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A good rule of thumb is that if the economy is steady and growing, equity returns are (on average – there are no guarantees!) positive. Part of this is because corporate profits should grow side by side with the economy. And when I say “profits” and “the economy” I am really talking about the US which, these days, makes up around two thirds of global indices. (I am sorry to say that the S&P 500 is over 20 times larger than the UK FTSE 100 these days for example.)
So, the US economy matters and has recently been doing well. But I think you could have three legitimate concerns looking forward:
- Rising oil prices (and borrowing costs) should mean consumers have less money to spend elsewhere.
- AI is slowing jobs growth, especially for more junior people where AI replacement is more likely.
- There was a whole lot of lending done in the 2021 boom which is starting to fall due around now. This might create some real trouble in credit markets and raise the cost of borrowing for everyone.
In recent months I have seen and heard some anecdotal evidence for each of these concerns. But, even if I squint really hard, I can’t see much evidence in aggregate for any of them right now. I’ll show some charts on this below. But if you are short of time, my conclusion is that the US economy still looks strong to me and this continues to provide a tailwind for equities. In the interests of balance, a strong economy with inflation above target also means I don’t see the need for US rate cuts any time soon. What is good for equities is probably, at the margin, also bad for bonds.
A good place to start for a snapshot of the US economy is the Atlanta Fed GDPNow model which takes the latest data releases and uses them to project current growth rates. You can see a bit of slowdown post the US/Iran war, but we are still tracking above trend:
Torsten Slok of Apollo has dug deeper looking at post-war US hotel bookings and airline travel and you just can’t see any impact. Here are same-store retail sales for example. If anything, the war looks like a positive!
Which brings me to my second potential concern: private credit markets. There sure was a lot of lending done at very high prices in 2021 and any loans with a 5 year term are due around now. Money has been flowing out of open-ended private credit vehicles as a result (which will further reduce the pool of cash available to refinance these loans). However, default rates remain low. And even if you add in loans that are extended or exchanged for equity (the orange line below) the picture actually looks to be improving, not getting worse:
Which leaves AI. This remains the dominant investment theme of the current era. AI infrastructure investment alone is expected to add around 1% to US GDP this year. The catch is that AI is only really valuable if it can enhance or replace entirely jobs humans do today. And while you can see the impact of this on some parts of the job market (call centre employment is falling sharply) you just can’t see its impact in aggregate. US jobs growth remains positive and there is no correlation (yet) between AI adoption and the unemployment rate at the industry level:
One reason for this is that AI is spurring people to start new companies to benefit from the new technology. My instincts are that new, AI-first businesses will do a better job of capturing the value that AI creates than the existing incumbents. The challenges facing older businesses are that their data, people and processes are probably set up for the old world and not the new one. And transforming large businesses where people and management structures are naturally resistant to change can take longer and be much harder than you originally think. So, while you might continue to see plenty of negative headlines for existing businesses that are slowly adapting to AI, remember that there are new cohorts of AI first businesses being created every day. And I think this is part of the reason for the strength of US jobs growth today. And, if anything, AI probably makes it easier for you to start your own business, not harder:
As ever, there are plenty of things to worry about right now. But I don’t think a slowing US economy is one of them. And if you are asking yourself how an equities be so strong in the face of all that has been thrown at them, this is part of the reason.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
