Charts of the Week

Fracking as a leading indicator

Primary Vision's Frac spread count is now available on Macrobond. This indicator measures the number of crews actively conducting hydraulic fracturing (known as “fracking”) of shale in the US, which serves as a leading indicator of oil production.

This chart analyzes the correlation between Frac spread count and future earnings in the energy sector, which is represented by 12-month forward earnings per share sourced from Macrobond/FactSet Equity Factor Aggregates. Historical data shows a robust correlation between the two indicators, suggesting that Frac spread count can provide investors with valuable insights into the future performance of the US energy sector.

Macrobond users can now create dynamic charts using our standard tools, click here to learn more.

Central bank interest rate moves

It has been a busy week for central banks, with more than 20 gathering for meetings and the Bank of Japan making headlines as the latest one to exit negative interest rates.

Many central banks are holding interest rates steady for now, but in a surprise move, the Swiss National Bank (SNB) reduced its main interest rate by 25 basis points to 1.5 per cent on Thursday – a decision enabled by the country’s effective control of inflation.

Markets largely expect interest rate reductions from the Federal Reserve, European Central Bank, and Bank of England over the coming months.‍

Emerging market equities’ returns and the US dollar index

The Federal Reserve’s fund rate appears to have reached a peak since July 2023 and is expected to decline over the months ahead. This is likely to mitigate the strength of the US dollar against the backdrop of robust economic conditions, a strong labor market and a gradual easing of inflation rates, although these remain above target.

In this context, it is useful to analyze the return correlation between emerging market equity indices and the US dollar index on a country-by-country basis, where countries with a more negative correlation appear more attractive.

According to our calculations, most MSCI emerging market mid and large capitalization indices across countries have had a greater negative correlation to the US dollar index in recent years than long-run norms (in terms of medians and percentile ranges). As the chart shows, MSCI Peru, MSCI Taiwan and MSCI South Africa have the largest negative correlations.‍

A sector approach to Japanese equities

Japan’s stock market rally has been supported by solid earnings growth expectations, a weaker yen and Japanese equities not looking overvalued on a price to earnings ratio basis.  While Japanese-listed firms are multinational and exposed to global factors, the country’s economy faces the challenges of a reduced US-Japan interest rate differential, which would support the yen, and {{nofollow}}the Bank of Japan mostly ending its monetary ultra accommodation.

These challenges come on top of demographic issues including a shrinking workforce and rising social security costs. Against this backdrop, it is worth considering a sector-specifc approach to investing. This chart compares price to book ratios and return on equity, showing valuations together with profitability. Utilities and consumer cyclicals appear more profitable relative to the price to book ratio than other industries.

Record Chinese copper inventories 

This chart examines Chinese copper inventories, which have risen to historic highs since China agreed to {{nofollow}}production cuts in response to raw material shortages and underperforming plants.

This news has lifted copper prices, which have reached heights not seen since April 2023, as treatment and refining charges (TC/RCs) have plummeted due to a constrained supply of copper concentrate.

This drop in TC/RCs, driven by the rapid expansion of smelting capacity in China, India, and Indonesia, poses challenges for smelters, potentially impacting copper prices despite concerns over a global economic downturn. The closure of First Quantum Minerals' Cobre Panama mine has further tightened short-term projections, coinciding with increased demand from sectors such as power generation and electric vehicles due to the energy transition.

US: CPI increased 3.2% year-on-year 

US inflation numbers released this week show that the overall cost of living, as captured by the Consumer Price Index, increased 3.2 per cent from a year ago, with an increase of 0.4 per cent month over month.

The monthly measure was in line with expectations, while the 12-month reading was marginally higher. An increase in energy costs, reflecting global oil price fluctuations and domestic energy policy changes, helped to boost the headline inflation numbers, while food price rises slowed.

This deceleration was greater than expected, possibly due to better supply chain conditions and agricultural outputs.

