The latest data should reinforce expectations that the Fed will slow the pace of rate increases to 25 basis points at its meeting later today, after a 50bps hike in December and 75bps at the previous four gatherings.
But we think these developments may not be sufficient for US equities to outperform this year, especially as the outlook in other regions like China and Europe has improved.
US stocks are relatively expensive against a backdrop of slowing growth and weakening earnings. The 425bps of tightening from 2022 are still feeding through into the economy, especially in rate-sensitive sectors like housing. Beneath the 2.9% annualized GDP growth for the fourth quarter, residential investment fell 26.7%, the seventh consecutive quarterly decline. Business activity also contracted for the seventh month in a row in January, based on the flash purchasing managers’ index readings. In addition, the fourth quarter earnings season has started with the median company in the S&P 500 lowering its earnings per share guidance for the first quarter of 2023 by 2.1%. Overall, we expect S&P 500 earnings to contract 4% in 2023.
Despite this slowing, the US stock market is trading at 17.6 times the consensus estimate for 2023 earnings, a 10% premium to its average over the past 15 years. It is also around 40% richer than both MSCI Europe (12.5x) and MSCI EM (12.1x).
Data is starting to point to an economic rebound in China following an early reopening. The official January PMIs showed that the nation’s manufacturing and services activity expanded for the first time in four months. Meanwhile, consumption and mobility data over the recent Lunar New Year holidays also pointed to a solid recovery. VAT-based invoice data from the China Tax Authority showed that consumer revenues during the CNY holidays rose 12.2% y/y (to 112.4% of the 2019 level). Domestic tourism recorded the strongest visitors and revenue levels since the pandemic, while passenger traffic rose 74% to reach 54% of 2019 levels.
Against this backdrop, we are most preferred on Chinese equities, with a preference for sectors most likely to gain from the reopening, including pharmaceuticals, medical equipment, transportation, capital goods, and materials. Broader EM equities, as well as US and European companies that are highly exposed to Chinese spending, should also benefit. This would include German equities.
The Eurozone economic outlook is improving due to lower gas prices, with a warm winter helping to avert an energy crisis. The Eurozone’s gross domestic product grew by 0.1% in the final quarter of 2022, according to preliminary estimates, defying market forecasts of a 0.1% contraction, despite high inflation and the war in Ukraine. The Eurozone flash composite PMI also moved into expansion territory in January for the first time since June, coming in at 50.2.
We expect lower gas prices in Europe to be particularly supportive of the European consumer. Therefore, we like the region's consumer stocks as well as German equities, which should benefit from both Europe's improving growth and China’s reopening thanks to this market’s export-oriented composition.
So, despite early signs of easing US labor costs and prospects of an end to the Fed rate-hike cycle, we believe that US equities will underperform regional peers this year. We are least preferred on US equities. Meanwhile, we expect emerging markets, including China and German equities, to be among the main early beneficiaries from an inflection point in global growth in 2023.
Main contributors - Mark Haefele, Patricia Lui, Christopher Swann, Vincent Heaney
Content is a product of the Chief Investment Office (CIO).
Original report - Slowing Fed rate hikes unlikely to spur US outperformance, 1 February 2023.