And then there was blood. Very painful week for equities across the board, as well as bonds, while rates rose to a record. Cash, USD, CHF, and commodities could act as safe havens. Reassessing the economic/rates scenario; the disinflation expected in 2H23 might not materialize – watch out for US GDP on Thursday. Massive week for US Earnings – truly a make-or-break moment. Biggest tail risk is inflation staying high(er for longer), forcing the Fed to continue to hike to and beyond 6%.
Major market events 23rd – 27th October 2023
Highlights for the week
Mon: EU Consumer Confidence
Tue: JP Services PMI, UK Unemployment Rate, DE Services PMI, DE Manufacturing PMI, EU Services PMI, EU Manufacturing PMI, UK Services PMI, UK Manufacturing PMI, US Services PMI
Wed: AU CPI, DE IFO Business Climate Index, US Fed Chair Powell Speaks
Thu: EU ECB Interest Rate Decision, US GDP, US Core Durable Goods Orders, US Initial Jobless Claims
Fri: JP CPI, AU PPI, US Core PCE Price Index
|Euro Stoxx 50||4,136.12||4,024.68||-2.69%||4.37%|
* Simply put, last week was a disaster, ironically not because of the wars. Everything that could fall did it with a bang. The culprit is always the same: rates – and it seems that whatever the market says or does matters very little to them. We had the 10-year treasuries touch a yield of 4.99% before receding, sending prices plummeting once more across the board. It looks like what I feared manifested itself in the second week of the conflict – that’s a very meager consolation. Equities were down across the board, followed closely by bonds, while rates did just the opposite. What is puzzling is that while we might have inflation not receding anymore (or not receding as forecasted/hoped), there wasn’t any single incremental data to justify such an upshoot in rates, which is leaving even Governor Powell short of answers. He has at the very least acknowledged the massive tightening in financial conditions, and conceded that, as a result, the Fed might have to raise rates less than forecasted. Anyway, massive risk-off week across many asset classes; rates did reach a new summit but I’m not going to call this a capitulation yet – I fear there’s more to come. At the moment – and this is going to be a long and painful exercise, I fear – the market has to become confident that inflation is at least stabilizing, and stop sending rates on haywire. As mentioned before, risks abound – James Bullard, former CEO of the St. Louis Fed, reminded markets on Friday that the biggest tail risk is inflation not receding, forcing the Fed to increase rates to as much as 6% or 6.5%. In short, higher rates are here to stay; and breaking the long-term declining trend of yields in interest rates on the 10-year treasury will lead almost certainly to an overshoot. This additional conflict seems to be manageable by the markets (any loss of life is much regrettable), provided it does not escalate to another important regional player like Iran, which would be a game-changer. Should that happen, turn to commodities, USD, and CHF (but watch out for gold’s triple top) as safe havens. If a full-scale war does develop we really should brace for (much) higher rates, due to a likely massive spike in oil and imported inflation. Data will be key in driving the Federal Reserve going forward, but many well-respected market pundits such as Mohamed El Erian are questioning that view, as under the current environment talking about 6% (or more!) is no longer taboo. The market is definitely not sold on Fed cuts and fears we have yet to touch the summit in rates.
* The immense confusion turned to immense pain once again; and ok, value did a little better, but it wasn’t enough to stop the powerful slide and to send the Dow Jones to a negative performance YTD. Earnings have started to come in, and so far they have mostly failed to impress or be a game changer; but as we are on a roll, the next few weeks will be also very important. I feel like something is amiss – the Atlanta Fed GDPNow (more on that later) is being reviewed higher and higher, even dragging the Blue Chips consensus up, and all we get from earnings is an estimate for 3Q23 of -0.4%? Something absolutely has got to give. Interest rates will continue to be in the driving seat for at least the next 6 months, and everything else will reflect that. Therefore the current recommendation is to be very prudent on both equities and bonds and prefer cash, the USD, the CHF, and commodities. Don’t put all eggs in one basket, but reinvest periodically at higher rates which are likely to be available in the near to mid-term future. This is not meant to chase yields – if you have any liquidity, be disciplined and put at least half on the money market; with the rest you can reinvest at the higher yields available, bearing in mind that while the ride is going to be a rollercoaster, if the issue doesn’t default these will be always reimbursed at par on expiry.
* Once again markets are licking their deeper and deeper 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 are just about to find the second, and I just wonder – will it be enough to satisfy the needs of an uber-anxious market? There is a total consensus (99.9%!), according to the CME FedWatch tool, for the Fed to stay on hold in November, but the real question is what lies down the road. Let’s have a look: a hike in December has gone down to 24.1%, rising to 30.8% in January, while starting from March we should be back in the current 525-550% range, with even a small chance of a cut. The first cut – with a 64.9% chance – has been brought forward to June. Looking at these numbers, and at the shock in rates, one could argue that the Fed is effectively on hold and has reached the top in rates and the next move will be down not up – I just wonder if will it be possible? I fear this latest development in geopolitics means that rates will have to go up before they come down. Unfortunately, wars can last for years, as we have seen with Russia/Ukraine. There is more to tell – the inverted US yield curve has recently seen a strong steepening, which is a predictor of a recession. Check out this great chart from Charlie Bilello.