EU: inflation continues to decelerate

This heatmap tracks the annual percentage change across the major items in the EU’s inflationary basket of goods and services. It is important to note that food and non-alcoholic beverages, transport, and housing have the highest weighting in the basket, in that order.

Headline inflation decelerated to 3.1 per cent on an annual basis, down from 3.4 per cent The highest inflation points were in non-alcoholic beverages, tobacco, water and insurance, potentially reflecting changes in consumer habits following the pandemic and regulatory impacts on insurance and tobacco products.

On the other hand, milk, cheese and eggs, communication, and transport services all experienced almost no or even negative annual inflation. This may be attributable to market competition keeping prices down as well as technological advances improving productivity and reducing costs.

Japan: inflation cooling, with utilities key contributors

Japan’s overall inflation has been cooling, driven by price drops for electricity and gas. Several food items have also shown moderation in prices.

On the other hand, prices for transportation, medical care, culture and recreation are rising, perhaps in line with service costs and wages. These may be driven by demographic changes such as an ageing population and labor shortages.

The {{nofollow}}Bank of Japan closely monitors wage growth as a key determinant in deciding the timing and degree of adjustments to its yield curve control and negative interest rate policies.

UK: a mixed inflationary picture

This heatmap tracks the evolution of inflationary items in the UK. The highest-weighted items are restaurants and hotels, recreation and culture, and transport. Across these, insurance, tobacco and alcoholic beverages prices rose fastest, reflecting tax policy changes and post-Brexit dynamics.

Conversely, gas and electricity fell the most – by 26.5 per cent and 13 per cent respectively, which may be due to government policy interventions and shifts in global energy markets.

Sweden: inflation driven by housing

The weak Swedish crown has made the Riksbank’s task to slow inflation a tough nut to crack for an economy reliant on energy and commodity imports. While several categories are showing a slowdown in price increases, Swedish inflation is primarily driven by increasing housing costs.

These reflect both dynamics in the domestic market, such as limited supply in major cities and strict building regulations, along with the broader global economic environment.

Canada: positive news for disinflation

A real estate crisis continues to loom large in Canada, where high demand and limited supply have made shelter prices, both rented and owned, relatively hot categories. However, headline inflation rates have finally dropped below the upper target limit of three per cent, signaling a potential easing of price pressures across the economy. February's figures are expected to be released next week, raising the question of whether the downtrend will continue or be driven up again by real estate.

Meanwhile, tobacco prices have finally begun to drop, offering smokers some relief in an otherwise challenging market. This could be the result of changes in market dynamics and regulation affecting consumer behavior and company pricing strategies.

S&P 500: the January Effect 

Can the performance of the S&P 500 in January set the tone for the rest of the year? The first month of the year has often been viewed as a bellwether for the following 11 months in a phenomenon known as the “January Effect” or “January Barometer.” 

This chart reveals a trend going back to 1929, showing that a positive January often leads to a yearly gain of 13.2 per cent. Conversely, a negative January typically precedes an annual loss of 1.8 per cent. The rise of 1.6 per cent in January this year hints at a strong 2024, with a six per cent increase surpassing the average improvement when the S&P 500 is in positive territory.‍

S&P 500: the US Election

Investors are understandably eager to understand how the US election could impact equities, particularly the S&P 500. We have therefore analyzed the historical performance of that index at the year-end following past presidential elections, with a specific focus on periods when the incumbent party was Democratic. 

On average, a win by the Democratic party correlates with the S&P 500 achieving returns between 10.4 per cent and 13.4 per cent. 

In contrast, Republican victories see the index delivering slightly lower year-end returns in the range of nine per cent to 9.5 per cent. 

While Democratic wins are correlated with greater returns, the range of outcomes in that scenario are broader and so more unpredictable, suggesting that the S&P 500's performance in election years is not purely politically driven.

Adding Bitcoin to a 60/40 portfolio

A dash of Bitcoin can go a long way to juicing up investment returns, this chart suggests. 

Adding a mere one per cent allocation of the cryptocurrency to a classic 60/40 investment mix (60 per cent equities and 40 per cent 10-year bonds) can deliver a striking six per cent fillip to a portfolio.

