Monday Macro: five questions worth asking with big macro implications

On meltups, China, spare cash and optimism about the UK economy

Programming note: There will be a short, one-week break from Friday, November 29th, to Friday, December 6th, inclusive. I'm away on business again, so the letters will take a breather for a few days. Also, thank you for the wave of renewals over the last month; it's very much appreciated. To those who haven’t renewed or are thinking about starting a subscription, hurry! On December 1st, I am increasing the annual rate to £60 from £50 and the monthly rate from £5 to £6.

Markets are zigzagging, as usual, and far too many of us are trying to figure out what might happen next in the impending Trump administration. Rather than opine any further on this, I thought I’d pose five questions that I think are worth pondering, all based on recent research that has piqued my interest! How you, or I, for that matter, answer these questions is completely up for debate; nevertheless, here we go!

Q1: Is an even bigger US stock market meltup on the way?

In reality, this question (1) is interrelated with the second (2) question (the US consumer and savings). Put simply, there’s a lot of dry powder out there waiting to be deployed into the world's most exceptional market, the US. Michael Howell of Cross Border Capital has a great narrative: first liquidity, and then fund and bond flows, powers everything. But under the bonnet, another force is at work – the great passive savings accumulation machine that kicks in vast amounts of money that must be deployed regularly (monthly). So, all you need do is look at these flow mechanisms and project forward.

One way of doing that is via fund flow data from investment bank Deutsche. Their latest report makes for compelling reading – take note of the weight of capital looking to move into the US and also note the sector-by-sector fund flows:

“Our measure of aggregate equity positioning rose massively after the election, the biggest weekly jump on record in our data going back to 2010, giving back some on Friday. Positioning rose from just above neutral to a four-month high, near the upper end of its long-run band, albeit not at an extreme (z score 0.84, 94th percentile). Discretionary investor positioning (z score 1.05, 96th percentile) has surged and is now clearly elevated, while systematic strategies positioning (z score 0.80, 86th percentile) has risen sharply but is still well below prior peaks.

“Historically, the S&P 500 has rallied by about 5%, on average, from election day to year-end. The post-election rally took the S&P 500 to the top of the steep trend channel in place for the last 2 years but it has now given back some”.

Bloomberg Finance LP, Deutsche Bank Asset Allocation

“ Sector by sector fund slows: Surge in inflows into US equity funds with a rotation towards cyclicals, while bond inflows slowed. Equity funds have seen inflows of over $80bn following the election, entirely into the US. This surge added to the already strong trend in place over the last 12 months (now totaling just over $600bn). On the flip side, EM funds (-$7.5bn) saw the biggest weekly outflows since the China deval shock in 2015, just a few weeks after clocking record inflows in early October. Europe (-$3.1bn) continued to see outflows. Across equity sectors, Financials and Industrials funds saw large inflows this week while defensive bond-like sectors and Tech funds saw outflows. Bond funds ($2.8bn) meanwhile saw inflows this week but at the slowest pace of the year, with outflows from government and EM bond funds, even as IG and HY enjoyed robust inflows.”

Q2: US consumers and investors still have a lot of spare cash to spend AND invest

Picking up on the first question, note that US retail investors are becoming an even more critical part of the US stock market – broker accounts, along with 401K accounts, form the basis of vast passive wealth accumulation machines, using core ETF portfolios, and are strategically crucial now. This is linked to the fact that many in the US have a lot of money to spend despite their gloomy political postures. As evidence of this, here’s some recent excerpts from CEO calls collated by The Transcript Newsletter:

Consumers are spending more again
"The consumer was slowing down in late summer—we saw it. It was concerning me because I thought it was slowing down to the point where it may be underneath what would imply a stable 2% (plus or minus) growth economy with lower inflation. The good news is, as we came into September and October if you look at the two months together—particularly October—it looks like it's leveling out. The expectations of our consumers to spend more in the holiday season are up by 7%, which is good" - Bank of America ($BAC ) CEO Brian Moynihan

Confidence has come back up
"I think that confidence has come up. You saw it rise when the Fed announced they were going to cut rates—even before they actually cut them—consumer confidence moved up a little" - Bank of America ($BAC ) CEO Brian Moynihan

Consumers are in a good place
"Households remain in pretty good shape. And unemployment is extremely low. There has been some real wage gains. Inflation has largely abated. And consumer household debt levels are relatively low by historic standards" - TransUnion ($TRU ) President, CEO & Director Christopher A. Cartwright

