The American economy mid-2022
The time is approaching when investors might choose to look into 2022, and it does not seem to be quite as easy this time. Over the past six months, I have spent much more time assessing the overall direction in the financial markets and large economies, more than what I would normally spend on our global “conviction model”, especially concerning USA. The time consumption has its explanation; the reopening after the Covid-19 lockdowns and getting the world and the global economy back on track is a journey that is somewhat more uneven than originally expected.
The changes that happen in the overall global economic picture currently happen fast, and just within months. These changes represent very large shifts in expectations and data, covering for example, production and consumption. It is understandable that after an almost global shutdown, all expectations and developments in the process of reopening must be continuously calibrated and adjusted. One reason for my own extra time consumption in this connection is that also in the US, the fluctuations in economic data are large, here the challenge is that the US economy is the world’s largest and most significant economy.
Changes in the economy would normally happen over a somewhat longer duration span, though the current fast changes have had little effect on the financial markets, so far. One of many examples that can be observed in graph one, which shows the manufacturing sector’s assessment in the region of the United States that is covered by the US Federal Reserve’s branch in Philadelphia. At the first glance, the development looks dramatic, and certainly, the decline in the index has been bigger than what was expected among Wall Street economists. However, the development is not quite as dramatic, because the index also shows that there is progress on all fronts, so the companies report, just not as much as the economists had expected.
Based on graph one, the outlook seems like one must change the allocation to equities to “severely underweight”, though my view remains very different. However, many investors have been pampered with rising prices every day, therefore, headwinds can quickly be considered as a prediction of doomsday. But with a slightly more balanced view, then my biggest focus is on how a less positive development in the American economy will affect US equities, and secondly, the global stock markets.
A particularly strong argument for ever-rising stock prices is rising corporate profits, where graph two is precisely the argument for those investors who continue to contend for a positive US stock market. As mentioned, rising corporate profits are a good guarantor against a sour stock market, but profits must origin from somewhere, here, high macroeconomic growth rates naturally help.
Concerning the fear of large drops in the stock markets, a good and simple litmus test is the lack of negative reactions among investors, so far. By that, I mean that the release of a great deal of negative news lately should have led to a bigger firesale, if the stock markets were nervous.
Across the globe, the developments in the regional stock markets are positioned somewhat differently than the ever-rising US stock markets. I consider China’s stock market as almost cheap, but some investors are not comfortable with Chinese stocks, so for these investors, a China allocation it is not an alternative. Concerning both the bond and stock markets in several Emerging Market countries, I am prepared to increase the allocation when the timing seems appropriate. So far, I have postponed the next Emerging Markets check until October, but the key here is that it awaits to be another potential destination for increased allocations. I believe that the European continent will continue to show the weakest economic growth, and the stock market here will possibly disappoint optimistic investors, but on the other hand, I still see opportunities in the British stock market.
About the United States, then my considerations are not whether I mean that the world is about to collapse if the American economy experiences more headwind, but more of how will a change of direction in the U.S. economy fit into the global context I have just outlined?
My expectation is that more macroeconomic noise will come from US during the rest of this year, and even more noise may be on the way. Last week, US Treasury Secretary Janet Yellen announced that the government is running out of money. That discussion is gradually recurring, but it is not healthy for the financial markets, as it contributes even more noise.
Further ahead in 2022 comes the US midterm elections, where the prospect right now is that former President Trump will play a very active role. If so, I expect an election campaign with an extremely harsh tone that’s probably so noisy, it will affect the financial markets.
My conclusion on the latest developments is that the air for US equities continues to get thinner, but it is not yet time to change the allocation. At best, the time for a possible reduction in US equities will match the same time where Emerging Market countries are attractive again, thus it becomes a shift in the portfolio. If the timing turns out to be more unfortunate, then it ends up as an outright reduction of US stocks, but presently, the only change that affects my assessment of the US economy and stock markets is that I am now “more concerned”, based on my expectations when looking into 2022.