This impact highlights not only Bitcoin's role as a powerful means of enhancing returns, but also underscores how digital currencies are reshaping the investment landscape, with minimal exposure potentially delivering disproportionate benefits.

Emerging markets with high bond yields and limited FX risk

The Federal Reserve’s interest rate hikes appear to have peaked, laying the foundation for a potential weakening of the strong US dollar. This would be a major development given the dollar's position as a global reserve currency that has outperformed many other currencies in recent years. 

Meanwhile, many emerging market central banks have lowered their interest rates, potentially making bonds and other investments denominated in their respective currencies more attractive. 

This chart highlights 10-year government bond yields against the backdrop of foreign exchange volatility — a primary concern for bond investors — with the aim of identifying opportunities where the potential for income (yield) and capital appreciation outweighs the risks associated with foreign exchange (FX) volatility. 

India, Indonesia and the Philippines emerge as standout countries from this analysis, with bonds offering both high yields and limited currency risk.

CAGR vs. volatility by asset class

This chart compares the volatility and the Compound Annual Growth Rate (CAGR) of various asset classes over the past 20 years, with CAGR measuring the mean annual growth rate over the period assuming that profits are reinvested at the end of each year.

US equities have been stable over the period, with only minor fluctuations in price while yielding the highest growth rates, suggesting a favorable risk-reward balance for investors.

Emerging market equities have also been volatile, but have delivered lower returns than their US counterparts, indicating a higher risk for the returns achieved. European equities, infrastructure and real estate investment trusts (REITs) have clustered in a band of lower volatility and moderate growth, suggesting they can be considered stable investment options with reasonable growth potential for investors with a lower risk appetite.

Real estate bubbles worldwide

This chart combines the UBS Global Real Estate Bubble Index with economic forecasts from Oxford Economics for major cities around the world. The Bubble Index categorizes markets as follows: below -1.5 indicates a depressed market; -1.5 to -0.5 an undervalued market; -0.5 to 0.5 fair value; 0.5 to 1.5 an overvalued market, and above 1.5 a bubble. Based on the latest data, only Zurich and Tokyo appear significantly overvalued, with their bubble status having increased over the past few years. Compared to two years ago, the number of cities classified as overvalued has dropped from nine to two, reflecting changes in the global real estate market.

Fed's rate peak and government bond yields

This chart examines 10-year government bond yield trends in major economies once the Federal Reserve reaches the highest point of increasing interest rates, known as the “Fed's rate peak,” using data from 1984 to the present. 

Specifically, it looks at the latest cycle, suggesting the Fed's rate peak was in July 2023, with the European Central Bank and the Bank of England potentially peaking shortly after. 

The 10-year US Treasury yield is above the typical range, suggesting higher interest rates. In contrast, the German 10-year bond, the Bund, shows a slight increase but remains within a normal range, while the UK's 10-year bond, the Gilt, is at or below its average rate. These trends may reflect the recent surge in US consumer prices, Germany's positive economic data and the UK's less favorable economic and inflation figures.

Australia employment indicators

This chart highlights the current state of the Australian job market via a range of indicators such as unemployment and underemployment rates, comparing them to data since 2000. The indicators suggest that the Australian labor market remains tight, although there has been a slight normalization. This ongoing tightness, especially if it continues to be slower to reach full employment, may contribute to ongoing inflationary pressures in the country.

EMs offer superior growth

EMs offer better growth prospects than DMs, according to this analysis of Purchasing Managers’ Index (PMI) data. 

DMs have experienced significant challenges recently, with weakness in the eurozone and the UK and Japan falling into technical recession since the second half of last year.

By contrast, EMs have shown resilience in the face of global headwinds such as higher borrowing costs, worsening trade conditions and inflation.

However, various PMI indicators have exhibited different trends over the last two years. The Services PMI for EMs has consistently outperformed that of DMs. While DM Manufacturing was robust in January 2022, EM Manufacturing has taken the lead since last year. 

