Main market events 24-29th October. Trick or Treat?

Weekly Trading Plan

The highlights for the coming week:

– EZ/UK/US Flash PMIs

– ECB, Bank of Canada, and BOJ

– Tory leadership race in the UK

– Q3 Earnings season underway

Earnings Calendar Highlights

So far, 20% of the companies in the S&P 500 have reported earnings for Q3 2022.

According to Factset, out of these companies, 72% have reported actual EPS above the mean EPS estimate, 3% have reported actual EPS equal to the mean estimates, and 25% have reported actual EPS below the mean estimate. The percentage of companies reporting EPS above the mean EPS estimate is below the 1-year average (78%), below the 5-year average (77%), and below the 10- year average (73%). Below the norm, but nothing catastrophic, considering that many investors were dubious about the reliability of the consensus estimate!

The earnings season is heating up this week, with several big names (Alphabet, Microsoft, Meta, Amazon, Intel, etc. ) revealing their ability to navigate a very difficult operating environment.

Source: Earnings Whispers

What has been, so far, the market impact of positive/negative earnings surprises?

I find two charts particularly helpful in this regard. The first chart plots the average price change (from 2-day before to 2-day after the report) for different buckets of % earnings surprises.

Source: Factset

The second chart, instead, plots the average price change around the report date differentiating between companies reporting positive EPS surprises and those firms reporting negative earning surprises. The data for the current quarter is plotted against the average price change % of the last 5 years.

Source: Factset

To date, the market is rewarding positive earnings surprises less than average and punishing negative earnings surprises more than average. I find this price action somewhat surprising given the market positioning, which is, according to various surveys, supposed to be very light/short.

PMIs on Monday

France PMI , Geman PMI, EZ PMI, UK & US PMIs.

Expectations are for the EZ October’s PMI to remain in contractionary territory. A mild recession seems to be what the market is currently pricing for Europe. In the United Kingdom, the October release will probably not be a game changer, given the gravitas of the political turmoil. All eyes will be on the choice of the upcoming Prime Minister, and the actual fiscal plan deployed to plug the GBP 40bn hole in the public finances.

In the US PMI is expected to be more encouraging. The market is still convinced that in relative terms, the US economy is in a much better shape. The outperformance of the US economy is a clear consensus trade, but so far there is little macro evidence against this investment thesis.

Central Banks

BOC: a further 75bp hike, given the upside in inflation, is the most likely outcome. Looking ahead, markets are currently pricing a terminal rate of around 4.5% in April. A recent commentary from Governor Macklem noted if the recent CAD depreciation against the Dollar persists, there is going to be more work to do on interest rates.

ECB: With headline Y/Y HICP in September advancing to 9.9% from 9.1% and the core metric rising to 6.0% from 5.5%, policymakers are set to deliver another outsized rate hike following a 75bps increase in September. But, the devil will be in the details. There have been reports noting that the language regarding reinvestments could be tweaked, before outlining plans for a balance sheet reduction in December or February and then beginning with QT sometime in Q2 2023. The upcoming meeting could also see policymakers alter the terms of TLTROs, given that banks can currently park cash from operations at the ECB and earn a risk-free profit following recent rate hikes.

BOJ: Bank of Japan continues to be in its parallel universe, engaging in emergency bond buying to underpin its faltering debt market. While BOJ is buying tons of JGBs to keep yields in check (see chart below)

the Yen looks trapped in a devaluation spiral, with BOJ seemingly comfortable leaving FX intervention to the government. With regards to the next meeting, BOJ is widely expected to maintain its monetary policy settings and keep rates at -0.10%, while sticking to QQE with Yield Curve Control to flexibly target 10yr JGBs at around 0%. I remain convinced, however, that shorting JGBs, betting eventually on a policy shift remains a sensible choice, given the strong asymmetry of the trade. It looks like though, that’s probably for patient investors, as it will probably take some time before it plays out. Maybe next year, once Kuroda’s mandate is over?

UK Leadership Race

As Boris Johnson pulls out of the race to be the new prime minister to replace Liz Truss, Sunak seems now to be the clear favorite to stand as the next UK prime minister possibly as soon as Monday. He is seen as an economic fixer who implemented the furlough scheme during Covid and predicted the disastrous market reaction to Truss’ unfunded tax cuts, but there are several question marks. Sunak has just seven years of experience as MP and he was a cabinet minister for just two. It is not clear if he has the breadth of experience across departments to deal with multiple crises.

Market Sentiment

The San Francisco FED Daily News Sentiment Index, a high-frequency measure of economic sentiment based on lexical analysis of economics-related news articles has reached a two-year low.

…and last week, retail traders bought $19.9bn of puts to open. This is the first time in history that puts were 3x the calls.

Market Conclusions

Given the very negative market sentiment, it feels that, at least for now, the risk assets markets may have relatively limited downside. However, the upside of possible short squeezes seems also to be limited.

From the BOC/ECB side, risks seem to be slightly tilted to the downside. That’s especially true for the ECB. The actual size of the rate hike (50/75/100bps) won’t probably be a game changer. But, any change in language pointing at a timeline where the ECB will be starting to reduce the balance sheet sometime next year will be a killer. I don’t think the Eurozone can afford to do QT. But my concern is that they will give it a try, before realizing that is an absolute no-go! I think the UK Gilts carnage should serve as an example.

Solid earnings could be a relief this week, but I am not convinced this will be enough. At this point there can only be one driver for a sustained market rally:

FED Pivot

FED Step-Down

…FED SLOW DOWN

Call it however you like! STOP, END OF THE MONETARY DEBUFF

Disclaimer

All views expressed on this site are my own and do not represent the opinions of any entity whatsoever with which I have been, am now, or will be affiliated. I assume no responsibility for any errors or omissions in the content of this site and there is no guarantee for completeness or accuracy. The content is food for thought and it is not meant to be a solicitation to trade or invest. Readers should perform their own investment analysis and research and/or seek the advice of a licensed professional with direct knowledge of the reader’s specific risk profile characteristics.