"If you look at consumers' liquidity position, this is retail consumer, they're indexing 120 to pre-Covid. So they have good liquidity... If you look at some of the things that's happening with their savings, they're saving 100 bps more than they were saving last year. And so that's putting the consumer in a really, really good place" - Truist Financial ($TFC ) Senior EVP Dontá Wilson

OK, some of that money is finding its way into spending – that’s the point of the first question. That’s good for the global economy! But some of that money is also finding its way into the stock markets. And what’s possibly helping is that despite analysis by Fed Economists, the accumulated wealth post-COVID is still there, with lots of significant positive balances waiting to be invested. Last summer, Fed economists claimed that “the US excess savings stock is currently completely depleted, which contrasts with other advanced economies where households still hold a buffer of excess savings of about 3 to 5 % of GDP” .

Vincent Deluard, strategist at US markets firm StoneX, immediately refuted this analysis, which was subsequently backed up by the Bureau of Economic Analysis research. He still maintains that bank reserves have not normalized from their post-COVID increase, and money market funds assets have grown by another trillion to a record $6.6 trillion. However, these amounts are dwarfed by the $44 trillion spike in household net worth. The post-COVID wealth shock handed households 50 years of personal savings! Yet Deluard reckons this wealth effect may be even more stimulative than usual for two reasons.

“First, stock-based compensation at Nasdaq 100 firms has been multiplied by seven in the past decade. Nasdaq 100 firm paid out $163 billion in stock-options this past year, or about 1% of personal disposable income. Second, the bull market in cryptocurrencies created gains of about $1.1 trillion in the past six months. NBER economists found that the marginal propensity to spend capital gains on cryptocurrency was much higher than on traditional assets. Based on their estimates, the unfolding crypto bull market should boost consumption by close to $100 billion.

“Investors can see the effect of the wealth miracle, the private lending boom, and the soaring gig economy on anecdotal indicators such as cruise line bookings, dinner reservations, same-store retail sales, and travellers crossing at TSA checkpoints. The consumption boom will likely accelerate after the red sweep at the election, which further increased asset prices, will likely remove regulatory hurdle on bank lending and deal-making, and caused a confidence shock among Republican voters.”

Q3: Is there a chance that the UK economy might be surprised by the upside?

In one word, I’d say yes. In the run-up to the budget, there was widespread fear and loathing, and after the budget, there’s been a constant drumbeat of business pain – all very real and not to be sniffed at.

However, my core view is that elements of the earlier US story are also true for the UK. All those post-pandemic savings haven’t been spent, and we’re seeing evidence that the wealth effect is also having an effect in the UK, while UK house prices are also starting to show some evidence of positive growth. Add the boost to spending after the budget, and we have the groundwork for a sustained, though subdued revival. On this theme, I’d point to a recent economics white paper by the forecasting team at French Bank SocGen:

“Labour’s planned cash injection in public services is likely to support economic growth next year. In our own forecast, though, GDP growth is broadly unchanged, as we have reduced the pace we see households lowering their savings rate, which offsets the stronger-than-expected fiscal loosening in the budget. An increase in firms’ labour costs from the budget is likely to put upwards pressure on inflation, with the exact magnitude determined by the extent to which businesses are able to pass these higher costs onto consumers. Along with geopolitical and tariff uncertainties, this should see the Bank of England continue its gradual pace of easing: 25bp worth of cuts every quarter. Growth outlook GDP growth went from the highest in the G7 to just 0.1% qoq in 3Q, which is below its potential.

 Taken together, the boost to GDP from the budget should offset lower household consumption, resulting in 2025 GDP being 0.1pp higher vs the September GEO. The composition of growth is, however, materially different, with most of the gains coming from government consumption next year. A faster reduction in the household savings rate, driven by BoE rate cuts, or households spending the excess savings they have accumulated since the pandemic poses an upside risk. US tariffs and its uncertainty pose a downside risk”.

Of course, there’s good reasons to be cautious and the SocGen economists do suggest keeping a beady eye on the outlook for services inflation remains key.

“As the catch-up in workers trying to recuperate the loss in real earnings comes to an end at some point next year, we see nominal wage growth slowing further, helping to keep services inflation on its weakening trend. And although firms face higher labour costs from the budget, we believe they will have limited scope to pass on these higher costs in the face of sluggish household consumption growth. Therefore, we see services inflation returning to levels more consistent with the 2% inflation target in early 2026. Labour market

“[Interest rate policy]. We interpret the gradual approach as one 25bp cut every quarter, which is our current forecast. One modification to our call is we now expect the MPC to stop cutting when Bank Rate reaches 3%. However, if services inflation continues to undershoot expectations and GDP growth remains sluggish, we are more likely to add rate cuts to our forecast”.

