Consumers fail to splash the cash, as UK poised for a recession

UK retail sales fell more than expected in December, and were down 3.3% excluding auto fuel, compared with November. This suggests that wet weather, higher interest rates and signs that the job market could be cooling have knocked consumer sentiment. It also suggests that the UK consumer is choosing to spend their money on things other than goods, such as foreign travel and experiences, which was evident in the inflation data released earlier this week.

The key drivers of the weakness in retail sales included clothing and footwear and general goods. The volume of goods bought was also lower across the board, including for online sales. Non-store retailing saw volumes decline by 2.1% on the month, while overall online sales were flat in December. The UK consumer has diverged from their US counterpart, in the US retail sales in December were 0.6% higher, excluding autos and gas.

Retail sales add to signs of a recession

There was a bright spot in this retail sales report, the November retail sales data was revised higher to 1.4%, as shoppers were enticed by Black Friday deals, and may have brought forward some of their spending. However, the retail sales data does not paint a pretty picture of the UK economy. Retail sales fell by 0.9% in Q4, which increases the chance of a recession for the UK. Earlier this week, wage growth slowed at its fastest ever pace, which could constrain the consumer further as we move through 2024.

Retail sales knock the pound, and could dent the FTSE’s retail sector

The pound slipped on the retail sales news, and GBP/USD is back below $1.27. Gilt yields are also lower, and the 2-year Gilt yield fell 8 basis points on Thursday. There could be more declines on Friday as the market re-asses the Bank of England’s rate cut expectations now that there is solid data to suggest the UK consumer is under pressure. Earlier this week, the first rate hike from the BOE had been pushed back to June, with just over 4 rate cuts priced in by the market for 2024 as a whole. Expectations for UK rate cuts could once again be recalibrated if the market thinks the BOE will be concerned with the trend in consumer spending.

The FTSE 100 was one of the weakest performers in Europe on Thursday and there was weakness for utilities, energy, healthcare and consumer staples. Consumer discretionary was the best performing sector, up nearly 3%, although Friday’s retail sales data could take the shine off some of the UK’S consumer stocks. The futures market is predicting a positive open for the FTSE 100, and we expect shares in Europe to follow Asia higher.

Asian stocks diverge, with China under pressure and Japan surging

Elsewhere, sentiment has continued to improve during the Asian session on Friday, after a recovery rally for Europe and the US on Thursday. The Nikkei rallied more than 1.4% on Friday and recovered losses from earlier this week, as this index continues its march towards its record high at 38,915 last reached on 29^th December 1989. There were strong gains for the S&P 500 and the Nasdaq, as the IT sector, communication services and industrials all rallied strongly. Investor sentiment trumped the move higher in US Treasury yields, which are continuing to extend gains as we move into Friday. The US 2-year yield is now 4.36%, and 10-year yields continue to probe deeper into territory above 4%. The 10-year Treasury yield is trading at 4.16% and is at its highest level since 12^th December.

Can Treasury yields and stocks rally at the same time?

When Treasury yields and stocks rally at the same time this can tell us something about market sentiment. Sometimes it’s a signal that something will have to give; stocks can’t rally if yields surge indefinitely, at some point the market will worry about the cost of capital. However, there are some occasions when they can move higher in unison: when Treasury yields rise because of growing signs there will be a soft landing for the world’s largest economy.

More signs of a US soft economic landing tame volatility

Earlier this week there were concerns that delayed rate cuts from the Federal Reserve and other major central banks would stymie stock markets, however, on Thursday two pieces of news helped to restore faith in markets. The first was the strong initial jobless claims report from the US. Last week, initial jobless claims fell to 187k, down from a revised 202k for the week prior. It’s rare for initial jobless claims to fall below 200k, and the 187k reading is the lowest level since September 2022, and one of the lowest levels in more than 50 years. While weekly data can be volatile, it does seem clear that layoffs remain low in the US and are not trending higher. The US jobs market appears to be robust and well able to withstand higher interest rates. This feeds into the soft-landing narrative. It could also trigger a broader stock market rally, with sectors other than tech benefitting if the economic outlook is bright.

A robust jobs market may be able to sustain the US consumer in the coming months, and economists expect the University of Michigan consumer sentiment survey to show a pickup in sentiment at the start of the year, with inflation expectations remaining fairly stable.

Artificial Intelligence boom continues

Another theme that is powering market sentiment is AI. We have already spoken about the stellar start to the year for AI stocks like Nvidia, and earlier this week Microsoft overtook Apple as the world’s most valuable company. There were further signs that AI could be monetized this year, with stronger than expected results for Taiwan Semiconductor, the main supplier of chips to Apple and Nvidia. Its stock price surged more than 6% after it reported Q4 results that were better than analyst expectations and gave a positive outlook for 2024. Its confidence around customer demand for its latest, more high-tech chips, despite market competition and concerns about a slowing market for smartphones, helped to drive the stock. Chip makers are cyclical, so the fact TSMC is providing a positive outlook for this year is good news for the global economy. Its growing confidence in AI and its contribution to its future revenues is also encouraging for this key theme that may continue to be a big driver of market gains this year.

China stock market woes

Chinese stock market gloom continues. Chinese stocks listed in Hong Kong are poised to have their worst week in 10 months, as the government show no signs of increasing stimulus although economic growth is showing signs of faltering. We expect Chinese shares to continue to underperform the global market, and the Nasdaq golden dragon index is lower by nearly 8% this week.