Five charts that matter for investors

It’s a mIRAcle

The US economy’s resilience in the face of one of the fastest interest rate cycles in history has been puzzling. Several explanations have been put forward, including the large amount of excess savings built up in the pandemic and the US government’s willingness to run a large budget deficit. 

While consumers’ “COVID piggy banks” are soon to be depleted, the fiscal incentives that were part of the Inflation Reduction Act (IRA) and the CHIPS and Science Act are just starting to bear fruits.

According to the White House, the CHIPS Act, which creates a 25% tax credit for capital investments in semiconductor manufacturing, has already led to $231 billion of private-sector semiconductor investments being announced in the United States¹. The IRA on the other hand has led to over $110 billion in clean-energy manufacturing investments in the last year alone. Data from the US Census Bureau seem to corroborate some of these claims, as private investments in US manufacturing have skyrocketed in the last 18 months, driven by the computer industry (see chart).  

Investments in US manufacturing are booming

Private investments in US manufacturing by industrial sector in the last two decades

Closer to home

Not only the is the US “reshoring” manufacturing activities, its trading partners are changing places. Indeed, over the last 12 months America has imported more from Mexico than it has from China, a first in the last 20 years (see chart). 

This has important implications at a time when the domestic economy appears to be purring (still) while China’s economic activity could do with an external boost. It also shifts geopolitical forces, creating room for tensions to rise further in the months and years to come.

Finally, from a foreign-exchange perspective, it explains why the Mexican peso (MXN) has been one of the best performing currencies against the US dollar this year. It also points to the prospect of MXN weakness should the world’s largest economy hit a road bump in coming months. 

US imports more goods from Mexico than from China 

US imports from China and Mexico since 1990 shows a surge in the latter’s imports in the last year, as those from the former plunge

Size matters

Historically, smaller companies have been associated with positive cyclical momentum and structurally-stronger earnings growth. This was until interest rates skyrocketed. The Russell Microcap’s underperformance relative to the S&P 500 is reaching levels not seen in the last 18 years (see chart).

The Russell Microcap index consists of the smallest 1,000 securities in the small-cap Russell 2000® Index, plus the next 1,000 smallest eligible securities by market capitalisation (cap). The median company in this index has a market cap of less than $250 million. These are the companies that are most likely to struggle when access to funding is restricted.

Small- and micro-cap companies could have their moments when interest rates start to fall, but only if the US Federal Reserve manages a ‘soft landing’ for the economy. If rates come down for the wrong reasons (such as a recession) more underperformance may be on the way. 

US small-companies extend run of underperformance with larger ones

The Russell Microcap Index extends its underperformance compared with the S&P 500 since 2005

A pinch of salt

Whether they work for a large investment bank, a small asset manager or a central bank, economists have found it tough to predict the future since 2020. Take the US Federal Reserve’s (Fed) projections for inflation (core personal consumption expenditure, or core PCE) for example. 

Back in September 2021, the Federal Open Markets Committee (FOMC) was anticipating core PCE to be around 2.2% in 2023 and 2.1% in 2024. Fast forward to today and August’s core PCE reading was 3.9%, while the latest FOMC’s projections point to core prices being up 2.6% in 2024 (see chart).

Too often investors take FOMC projections as a forewarning of reality. The same apply to the ‘dot plot’ forecasts and projections when it comes to interest rates. According to September’s dots, rate-setters are suggesting that US interest rates will be at 5.125% at the end of 2024. This compares to a 2024 “forecast” of 3.875% a year ago.  

This is not to blame the Fed, policymakers and investors are all flying blind and policy remains “data dependent”.

The FOMC’s projections rarely materialise

The Federal Open Market Committee’s projections for core PCE out to 2026

Fixed for longer

Given the unprecedented pace of monetary tightening and the sharp interest rate increases in the last two years, many economic pundits had anticipated the largest economies to be in recession by now. However, given the infamous “long and variable” lags with which policy filters transmits to the real world, there was always uncertainty as to when the full effects of the hiking cycle would be felt.

Maybe these lags have simply become longer as a function of a changing debt profile. Indeed, according to data from the Bank for International Settlements (BIS), non-financial corporations around the world have increasingly relied on both longer-term and fixed-rate debt since the great financial crisis (see chart). This is particularly the case in the US and the eurozone.

The main consequence is that, on aggregate, companies have built larger buffers against higher rates and the effects of the recent hikes may not become apparent for another few months. That being so, and unless central banks start cutting rates much earlier than anticipated, it’s important to remember that these effects will filter through, eventually.

Non-financial companies increasingly rely on long-term and fixed-term debt

Analysis of non-financial companies’ debt that is fixed-rate or long-term in nature