Q4: Nothing lasts forever. The end of US exceptionalism

So far, we’ve mapped out what I think is a perfectly conceivable and even probable route map for investing more money in the US – and perhaps a few extra pounds in the UK. But regular readers will know that although I think fund flows are the real market driver, valuations matter at some point. All it requires is for markets to have a macro shock – and Trump is perfectly capable of delivering that – and suddenly, today’s great white-hot growth prospect becomes tomorrow's hopelessly overvalued turkey. Do I think that's imminent? No, but is it possible? Yes.

When that turn – away from American exceptionalism – happens, then other markets suddenly become more interesting. I’ve already suggested the UK as one candidate; last week, I looked at Japan. In the following question, we pose the Chinese question. But in this question, what about American exceptionalism? Will it last forever? A great contrarian note comes from Dan Suzuki, Deputy Chief Investment Officer and Chairman of the Investment Committee at Richard Bernstein Advisors LLC.He’s looked at the best investment trades of the past 50 years and asked what links them all together – the answer is twists and turns in American exceptionalism. According to Suzuki, each of the following trades would have generated excess returns averaging 7-19% per year spanning periods of 8-22 years:

• International stocks over US stocks (1967 – 1988): The dominant US Nifty 50 large caps ceased to live up to lofty market expectations, giving way to international stock leadership, especially driven by the ascent of Japanese manufacturing efficiency (Chart 1).

• US stocks over cash (1987 – 2000): In the wake of the 1987 stock market crash, US stocks climbed a wall of worry until telecommunication and technology stocks took the reins beginning in the mid-1990s, while interest rates on cash continued to fall (Chart 2).

• Energy stocks over the broad market (2000 – 2008): The bookends of the bursting technology bubble and the financial crisis weighed on broad index returns, while strong emerging market growth caused energy demand to outstrip supply (Chart 3).

• US stocks over cash (2009 – 2023): Following the financial crisis, US stocks climbed another wall of worry. The prolonged period of low interest rates not only minimized cash returns but also boosted liquidity and investment demand for high growth technologies (Chart 4).

Suzuki argues that each of these is, in one way or another, about the rise of American exceptionalism.

“Beginning with the ascension of the US Nifty 50 stocks in the 1950s and 1960s, followed by the Tech and Telecom bubble of the 1990s, to the so-called Magnificent 7 leading today’s markets, a certain group of US companies becomes so dominant that they come to be perceived as the only stocks worth owning. Each time that became the pervasive sentiment, it generally signaled that the next big investment opportunities lay elsewhere (Chart 5).

“As the US has gone from “uninvestable” at the beginning of this bull market to today’s “obvious trade,” its share of the global stock market has surged from 40% to 64% (Chart 6), pushing market concentration to unprecedented levels (Chart 7). The US is the most expensive it has ever been compared to the rest of the world, with the premium having gone from -11% (a discount) in 2009 to +60% today (Chart 8). But rather than take steps to mitigate this extreme portfolio concentration, it appears that investors are doubling down. According to Bank of America’s latest fund manager survey, institutional investors are overweight US stocks, but even more worrisome may be the concentration in smaller investor portfolios. According to a recent Wall Street Journal article citing Vanda Research, the average individual’s stock portfolio has 40% of its value tied up in just three tech stocks!

“Eventually, high valuations and unattainable growth expectations lead to disappointments and significant devaluations. The subsequent period of deteriorating fundamentals and weak returns causes the pendulum to swing to opposite extremes. As a result, periods of significant outperformance tend to be followed by periods of significant underperformance, reversing much of the previously earned extraordinary gains, even for the biggest of secular themes …..With all eyes on US large cap growth stocks and disinflation beneficiaries, we see bigger opportunities in international, small caps, value stocks and inflation beneficiaries.”

Q5: Are we all getting China wrong? What are we missing?

My last question is the most awkward: What should we do about China? I have consistently been cynical about China and Chinese equities, and I remain so. But I’m also constantly astonished by the inventiveness of the Chinese and the resourcefulness of Chinese entrepreneurs. Take the car market. From a standing start, Chinese electric car manufacturers are building an enormous beachhead in Europe, especially the UK, where MG and increasingly BYD cars are everywhere. Sure, they’ve been helped by massive government subsidies (as were the Japanese in the beginning), but the technology is hugely impressive.