The Composite PMI for January 2024 also shows how EMs are outperforming DMs.

Inflation generally easing across EMs

Inflationary pressures are easing across EMs following a peak in response to the Ukraine conflict in March 2022. 

This is due to a combination of factors including lower commodity prices, the stabilization or strengthening of EM currencies against the US dollar and other major currencies, tighter monetary policy and more efficient supply chains.

A full three-quarters of EM economies posted lower headline Consumer Price Indices in January 2024 compared to the previous month. Major Asian and Latin American EMs are also experiencing inflation below their long-term trends.

Over the last four years, EMs have seen more inflation volatility than DMs for a number of reasons including pandemic-related supply disruptions and higher food prices.

EM equities appear undervalued

Now could be the time to buy EM stocks, with valuations looking attractive based on this analysis of MSCI indices’ relative forward price to earnings (P/E) ratios.  

Despite a more favorable growth outlook, EM equities continue to trade at a discount to their DM peers due to perceived risks, offering potential opportunities for investors seeking value. 

The current EM forward P/E ratio is at a greater discount relative to DM than the 30-year median, indicating potential underpricing.

However, it is worth noting that forward P/E ratios in EMs vary significantly by country. This is due to a range of factors including individual countries’ growth prospects, monetary policies and political stability. 

Financial stability is improving in EMs

EM companies are improving their financial stability, according to the Altman z-score. This is a formula for determining whether a company is heading for bankruptcy within the next two years by considering profitability, leverage, liquidity, solvency and activity ratios. 

The aggregate EM z-score is at 4.8, higher than the 4.3 average since 2006. Values look significantly better if considered for private non-manufacturing companies. 

Key factors affecting z-scores in EM include economic policies, external debt levels, commodity dependence and the impact of the Covid-19 pandemic.

Are commodities set to stabilize?

This chart shows the relationship between commodity prices and the US real interest rate, highlighting the inverse correlation between commodity returns and US interest rates. 

Low real interest rates reduce the costs of holding inventory and investing in commodities, making them more appealing to investors, thus increasing demand and prices. Such conditions often contribute to a weakening of the dollar, making commodities more affordable for holders of other currencies. This also makes yield-generating assets less attractive, prompting investors to explore alternatives, including commodities.

The chart shows that the US 10-year real yield turned positive from July 2023, with inflation decelerating. Commodity returns were negative during this period.

While a balance between growth-led demand and monetary easing, leading to lower yields, should help stabilize commodities, a range of risks could impact commodity returns. These include geopolitical risks, volatile shipping costs and uncertain weather conditions.

Contrasting inflation dynamics: US stagnation vs. European decline

From {{nofollow}}Jeffrey Kleintop, {{nofollow}}Charles Schwab.

In recent months, the inflation landscape has shown a stark contrast between the US and Europe. Since June 2023, the US Consumer Price Index (CPI) has stagnated, hovering just above the 3% mark, in notable contrast to Europe, where CPI has sharply decreased to below 3% over the same period.

The main driver of this disparity is the US's persistent service sector inflation, especially in housing, which is nearly double that of Europe. 

Conversely, in Europe, inflation across all major categories is on a downward trend, signaling a promising reduction in CPI. This decrease is likely to converge with the central bank’s 2% target at a faster rate than in the US. This may increase market confidence in the ECB’s capacity for earlier or more aggressive rate cuts.

This divergence in inflation dynamics highlights the differing economic challenges and policy responses across the Atlantic, with Europe appearing to be on a quicker path to meeting its inflation targets than the US.

How broad-based are price pressures in the UK?

From {{nofollow}}Investec.

Between Brexit, the pandemic and the war in Ukraine, it’s been a turbulent few years for the UK economy. Contrary to initial expectations, the inflationary surge has persisted.

The Bank of England initiated aggressive monetary tightening in December 2021 to mitigate excessive price pressures. This chart assesses the progress made towards achieving the 2% CPI inflation target by analyzing trends across 39 inflation sub-categories.

