The turmoil in rates does not stop. Yet another tough week for risk-on assets, with US Equities down, rates up, and bonds down again. Navigating the uncertainty by staying on the sidelines in both equities and bonds until there is greater clarity on where rates are headed. The Fed paused in September, but might well hike again in December/January, and a first cut is not presently on the cards until June/July 2024. Watch carefully the ADP Payrolls on Wednesday and the Non Farm Payrolls on Friday for more clues.

Major market events 2nd – 6th October 2023 

Highlights for the week

Mon: EU Manufacturing PMI, UK Manufacturing PMI, EU Unemployment Rate, US ISM Manufacturing PMI, US Fed Chair Powell Speaks 

Tue: AU RBA Interest Rate Decision, CH CPI, US JOLTs Job Openings

Wed: EU Services PMI, UK Services PMI, EU PPI, US ADP Nonfarm Employment, US Services PMI, US ISM Non-Manufacturing PMI

Thu: DE Trade Balance, UK Construction PMI, US Trade Balance, US Initial Jobless Claims

Fri: JUS Nonfarm Payrolls, US Unemployment Rate, US Average Hourly Earnings

Performance Review

• Index	25/9/2023	29/9/2023	WTD	YTD
  Dow Jones	33,963.84	33,511.22	-1.33%	1.13%
  S&P 500	4,320.06	4,288.33	-0.73%	12.14%
  Nasdaq 100	14,701.10	14,717.34	0.11%	35.49%
  Euro Stoxx 50	4,207.16	4,174.66	-0.77%	8.26%
  Nikkei 225	32,402.41	31,845.61	-1.72%	23.83%

  Source: Google
  
  * The pain continues yet for another week, with an ongoing rally in yields keeping all risk assets in check. The very hawkish Fed continues on its mission to bring inflation back to 2% and they will continue to use all their tools at their disposal to do that. The rout in bonds has been massive, with yields rising by 50bps in a month in the US and in Italy, and by 36bp in AAA rated Germany, putting valuations under pressure. Little more than 4 years ago the yield on the 10-year Bund touched its lowest level at -0.89%, and now you can almost get a 3% interest on the same security – how much has changed in a relatively short period of time. I remember when 10-year OATs touched a yield of 3% which was their relative peak, and from then began the decline to negative rates – sic transit gloria mundi. I would like to state, however, that what is different this time is that inflation is not driven by consumer or corporate spending alone, but there are other factors at play, including the rising cost of energy, politics, and the progressive de-globalisation taking place pretty much across the world. I believe there needs to be a capitulation before a respite can begin – maybe with 10-year treasuries reaching a yield of as much as 5% (currently 4.69%). Some market pundits are stating that it is nonsense to think that interest rates will go up forever (like it was nonsense to think that negative rates would persist for long), but the current dislocation can last for quite a while until we see inflation starting to recede. There’s no question in my mind about the Fed’s hawkishness – they are clearly looking at inflation and if in order to win the game they will send the economy into a recession, so be it. We have a couple more weeks to go before we can look at earnings, and in the meantime, it’s probably better to hedge your bets. Data will be key in driving the Federal Reserve going forward, but under the current environment talking about 6% is no longer taboo. The market is definitely not sold on Fed cuts and fears we have yet to touch the summit in rates.
  
  * In this immense confusion, growth managed to have a decent week, trumping value. Goldman Sachs is saying that the Magnificent 7 relative valuation is the cheapest that we have seen for some time and – on a PEG ratio basis – is even cheap relative to the rest of the market. At the same time, sensitivity to rising rates has been reaffirmed, and clearly the ongoing environment does not benefit either growth or value. At this point in time, I would want to see how the crisis in rates unfolds before stepping into the equity market – as it seems only to go down. A prudent stance on bonds is also welcome – as recommended by Tom Baldacci in his Macro Thoughts. The great Ray Dalio mentioned that he prefers cash at the moment over bonds, as further testimony that the wild moves in rates are yet to stabilize. And why not? With yields so enticing, why take on board more risk (especially if you think that inflation, sooner or later, is headed downward?).
  
