Metallurgy / Chemicals / Rubber & Plastics

The double-digit increase in global stock markets may easily make people forget the dramatic events in the first half of 2023, including spy balloons, failed banks, interest rate hikes and Debt limit showdowns. The second half of the year may not be as dramatic, but as the economic recession in the cardboard industry expands, investors' returns will be relatively mild.

01 Carton recession

During a typical global recession, all economic sectors (such as manufacturing, services, retail, construction, and trade) often experience simultaneous declines. However, based on indicators such as industrial production, global trade volume, industry employment growth, and purchasing manager surveys of manufacturing companies, it seems that for most of the past year, only manufacturing and trade have been in a global recession.

We refer to this phenomenon as "cardboard decay" because manufactured and transported items are often packed in cardboard boxes. According to import and export data, the decrease in demand for corrugated cardboard (the raw material for most cardboard boxes) is similar to past economic downturns. The recent decline is reminiscent of the demand behavior during the shadow period of the global economic recession shown in the table below.

In contrast, the service industry, which accounts for the largest share of output in developed economies, continues to grow. The Global Services Purchasing Managers' Index (PMI) is still well above the threshold of 50- between contraction and expansion. As consumers shift towards purchasing experiences rather than goods, demand for tourism and entertainment remains strong. For example, the International Air Transport Association (IATA), the main organization of the aviation industry, said on June 5 that it expected the global net profit to double in 2023 due to the soaring flight volume in North America and Europe.

02 Profit recession

Evidence of a cardboard box recession suggests that a mild decline in corporate profits may continue. According to import and export data, global manufacturing PMI leads global companies in profit growth by a quarter. It currently continues to point out a decrease in the middle and low single digit year-on-year percentage of earnings per share. Although a decline in income has never been good news, compared to previous recessions of 20% or more, this decline is almost insignificant.

Looking further ahead, the profit expectation gap between the cardboard box industry and the service industry is in double digits. In the following year, the consensus among analysts tracked by FactSet on the profit growth forecast for manufacturing companies is+3.8%, while the service industry is+14.9%. Although analysts' predictions are often overly optimistic, the huge gap between them highlights the views of economists and analysts on the nature of the current economic environment.

03 From shortage to surplus

The shift from shortage to surplus in the global commodity market that occurred in mid-2022 may now be shifting to the global labor market in 2023. The communication in the company's financial report conference call and shareholder briefing shows an upward trend in the mention of layoffs, as well as a downward trend in the mention of labor shortages.

Loan conditions may also lead to weak employment prospects. There is a clear and intuitive dominant relationship between bank loan standards and employment growth. The recent tightening of lending standards by US and European banks suggests that there may be a shift from job growth to job contraction in the coming quarters.

Compared to the service industry, the employment growth in the cardboard box industry this year has been weak: US: Last Friday's US employment report showed a decrease of 2000 manufacturing jobs, while the total number of non farm jobs increased by 339000; Canada: Canada's data for May has not yet been released, but the total number of manufacturing jobs decreased by 3300 in March and April, while the number of service industry jobs increased by 111000; Germany: The breakdown of employment growth by industry is only done quarterly in Europe, but in the first quarter, according to import and export data, Germany's manufacturing industry net added 13000 jobs, while the overall economy net added 155000 jobs. The weak employment growth in the manufacturing industry may begin to spread to the service industry in the second half of this year.

04 Inflation

For inflation, a cardboard box recession may be "good news". The output price part of the manufacturing PMI indicates the price trend charged by manufacturers, and has been predicting the direction and level of inflation in Europe, the United States, and the United Kingdom six months in advance. The latest PMI price index in Europe shows that the inflation rate may rise from the current 6% to nearly 2% in the next six months. Inflation may continue to subside at the same rate as the rise.

If inflation reaches the target of 2%, the European Central Bank may suspend interest rate hikes this summer. This may mean that the attention of all markets in the first half of this year will shift around the actions of the central bank.

05 Outlook for the second half of 2023

In our 2023 outlook, we indicate that international stocks may once again outperform the market in 2023, as the previous cycle's leaders often experienced the largest reversal during bear markets, while recovery and the next cycle often saw new leaders emerge. The chart below shows the relative performance of the US and international stock indices, showing the situation of "shark attacks" in the stock market. These lines are just the ratio of one index divided by another index. When the blue line rises, the international stock market outperforms the US stock market. When the orange line rises, the US stock market outperforms the international stock market. They are mirrors of each other.

During the economic recession of the 1970s and 2000s, there were multiple "juvenile shark attacks". However, in the late 1980s, after about a decade of outstanding performance in the international stock market, the shark's chin widened greatly. As the US stock market began to outperform the market, the big mouth began to close and took a bite from the investment portfolios of investors who had not rebalanced international stocks. Now, the shark's huge chin may close again, as it has been extended for more than 10 years. This time, the market seems ready to take a share of the relative performance of the US stock market, as international stock markets may turn to outperform the market.

No one knows for sure whether we have seen the US stock market outperform the peak of international stock markets. After performing well in the international stock market, the shark's beak may open wider. According to import and export data, the surge in a small portion of American artificial intelligence (A.I.) stocks in May helped weaken the country's international leading performance in the first half of this year. Science and technology in the United States stocks outperformed the S&P 500 index in May with the largest increase since November 2002. Relatively speaking, the stock market may further boost the US stock market, but we still find international stocks attractive in the second half of 2023, thanks to more attractive valuations and faster profit growth.

We still hold a neutral attitude towards the performance of emerging market stocks this year, which seems to depend on the tension between China and the United States and the sustained recovery of the Chinese economy, as Chinese stocks have the highest weight in the MSCI emerging market index, exceeding 30%. Geopolitical tensions seem to have a negligible impact on China's domestically driven economic growth, but they do seem to pose pressure on the Chinese stock market. From the end of October to the peak on January 27th this year, this sharp drop disrupted 60% of the three month rebound.

Both leaders have stated that as US decision-makers arrange meetings with their Chinese counterparts, US China relations may soon thaw. However, due to the possibility that the Biden administration may issue administrative orders in the coming weeks to restrict US outward investment in China, the short-term tension may continue, so the transition may not be smooth. After the initial zero rebound of the epidemic, the momentum of the Chinese economy has slowed down, but more proactive stimulus measures may be introduced to revive the recovery.

There may be fewer surprises in the second half of 2023, because the Debt limit agreement has been in place by the beginning of 2025, the global central bank has begun to suspend interest rate hikes, the pressure on banks tends to stabilize, and there are signs that the potential tension between China and the United States has cooled. According to import and export data, the suspension of international stock market leadership in May may resume in the second half of this year. However, the double-digit returns on global stock markets in the first half of the year may already reflect expectations of the end of the cardboard box recession. If the weakness spreads to the service industry as inflation and employment growth slow down, the stock market may find it difficult to match these gains in the second half of the year. (Translated from: Global Printing and Packaging Industry)