The week in the markets -
March 3, 2023

East versus West: A tale of two economies

This week, we focus on the diverging paths of the world’s two largest economies. On one side of the world we have China showing improvement at the start of the year, having recently removed COVID-19 restrictions. On the other, the U.S. economy continues to show slowing economic momentum, with an increased risk of recession.

In China, the manufacturing sector saw its strongest level of growth momentum in more than a decade, while consumer activity was also on the rise. The Chinese Manufacturing Purchasing Managers’ Index (PMI) came in especially strong at 52.6%, above the base level of 50% (an index reading of 50% indicates no change in growth). Housing sales have increased for the first time in 20 months, according to data from the 100 biggest real estate developers. These metrics suggest an increase in Chinese aggregate demand and economic activity.

South Korea, which is a bell weather for global economic activity, saw exports drop 7.5% on a year-over-year basis in February. This was an improvement following the 16.6% decline in January (and better than market expectations of an 8.7% drop). Despite it being the first time shipments fell for five consecutive months since early 2020, the less-than-expected drop in exports may be a sign of an inflection point supported by China reopening.

In Europe, we continue to see an increase in demand, as a result of China’s reopening. Measured across the major developed economies, average supplier delivery times quickened in February to a degree not seen since the economic collapse of 2009. Faster delivery times are welcome news in the sense that fewer pandemic-related supply shortages are facilitating higher output, notably in Germany and the U.K., and are helping move pricing power from suppliers to buyers. The consumer has yet to see this effect trickle down to the real cost of goods, but this is a positive trend, which will have a beneficial impact on inflation. By pushing down industrial prices, manufacturers will see a slower rate of input-cost inflation. 

In the U.S., manufacturing activity continues to contract, as measured by the ISM Manufacturing PMI, albeit at a more modest pace than its lowest level in December 2022. The weakness on the manufacturing side has yet to manifest itself in job losses. Initial jobless claims continued to trend below 200,000 for the week, reinforcing the belief that companies would rather hold on to labour rather than risk the alternative, as far as cost-cutting scenarios are concerned. The soft-landing scenario the U.S. Federal Reserve is trying to accomplish looks plausible, however inflation is still likely to be sticky as wage pressure grows and demand for skilled labour are seen as obstacles to lowering the rate of change in prices.

Meanwhile, equity markets closed the month of February down, as investors weighed the economic and earnings risks against a backdrop of further interest rate increases by the U.S. Federal Reserve. We believe we are in a period of price discovery that is forcing investors to evaluate the upside potential versus the downside risks across asset classes. Similar to the economic divergences playing out, we believe asset class divergences are also emerging, with a return to market fundamentals favouring valuation and earnings potential over prior market leadership.