  * Once again the markets are licking their wounds, and while valuations are cheaper now, there needs to be a catalyst to trigger a recovery. This can be one of the following: i) lower rates, or ii) earnings growth. The first seems to be nowhere to be found and we need a couple more weeks for the second. The CME FedWatch tool is pricing a potential last hike (if indeed it will be the last one!) between December and January, and an interval of 4.50%-5.00% by the end of 2024, with 4.75% as the mid-point, envisaging a cut of 75-100 bps depending whether the Fed hikes again or not (but remember Powell said no cuts for the time being). The release of the ADP Nonfarm Payrolls on Wednesday, Jobless Claims on Thursday, and – last but not least – Non-Farm Payroll on Friday may shed more light on where we are (at the moment, in a very uncomfortable place). Meanwhile, the CME FedWatch tool has updated the first cut to June/July 2024 – I just wonder if will it be too late?
  
  * We’ve heard for some time about a hard (more likely) or soft landing for the economy, with a recession that was supposed to begin as early as in 2Q23, and the US economy seems to have performed better than anyone expected. Indeed, the Atlanta Fed’s GDPNow model is currently forecasting 3Q23 growth of 4.9%, stable from last week. One notable aspect is that – from the same survey – the current forecast derived from the Blue Chip consensus is now nearing 3%. After having gone past the rates tantrum, the baton passes on to the economy, which so far has performed admirably, despite the tough environment. Watch out for earnings, with a -0.1% growth now expected in 3Q23, vs an estimate of -0.4% as of Jun 30th. Revenue growth is faring a little better, at +1.5% in 3Q23, vs 1.2% as of Jun 30th. 
  
  * We need to reach October to have an update on 3Q23, however, if the current estimate of -0.1% is confirmed, it will be the fourth straight quarter of negative year-on-year growth. 

Earnings, What’s Next?

We are still in limbo between 2Q23 and 3Q23. Here’s a list of companies reporting this week. Highlights include Conagra (Thursday, Before Open), and Levi’s (Thursday, After Close).

Source: Earnings Whispers

Market Considerations

Revenue growth estimates for 2024 are forecasted to grow by 5.6% (5.0% on Jun 30th) and earnings growth estimates for 2024 are predicted to grow by 12.2% (11.8% on Jun 30th), so the future looks to be bright. We continue to debate whether the US economy will fall into a recession or not and what will be the peak rates for Fed Funds. October is traditionally a difficult months, often characterised by extreme volatility, so my optimism is somehow tempered here, even though the strong performance so far should prevent a catastrophe. 

We are probably shifting from a monetary risk to a macro risk, where the economy’s performance is more important than what the Fed does. We should be mindful that the economy is probably just doing okay, even though passing the peak in rates will remove the overhang present on the market. If and when rates diminish in importance, earnings (and top-line growth) will hopefully pick up their pace.

So the breakout happened, with both the S&P 500 and the Nasdaq 100 ahead of their previous Feb 2 highs. Next week will probably be sideways/down again, as the market consolidates and forms a base around current levels. My recommendation is to be disciplined and respect the stop, staying out of the market until we have greater clarity on where the rates are headed. Regarding bonds, the trajectory is that yields will eventually fall, albeit with a few bumps on the road, but given the run-up at the moment, I advise staying on the sidelines before pouncing.  Considering the Fed’s new forecast, we might have to wait until the second half of 2024 for that.

For the less volatility-prone of you, it may make sense to take all opportunities to alter the weights of your asset allocation by increasing the weights of safety assets at the expense of more risky assets by lightening up in equities and reinvesting in bonds at attractive (5%+) yields. 10-year yields were up once again last week in the US and Europe, though the ceiling should be near for both. For those wishing to keep their money in Equities with lower volatility, suggest switching to Japan as the company with the most stable outlook (the country with the more precise picture of rates at the moment) until rate perspectives become clearer in the US and Europe. They got a boost given the recent buy recommendation by Warren Buffett, and the oracle is very rarely wrong. So Japanese Equities are now investable regardless of the lower volatility derived by being the only nation in G7 not to raise rates in the current environment. Just watch out for the JPY – if the current strength in the economy and markets continues, you may want to hedge it as it will likely continue to slide (against all major currencies).

Happy trading and see you next week!

InflectionPoint

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