incorporate AI into all sectors of the economy), EVs, green technology, and space commerce. Investors also hope the government’s ambitious growth target will motivate them to remove regulatory pressure from the tech sector, which is causing its valuations to be heavily discounted.

China is trying to generate higher productivity growth as it can no longer rely on favourable demographics. It is expected to achieve this by increasing its reliance on the manufacturing ecosystem of the coastal provinces, which are already the biggest winners of China’s growth.

Rates

Everyone is watching FED funds futures, which have been wrong (pricing in rate cuts too aggressively) for the last 1.5 years. The Fed is slower than expected as it tries to minimize the risk of being forced to pivot direction multiple times by butting too early and then being forced to hike again. This would create a lot of uncertainty and be very negative for risk assets. However, recently, the FED has also been putting more emphasis on recession risks, which increase the longer the FED stays restrictive.

Rates keep rising this year, with 2Y having risen more than 20 basis points in the past week to 4.71%. The large directional changes that we’ve seen in the rates market over the last six months are usually associated with the inflation point. We have tighter liquidity, and the marginal speculators (marginal buyers/sellers) are now directing the market. Those readjustments create volatility, especially at the front of the curve, since investors are readjusting their expectations on speed and degree of rate cuts. However, they do not contest that rate cuts will come; therefore, the volatility is much lower for maturity above 5 years. Moreover, the natural adjustment from the current share of the yield curve would be the bullish steepening. For those reasons, the recent rate increase creates an excellent opportunity to lock in high coupons, and coupons above 4% will be very difficult to access in the future.

Finally, it’s worth highlighting the increased demand for government bonds on the old continent. UK set a new record for the Q1 sale, with an all-time high offer of £56b for a £4b offering of the 30Y inflation-linked bonds. UK 10y government bonds also had high demand with 3.6x oversubscription.

Credit

Credit investors still focus on the total yield and press spreads to new lows. European corporate Credit hit a two-year low after new hope for rate cuts in Europe moved it closer to German government bonds. A considerably improved outlook on the eurozone helped to converge the cost of borrowing closer to US corporates. The regional differences between US and Euro high-grade spreads are now the tightest in 10 months, and they have declined this year from 32 to 21 bps. This year, the average European IG spread has fallen from 136 to 115 bps, a 16 bps compression. In comparison, US IG Credit spreads compressed by 10 bps this year and fell from 104 bps to 94 bps.

The IG market is pushing toward all-time tight spreads, and HY is also very tight despite increased issuance volume and the fact that 2024 is a year of increased refinancing. If new issuance keeps up the high volume further into the year, investors will have more choices, become more selective, and demand wider spreads.

Equities

Market Cap concentrates on US Tech stocks, with weak participation from the rest of the market. Top 10 stocks now represent 30% of the index (the highest level since the ’80s). 7 are part of the largest sector – Information Technology & Communication, representing over 35% of the benchmark. Such dominance of the single industry happened only once in the last 100 years when Energy & Materials crossed 40% in the ’50s. In contrast, S&P EW has a 3rd (behind the dot-com bust and GFC ) longest streak (544 days in a row) without an old-time high. Technology and innovation are the reasons for dominance in the global economy. The US stock market now accounts for over 60% of the MSCI ACWI Index (the last time it was that prominent was 20 years ago, back in 2004).

Although the growth in earnings of technological companies has been priced in, other areas can surprise the upside. Analysts are still quite conservative when pricing in the earnings potential of financials. More specifically, the market remains very conservative when estimating the earnings of money-centre banks, asset managers, and broker-dealers are understated.