From an economic perspective, November was in many respects a repeat of October. On the whole, macro data supported our belief that economies in general are making good progress at the moment, in both the developed and the emerging world.
"Growth in the emerging world has become healthier"
In the US, the ADP Employment Change, which precedes the official government numbers by a day or two, came in at 235,000. This was both stronger than expected and the previous month, though the latter was revised down slightly. As for the government numbers, the change in private payrolls was a strong 252,000 although expectations were for 302,000. The previous month however was revised up from a fall of 40,000 to an increase of 15,000, meaning that the amalgamated two-month number came in bang in line with expectations.
The unemployment rate declined further to 4.1% from 4.2% in October. Some of this decline will have been the result of the fall in the participation rate from 63.1% to 62.7%, meaning that some without jobs stopped looking, thus pushing down the number of unemployed. This effect may have shown up more in the underemployment rate, which fell from 8.3% to 7.9%. The substantial fall in the participation rate over the last few years has been one of the interesting features of this economic cycle. Part of this fall will have been due to the US’s aging population but not all. The prospect of disaffected workers returning to the workforce at some point, thus pushing up the participation rate, provides hope that this cycle has further to run without putting undue pressure on wages and thus the Fed to raise interest rates more quickly than is currently anticipated.
On the inflation front, core inflation in the US nudged up slightly, from 1.7% to 1.8% year-on-year. This is a good thing, as some had worried that the decline earlier in the year was a sign of trouble to come. The Fed has said that they are still not sure why core inflation dipped, but it is possible that it was the delayed effect of the strong US dollar. Nevertheless, it is always a relief when a central bank can breathe a sigh of relief. The stronger employment conditions are not yet feeding through to wages. Average hourly earnings growth in October fell from 2.9% year-on-year to 2.4% year-on-year, while real average hourly earnings fell from 0.7% yoy to 0.4% yoy. This may be due to the fact that productivity growth is picking up, with non-farm productivity in the third quarter rising by 3.0% compared with 1.5% in the previous quarter. As with the participation rate, further gains in productivity would enable the cycle to progress further without inflation pressures intensifying.
In the UK, the Bank of England raised its base rate as expected from 0.25% to 0.5%. It thus joins the US as the only two major developed country central banks to increase interest rates this cycle. However, the case for raising interest rates in the UK appeared to be more about dealing with inflation pressures that were the result of the weak currency rather than a strong economy. That said, the economy did make progress during the month, with purchasing manager indices all much stronger than expected, whether in construction, manufacturing or services. The unemployment rate held steady at 4.3% while, encouragingly, core inflation came in below expectations at 2.7%.
Elsewhere, key data in Japan and Europe gave no cause for concern. The unemployment rate in Europe fell from 8.9% to 8.8%, and core inflation held steady at 0.9% yoy. As for Japan, joblessness held steady at 2.8% while CPI ex Fresh Food rose slightly from 0.7% to 0.8%.
There were further encouraging signs that growth in the emerging world has become healthier. For example, purchasing manager indices in China were both strong and stronger than expected, with a similar pattern in India.
As mentioned last month, the reason for focusing on employment and inflation is that these are the key indicators that central banks target when deciding on monetary policy. Thus, in November, there was nothing to suggest central banks needed to reconsider the monetary policy roadmaps that they had previously laid out.
As for financial markets, equity markets generally rose in October, though there was a bit of weakness in the UK and Europe which, at least in the case of Europe, can be put down to previous strength.
As far as the outlook is concerned, we continue to believe the global economy as a whole is moving from recovery phase to expansion phase (some like the US are firmly in the latter while others such as the Eurozone are still in the former). Thus we expect equity market returns to continue to fall slightly, but remain positive for the two or so years up to the point at which monetary policy becomes much tighter and when economies are likely to start peaking.
Inflation we think will continue to rise and we thus remain negative on safe haven bonds which anyway are very expensive in light of low or negative real yields.
Published in Investment Letter, December 2017
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.