The US economy has proven to be particularly resilient to the Fed’s aggressive monetary tightening, but the same can’t be said about the eurozone. The ECB’s successive rate hikes are having a growing impact on economic output.
The eurozone purchasing managers’ index slipped into contraction territory last summer but recently levelled off, and in the end the region – against all expectations – narrowly avoided a technical recession in the second half of the year. There are also major disparities within the eurozone, with peripheral countries doing much better than Germany, which is in recession. This economic softness, coupled with sharply falling inflation, makes us even more convinced that the ECB will start cutting rates in the coming months, despite the hawkish statements made by some members. In addition, the recent improvement in consumer confidence looks set to continue. Higher real wages should make it easier for households to gradually resume spending, and the savings many of them built up during the pandemic are still largely untouched, meaning European consumers have more in their wallets. Regarding fiscal policy, the EU’s recovery plan is being rolled out more slowly than expected – 65% of the funds have yet to be disbursed. The infrastructure programmes provided for under the plan will undoubtedly support the region’s economy over the next few years. So Europe’s economy will slowly, but surely, recover.
Eurozone equities rallied in the last few months of 2023 alongside a sharp uptick in investor optimism. The current earnings season has been mixed, suggesting that expectations were indeed quite high. But based on a number of market ratios, European equities still look attractive, compared to both other regions and their historical averages. For instance, the P/E ratio on the EuroStoxx 50 is currently 12.2, against a 25-year average of 13.4. The fund outflows seen in recent years indicate that Europe has fallen out of favour with investors, who apparently still view it as having a sluggish economy. That means any news which surprises even slightly on the upside will be cheered by investors.
US economic growth came in higher than expected in Q4 2023, reaching an annualised rate of +3.3%. Indicators for January suggest that it will maintain that momentum in early 2024. Job creation has picked up, with 353,000 jobs added, and the ISM purchasing managers’ index indicates that the outlook for the manufacturing sector could improve after 12 tough months. So it came as no surprise that the US Federal Reserve kept interest rates unchanged. And investors have pushed back the date on which they now expect the first rate cut. It’s unlikely to happen until the Fed’s meeting in May, or even June. This could well bring an end to the sharp downtrend in US long-term yields that began in late 2023. It’s therefore reasonable to expect 10-year yields to level off at the psychological threshold of 4%, especially since US wages don’t seem to slow down much anymore.
The Q4 2023 earnings of S&P 500 companies are likely to drop by 9% year on year. That’s excluding the ‘Magnificent 7’, made up mainly of tech stocks. Their profits are expected to jump by 60%.