Weekly Investment Update (07/21/2023)

U.S. Banks Highlight Consumer Resilience and Point to Cautious Path Forward

The second quarter earnings of the largest U.S. banks presented a picture of overall economic resilience. In particular, the U.S. consumer was a noted area of strength, though uncertainty regarding the future path of economic growth remains. Thus far, bank earnings have come in stronger than expectations. Bank of America reported similar comments in its earnings call, highlighting that the consumer remains healthy with strong credit quality and continued spending, though at a slowing rate. JPMorgan’s press release noted “consumer balance sheets remain healthy, and consumers are spending, albeit a little more slowly… and are slowly drawing down on their cash buffers.” Still, it also noted that 30-day-plus credit card delinquencies have moved higher, reaching pre-pandemic levels. Moreover, banks’ outlooks remained cautious, noting that sticky core inflation, higher interest rates, and heightened geopolitical tensions remain risks to economic growth.

Generally, banks provide insights into the health of the consumer and the economy given the amount of real-time data they possess on spending, savings buffers, and credit. Our Quarterly Investment Perspective, which includes additional commentary on the economy and markets, reiterates that the economy and consumer have remained more resilient than expectations, though both the economy and consumer spending have showed signs of slowing recently. Bessemer’s All Equity Model Portfolio is underweight the financials sector and banks relative to the benchmark.

Reshoring of Supply Chains Gains Momentum

In response to the rise in geopolitical tensions and companies’ desire to reduce lead time and production costs, there has been an emphasis on reshoring and nearshoring supply chains. Reshoring is when production relocates to the importing country, and nearshoring is a method of moving production closer to the end market. Given the prominence of manufacturing in China, companies are emphasizing supply chain diversification by adding additional production facilities in other countries, such as Mexico and India, with the goal of reducing an over-reliance on China. When assessing shifts in supply chains, there are various factors to consider, such as transportation costs, production costs, wage costs, switching costs, trade policy, and geopolitical environments, all of which have important investment implications; the relative importance of each of these factors can vary by industry.

Supply chain disruptions during the pandemic have led to changes in supply chain management. Following COVID-driven supply chain disruptions and subsequent lockdowns in China, many companies are diversifying away from their overdependence on China or are bringing supply chains closer to the end consumer. This notion was underscored as U.S. imports from China have fallen to their lowest percentage of overall imports since 2005.

We note that many supply chains are complex and difficult to relocate, and these trends will take some time to materialize. However, there are exciting investment opportunities that stem from the refocus in supply chains. Imports to the U.S. from Mexico have surpassed China’s, in-part driven by U.S. companies nearshoring supply chains. We believe that Bessemer holding Canadian Pacific Kansas City, a leading North American railway, is positioned to benefit from increased demand for cross-border transportation as a result of accelerating manufacturing between Mexico and the U.S.

China Reports Disappointing Second Quarter Economic Growth

China’s second quarter GDP grew at an annualized rate of 6.3%, about one percentage point below analyst expectations. Both export and import growth surprised to the downside due to a combination of weaker global demand and domestic consumption. China’s property sector also continued to struggle as housing prices declined 2.2% month-over-month in June. Lower property values have an outsized dampening impact on Chinese consumer confidence because housing is a much bigger percentage of Chinese households’ net worth relative to balance sheets in Western countries. Year-over-year government revenue growth also disappointed due to lower land sale and property tax revenue.

Although China’s overall unemployment rate held steady at 5.2% in June, the youth unemployment rate (ages between 16 and 24) set a record high of 21.3%. Taken in a vacuum, China’s youth unemployment rate isn’t an extreme outlier when compared to those of countries outside of the U.S. Countries such as Brazil, India, Spain, and Italy also have youth unemployment rates above 20%. However, the rapid 5 percentage point rise in China’s youth unemployment rate over the past two years is concerning. China’s COVID-Zero policies have hampered service industries such as hotel, catering, and education, which tend to hire more young workers than other industries. This year’s economic reopening should help such industries, but employment has not rebounded quickly. In addition, there is a structural mismatch between the types of students who are graduating from college and those targeted by employers. For example, the number of graduates who majored in sports or education has significantly increased over the past five years, but employer demand for those majors actually has declined.

In light of the recent economic data, the Chinese government is expected to announce additional fiscal and monetary stimulus at the upcoming Politburo meeting in late July. Bessemer’s portfolios hold a benchmark weight in Chinese equities, less than 4% of equity exposure, and the investment team will continue to closely monitor these developments.