Global Weekly Commentary: New regime fuels narrative flip flops
Flip flops
Market narratives have flip-flopped through the year as the new macro regime plays out. We stay selective amid stagnating activity and volatile inflation.
Market backdrop
U.S. stocks dipped and bond yields climbed after solid U.S. services data. Markets are coming around to our view of key central banks holding policy tight.
Week ahead
U.S. CPI data this week should show more post-pandemic normalization. We see inflation on a rollercoaster ride ahead as an aging population starts to bite.
We‘re in an unprecedented macro environment that is driving constant shifts in the market narrative: from hopes of avoiding recession to fears good macro news could be bad for markets in just a few months. We see the market moving with data as if we’re in a normal business cycle. But we’re in a new regime, with pandemic disruptions giving way to structural shifts that are playing out now, like an aging workforce. We see opportunities from timing market swings and staying selective.
Cooling down
Core goods and core services inflation, 2017-2023
Source: BlackRock Investment Institute, with data from LSEG Datastream, September 2023. Notes: The chart shows the three-month on three-month annualized rate of U.S. core goods and core services inflation using the Personal Consumption Expenditures (PCE) price index. The data has been rebased.
Inflation is likely to keep falling as pandemic mismatches resolve. See the chart. Core goods prices have seen the sharpest drop (dark orange line) as consumers shifted spending back toward services after splurging on goods during the pandemic. We estimate that about two-thirds of the spending shift has now unwound. At the same time, the spike in job openings is normalizing without a rise in unemployment. That has helped ease wage growth – leading to lower price pressure in core services as well (yellow line). Employers in leisure and retail, for example, now face less pressure to pay up for the workers they needed that were in short supply. Shifting narratives show how the market is trying to translate an assessment of the inflation and broader macro picture into investment views based on a typical business cycle. But we think mapping the macro outlook to markets is less straightforward in the new regime.
Euphoria over artificial intelligence (AI) has buoyed U.S. equities this year even with the tough macro backdrop. The bank turmoil in March revived recession fears, but equities soon resumed a climb and gained steam on falling inflation. By August, stocks stalled. Data suggesting solid growth spurred fears of higher-for-longer rates – “good news” became “bad news” – and bond yields surged as investors started demanding more term premium for the risk of holding long-term bonds.
Stealth stagnation
We think the narrative could flip again. A key part of the story has gone under the radar: stagnation. The economy has already stagnated for 18 months when taking the average of GDP and gross domestic income, according to U.S. Bureau of Economic Analysis data. Outright recession has so far been avoided and Q3 growth looks set to pick up, thanks to consumers spending their pandemic savings. But as savings are exhausted, next year could bring lower growth. Recession is still in the cards. But whether we go through recession and recovery, or flatlining activity, we think we end up in the same place. However we get there, it would mean the weakest two-and-a-half years for the U.S. economy outside the global financial crisis. So how has weak growth gone under the radar? One reason: Seemingly strong job growth largely reflects a catch-up from the pandemic shock. Adjusting for that, it’s been quite weak – and still worker shortages persist due to an aging population. With the job catch-up nearly complete, employment growth is slowing, we find. This sets up another potential narrative flip as stagnation sinks in. Take Europe. Activity has weakened and may be in recession. As a result, the early outperformance of European stocks this year has fizzled. And the European Central Bank may pause its rate hikes this week.
More broadly, all these market narratives apply a typical business cycle lens. We think the core issue is structural and playing out now. The labor force is growing more slowly as the population ages. Weak growth doesn’t translate into higher unemployment like it used to: We see full-employment stagnation. Demographic shifts causing worker shortages mean inflation can only be kept low with weaker growth, in our view. As labor shortages start to bind, we think inflation pressures could build again, putting inflation on a rollercoaster ride and compelling major central banks to hold policy tight.
Bottom line
Markets can run with narratives a while before flipping, creating potential for market-timing opportunities with the swings. We stay nimble and selective in stocks and credit. We underweight the broad market of developed market equities on a six- to 12-month horizon. And over that horizon, we look to harness mega forces like AI to tap structural drivers shaping returns now and in the future.
Market backdrop
U.S. stocks fell more than 1%, coming under pressure as 10-year Treasury yields pushed back near 16-year highs and markets priced out some of the Federal Reserve rate cuts seen next year. This week’s narrative was again “good news is bad news” – U.S. services activity topped expectations in August, reinforcing the higher-for-longer view on policy rates. European stocks hit six-month lows as grim German industrial production data highlighted the euro area’s potential recession.
U.S. CPI inflation data takes center stage this week. Inflation has fallen as pandemic-driven mismatches have reversed. We see inflation on a rollercoaster ride ahead as that process ends and an aging population constrains the workforce. In Europe, falling inflation and slowing economic activity will likely lead the ECB to hold policy rates steady this week.
Week ahead
Sept. 12
UK labor market data
Sept. 13
U.S. CPI
Sept. 14
European Central Bank (ECB) policy decision
Sept. 15
University of Michigan consumer sentiment survey
Source
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of Sept. 7, 2023. Notes: The two ends of the bars show the lowest and highest returns at any point in the last 12-months, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
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