The Monetary Policy Committee is now in a period of pause as it assesses the impact of past hikes. The BoE has estimated that about a third of the impact of tighter policy is still to come.

As Investec’s chart shows, most of the components continue to record inflation rates above 2% (indicated by red bars), suggesting further efforts are needed before policy can be eased. Relatively few categories (indicated by blue bars) fall below the CPI target. CPI inflation itself is charted in light brown.

To date, a significant portion of the drop in inflation can be attributed to falling wholesale energy prices. While that should eventually feed through to other sectors, the BoE will likely want to see price pressures easing across the board, especially in services, before it can declare victory and begin to cut rates.

Deflation in China: global implications 

From {{nofollow}}Dr. Tariq Chaudhry and {{nofollow}}Norman Liebke, {{nofollow}}Hamburg Commercial Bank.

Weak Chinese inflation has both cyclical and structural roots, driven by three primary factors: 1) declining pork prices due to oversupply; 2) weak energy prices, notably oil, despite geopolitical tensions and OPEC cuts; and 3) the spread of deflation from goods to services, exacerbating labour market weakness.

This chart breaks down components of the CPI, showing their contributions to the overall deflationary trend, with a specific focus on the plunge in pork prices presented in a separate panel. It’s notable that despite overall deflation, core inflation remains positive, indicating that volatile food and energy prices are the principal drivers of deflationary pressures.

Deflation in China poses economic risks both domestically and internationally. Domestically, consumers and businesses may delay spending or investments, potentially triggering a vicious cycle of further economic slowdown.

Internationally, China’s economic softness could accelerate interest rate cuts in emerging markets reliant on Chinese goods and could provoke concerns in the West about competitive disadvantages stemming from more affordable Chinese exports.

Trouble in the Panama Canal and Red Sea: The Baltic Dry Index and knock-ons for inflation

From {{nofollow}}Tom Duncan, {{nofollow}}Cromwell Property Group.

The Baltic Dry Index tracks the cost of shipping raw materials around the world, including coal and metals.

“We monitor the BDI to take the temperature on global trade and supply-chain risk,” Tom writes. “Since December it has risen significantly and shown greater volatility, reflective of the drought impacting the Panama Canal, attacks on Red Sea shipping and heightened geopolitical uncertainty.”

“We expect the BDI to continue to rise, with knock-on implications for the availability and cost of goods, inflation and a focus by businesses on supply chain resilience through nearshoring and reshoring.”

Watching the S&P 500: What happens after record highs?

From {{nofollow}}James Maxwell and {{nofollow}}Alex Varner, {{nofollow}}Main Management.

Our authors chart the US benchmark, highlighting periods where it was within 5 percent of a record. “The S&P 500 hit a new all-time high in mid-January, breaching the high-water mark set at the beginning of 2022,” James and Alex write. “That two-year period is right in the middle of how much time it has historically taken bear markets to reach new all-time highs, at #6 out of the 11 most recent bear markets.” 

As the chart shows, the 2020 pandemic crash took just six months to reach new all-time highs, whereas the 2007 global financial crisis and 2000 dot-com bubble took 5.5 and 7.2 years, respectively.

“New market highs often raise questions about whether stocks are overvalued and if returns going forward will be lower as a result. However, if we look at the previously observed bear markets and what happens after record highs are hit, the momentum typically continues to bring the market even higher. In fact, the S&P 500 has spent nearly half the time (42%) within 5% of its all-time high since 1948.”

Applying the Taylor Rule to Fed policy

From {{nofollow}}Sebastien McMahon, iA Global Asset Management

The Taylor Rule is often seen as a rough guideline for assessing the appropriateness of central bank policy. This chart compares the Taylor Rule with the Fed’s key policy rate and the performance of equities.

“Effective monetary policy in 2024 requires a gradual transition towards neutral interest rates while ensuring clear communication to avoid detrimental market volatility,” Sebastien writes. “Investors remain vigilant in monitoring the Taylor Rule recommendations to anticipate changes in policy and improvements in unemployment and inflation. The peak of the Taylor Rule forecast in September 2023 coincided with a market rally, fueling a positive outlook on the economy's stabilization.”

