Time to deliver: Three-minute macro
Delivery times for products are improving, which should help ease inflation pressures. But an hawkish Bank of Canada has us keeping an eye on the housing market, while we think the European equity market is underpricing risk in the region.
Delivery times improving (even if it doesn’t feel like it)
Anecdotally, it still may seem like it’s taking time to get the goods you need (or want), but we’re actually witnessing a remarkable decline in supplier delivery times recently, and July has been an extension of this trend. Delivery times in the United States, euro area, and Canada all peaked in 4Q21 and we are of the view that these will continue to decline. While July’s CPI results eased—giving investors and consumers alike a needed reprieve—any continued decline in delivery times should contribute to easing price pressures as U.S. CPI has typically followed the trend of delivery times by a few months.
These releases also support one of our key macro anchors: We’re transitioning from COVID-19-driven inflation to conflict-driven inflation. By 2023, we expect inflation to materially decelerate due to base effects, excess inventories in non-auto retail goods, and the alleviation of supply chain disruptions.
Importantly, while delivery times in the United States, euro area, and Canada have been following the same path, China’s data is bucking the trend. In fact, aside from a brief increase at the onset of the pandemic in 2020 and again in early 2022, delivery times in China were never elevated for a sustained period. This is supportive of our concerns about Chinese growth given the rising economic costs of ongoing COVID-zero policies where economic support remains underwhelming relative to the challenges that China faces.
Delivery times are improving
PMI suppliers' delivery times index, by region
A stingy Bank of Canada might sting Canadian banks
With a 100 basis point (bps) hike in July, the Bank of Canada continued to aggressively tighten monetary policy, putting pressure on both the Canadian consumer and Canadian banks. Canadian yield curves flattened off the back of this hawkish surprise, with the 2-year/10-year spread inverting for the first time since the first quarter of 2022; the 3-month/5-year spread also fell, heading closer to inversion.
This is on our radar since Canadian financials typically struggle to perform as the spread between 3-month and 5-year bonds moves closer to inversion. This relationship makes intuitive sense: Curve inversions typically occur because of a deteriorating macro backdrop, and since banks are cyclical in nature, their stock prices respond accordingly. This cyclicality is also intuitive, given the sector’s relationship with the consumer: Higher interest-rate levels are likely to exacerbate the strain of already-high household leverage. In particular, mortgage costs for Canadians (which are typically tied to 5-year yields) will continue to climb at a time when households are already being squeezed for cash by painful inflationary pressures; as a result, bank balance sheets may come under pressure as consumers struggle to keep up with increasing mortgage payments. The quantitative tightening program will also create headwinds for Canadian banks as record levels of liquidity are removed from the system, creating a drag on liquidity coverage ratios.
While our strategic asset allocation favors an overweight posture in Canadian equity, we see the current tightening cycle as a potential headwind to Canadian financials, putting broader pressure on the TSX in the short term, given the sector’s prominence.
Yield curve flattening a headwind for Canadian financials
3-month/5-year spread vs. financials' returns
The stubborn European equity risk premium
With a recession in Europe being our base case, we believe that the regional equity risk premium isn’t sufficiently compensating investors. High-yield securities have started to reflect the challenged outlook in Europe, and there has typically been a close relationship between the equity risk premium and high-yield spreads, but the former doesn’t seem to be getting the message that the latter is delivering.
Macro headwinds in Europe continue to build: growth forecasts are falling, while inflation forecasts are ratcheting higher. In fact, our estimates suggest that the consensus for European GDP is still too high in 2022 and 2023, possibly because of benign assumptions around Russia’s invasion of Ukraine. While Germany’s energy crisis is already putting pressure on households as they grapple with increasing energy costs, energy rationing would force consumer and corporate activity to slow—that is, German factories could conceivably be faced with limited output.
While high-yield markets have recently started to price in these risks, the equity risk premium has not caught up (as it has historically during other pre-recessionary periods), making us think that European equity markets aren’t compensating investors enough, considering the gloomy outlook. As it stands, the current premium is a function of a lofty earnings yield that is being propped by forward earnings that have actually risen year to date. We foresee this trend reversing, leading to lower European forward earnings in 2H22 and an even less attractive equity premium (all else being equal). Furthermore, at about 105bps, the spread between the European high-yield credit spread index and the equity risk premium hasn’t been this wide since 2008.
European equity risk premiums have some catching up to do
European equity risk premium vs. high-yield spreads
Important disclosures
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person.
All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients and prospects should seek professional advice for their particular situation. Neither Manulife Investment Management, nor any of its affiliates or representatives (collectively “Manulife Investment Management”) is providing tax, investment or legal advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Manulife Investment Management shall not assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by Manulife Investment Management and its subsidiaries and affiliates, which includes the John Hancock Investment Management brand.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.
2381566