Source: Creative Planning/Charlie Bilello
* I also believe that this increases the risk of a hard landing for the US economy, choked by the powerful double whammy of higher rates, and higher crude prices. The US is close to energy self-sufficiency; that is not true for Europe, whose lower rates might do little to absorb the shock of higher energy prices and higher inflation. 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. There are limits, though, and nothing is possibly worse than higher interest rates, which even Governor Powell has acknowledged operate with a lag. At the moment it seems all steam ahead, with the Atlanta Fed’s GDPNow model forecasting 3Q23 growth of 5.4%, up 0.3% from last week, with the Blue Chip consensus now well beyond 3%. The New York Fed Nowcast, which produces an annual forecast, sees annual growth at 2.55%, plus 0.05% from last week, and up from 2% in May. Even more interestingly, there is no recession forecast in their model, up to one sigma (and it was there in May). O Earnings, where art though? Watch out, with a -0.4% growth now expected in 3Q23, compared with an estimate of -0.3% as of Sep 30th. If confirmed it would be the fourth straight quarter of yearly earnings decline, since 3Q22. Revenue growth is faring a little better, at 1.9% in 3Q23, vs 1.6% as of Sep 30th, stable from last week.
Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts; Federal Reserve Bank of Atlanta
Source: Federal Reserve Bank of New York; New York Fed Staff Nowcast
* Earnings are finally here – likely to meet/exceed estimates but watch out for the guidance. The current bottom-up estimate of $220.20 matches with the following forecasts: $224 from Goldman Sachs, $205 from J.P. Morgan, $200 from Bank of America, and $ 185 from Morgan Stanley, and has seen a strong decline last week. However, geopolitics is likely to obscure everything for a while. Hang tight!
Earnings, What’s Next?
This is it – the first of the massive weekly reports. Truly a make-or-break moment. Here’s a list of companies reporting this week. Highlights include Microsoft (Tuesday, After Close), Alphabet (Tuesday, After Close), Meta Platforms (Wednesday, After Close), Amazon (Thursday, After Close), to quote just the very top of the list, with many more great reports to follow (such as Visa, Texas Instruments, IBM, and Intel).
Source: Earnings Whispers
Revenue growth estimates for 2024 are forecasted to grow by 5.6% (5.6% on Sep 30th) and earnings growth estimates for 2024 are predicted to grow by 12.2% (12.2% on Sep 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 month, often characterized by extreme volatility, so my optimism is somehow tempered here. I also wish we didn’t have to deal with another war. We need to see whether this will be left to Israel and the Palestinians or whether it will include anyone else (Iran).
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. I participated in an online survey that saw more market pundits believing that the 10-year treasuries would be below 5% by the end of the year. I am not so sanguine (was in the > 5% camp), but this is definitely an outcome which I would love to see.
So for the S&P 500, the Feb 2 peak held its own last week. As long as the index stays above 4179.76 then the downside should be relatively limited. The Nasdaq 100’s Feb 2 peak is a bit further down (12,803.14) and, barring a major escalation in the conflict, or lousy earnings, should hold. My advice is to stay out of the equities market until we have greater clarity on where the rates are headed.
Regarding bonds, the expected disinflation in 2H23 might well not materialize, given an expected spike in the price of crude. The Brent may well go to $100 per barrel soon – it all depends on how the geopolitics scenario will unfold. Once again, until we have more clarity on any peaceful resolution of the conflict between Israel and Hamas, I advise staying on the sidelines and investing any liquidity in the money market (up to 1 year).
Cash (money market funds), USD, CHF, and commodities are a few of the asset classes that make sense now. Japanese equities might well be more defensively positioned, but they are facing an increase in rates as 10-year JGBs at 0.80% are currently on their way to the upper band set by the BOJ (1%). Before the great fall to negative rates, 10-year JGBs were yielding 2%, and it might well be that it is there that they are heading. Watch out for the JPY as it may slide further as the world becomes once again centered on the USD. Still, they might be the more investable part of equities right now, thanks to good economic performance (GDP above estimates) and a still dovish Central Bank. The BOJ might decide to drop its Yield Curve Control before the end of the year, leaving room for rates to increase and stop the decline of the JPY. It is still the safest part of equities, but I’d hold off from deploying any capital until the rates mayhem hasn’t settled.
Happy trading and see you next week!
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