“The current scenario is unique because the policy rate reduction could arise from an authentic soft landing that coincides with normalizing inflation instead of past instances when central banks felt compelled to ease rates due to a looming recession,” he continues. “Hence, the Fed might be able to sustain economic growth and limit the harmful effects of inflation with limited stimulation of growth. If central bankers start moving aggressively with cuts, then it’s highly unlikely that it’s because inflation has normalized without any significant economic damage.”

Equity risk premiums: US stocks seem unrewarding versus bonds

Stocks are supposed to be riskier than bonds in exchange for higher returns over time. However, in the US, that risk comes with less reward these days. With interest rates holding near the highest in almost two decades, portfolio allocation between bonds and stocks is more important than ever. 

This chart creates a simplified “equity risk premium” for US stocks: it subtracts the 10-year Treasury yield from the equity earnings yield. A negative reading (last experienced in 2002) means bonds in fact returned more than stocks.

We aren’t back there yet, but we are close. Last year, the risk premium dropped through its 2007 low, and we are barely above zero. 

Today, equity valuations remain high, and bond yields have risen significantly, limiting the excess returns investors can generate from stocks.

Equity risk premiums: China – an attractive entry point? 

The picture is quite different in China. The equity risk premium has surpassed 5 percent. Soon, it might be more than two standard deviations away from the average.

(Our charts use color-coding to denote standard-deviation ranges from the norm.)

As China loosens monetary policy while {{nofollow}}stock prices remain in the doldrums, the unpopular equities market appears to be at its most attractive entry point since 2008.

Speaking of 2008 (and 2007), note how the equity rate premium swings outside the two-standard-deviation range in both directions during and after the global financial crisis – showing the effect that a crash, crisis-fighting rate cuts and the first stages of recovery can have on this measure.

Equity risk premiums: Brazil – a different world

Like China, Brazil also appears to offer an attractive entry point for stocks. The equity risk premium has wavered near a multi-decade high since 2019. 

What’s notable is how different the average ERP is for Brazil over the past 22 years: negative 2 percent, versus positive 3 percent in the US. Bonds are historically more attractive than stocks given the risks.

As inflation has historically been much higher in Brazil, so have 10-year government bond yields. But in recent years, equity earnings yields have improved markedly.

Business confidence clocks: German doldrums

Our second trio of charts use the “business cycle clock” visualization, which tracks an economy through expansion, downswing, contraction and upswing phases. 

They rely on the results of local surveys of executive sentiment, plotting a month-on-month trajectory using two variables: month-on-month change (the X axis) and the Z-score, i.e. the latest reading’s statistical divergence from the three-year average (the Y axis). 

Business confidence in Germany remains in the doldrums, as this “clock” shows. We’ve broken down Europe’s largest economy into services, consumer, construction, industrial and retail sectors for greater granularity.

All sectors are in contraction. The consumer sector was in an upswing, but that just ended. A potential retail recovery stalled in mid-2023.

Business confidence clocks: Mostly optimism in Spain

This trio of charts also focuses on the eurozone, demonstrating the challenge of running a single monetary policy for divergent economies. 

Even after the 2022-23 run of rate hikes, Spain’s “clock” looks quite healthy by comparison to Germany.

The consumer sector is an outlier, much weaker historically than its peers and heading from upswing to contraction. Services and industrial sectors are expanding. Construction and retail are only just in downswing territory. 

Business confidence clocks: a mixed picture in Italy

Our Italian “clock” is notable for how dispersed the various business sectors are, as opposed to the more uniform trends in Germany and Spain.

Retail and construction business confidence remain high in absolute terms, though both are straddling the line between expansion and downturn. Services confidence is right on the historic average, with little change month-on-month. And the industrial sector is in the grip of sustained deterioration. The consumer sector had recovered from a much worse downturn than the other sectors, but its recovery is stalling.