When it comes to investing in China, cynics like me tend to default to three natural reactions. The first is to point to the poor corporate governance and the overwhelming influence of the CCP. They are what they see on the biscuit tin—communists. Our next reaction is to look at Taiwan and imagine the horror of what might happen if they try to capture the island. Our last response is to look at Trump and imagine the tsunami of tariffs heading their way.

Case proved – foreign investment in China RIP?

Maybe, but what happens if Trump does a deal with China and dials down the tariffs and anti-China hawkishness? What happens also if he essentially sells Taiwan down the river to the point where they are forced to make a deal with China? And what happens if Chinese businesses in the technology space genuinely develop groundbreaking products that generate the same enthusiasm as AI?

Perhaps, more probably, even if tariff barriers with the West do become a problem, why wouldn’t China just shrug and refocus its attention on the rest of the world, trying to build an economic superpower outside of the US dollar nexus?

There’s no definitive answer any of us could give to these questions except to say—keep watching China. On that subject, I recommend a paper by Gavekal’s Louis-Vincent Gave, which highlights how Western leaders missed China’s leap in industrial growth due to travel restrictions, media bias, and cultural prejudice. However, China’s expanding economic influence may compel a reassessment of its importance and potential for investment.

“….the third vision of China: that it is only just beginning to leapfrog the West in a whole range of industries. This vision is starting to show up itself in the perception of Western brands in China, and their sales. For example, Apple’s iPhones no longer figure in the five best-selling smartphone models in China. And Audi’s new electric cars made and sold in China will no longer carry the company’s iconic four-circle logo; the branding is now perceived to be more of a hindrance than a benefit.

To put it another way, following years of investment in transport infrastructure, education, industrial robots, the electricity grid and other areas, the Chinese economy today is a coiled spring. So far, the productivity gains engendered by these investments have manifested themselves in record trade surpluses and capital flight—into Sydney and Vancouver real estate, and Singapore and Hong Kong private banking. This has mostly been because money earners’ confidence in their government has been low. From bursting the real estate bubble, through cracking down on big tech and private education, to the long Covid lockdowns, in recent years the Chinese government has done little to foster trust among China’s wealthy.

It’s small surprise, then, that many rich Chinese have lost faith in their government’s ability to deliver a stable and predictable business environment. This brings me to the recent stimulus announcements and the all-important question whether the measures rolled out will prove sufficient to revitalize domestic confidence in a meaningful way. Will it even be possible to lift confidence as long as the Damocles’ sword of a wider trade conflict with the US and yet more sanctions looms over the head of Chinese businesses? From this perspective, perhaps the most bullish development for China would be for the new US administration (regardless who sits behind the Resolute desk) to come in and look to repair the damage done to relations by the 2018 semiconductor sanctions and the 2021 Anchorage meeting (see Punitive Tariffs Or Towards A New Plaza Accord?). At the risk of mixing metaphors, this could be the match that lights the fuse that ignites a real fireworks show

Just a few weeks ago, China was still said to be uninvestible. This view had led many people, including prominent Western CEOs, to conclude that China no longer mattered. This was a logical leap encouraged by Western media organizations, whose coverage of China has been relentlessly negative. It was a leap that turned out to be a massive mistake. When it comes to China’s relevance to investors, there are four ways of looking at things.

• China can be uninvestible and unimportant. This is the pool that most investors have been swimming in for the last few years. But this is akin to saying that China is like Africa. It simply doesn’t pass the smell test. Instead of sliding into irrelevance, China’s impact on the global economy only continues to grow.

• China can be uninvestible but important. This is essentially what Jim Farley, fresh back from his China trip, told The Wall Street Journal.

• China can be investible but unimportant. This is the space Japan inhabited for a couple of decades, and into which Europe seems to be gently sliding. However, the idea that China today is where Japan has been for the last three decades is grossly misplaced on many fronts, including the competitiveness of its economy, its overall cost structure, and its weight in global indexes.

• China can be investible and important. This is what David Tepper of Appaloosa Management argued on CNBC following the announcement of China’s stimulus (see Changing Narratives Around The World). For now, this is still a minority view, at least among Western investors. Not that Western investors matter all that much. What truly matters is whether Chinese investors themselves start rallying to this view. If they do, the unfolding bull markets in Chinese equities and the renminbi could really have legs.”