Home runs for both Equities and Bonds last week, with rates now responding to favorable economic data and slowing down. Positive outcomes by the meetings of the Federal Reserve, the Bank of England, and the Bank of Japan. For the bravest of you, it could make sense to deepen a toe in Equities, with a 3% weekly stop loss. Earnings for 3Q23 are coming to an end, and so far they seem to have eaten 4Q23’s lunch; bland growth for 2023 at 0.6%. The biggest tail risk is inflation staying high(er for longer), and triggering an increase in rates as just witnessed in August-September.
Major market events 6th-10th November 2023
Highlights for the week
Mon: JP Services PMI, DE Factory Orders, DE Services PMI, EU Services PMI, UK Construction PMI, JP Household Spending
Tue: CN Trade Balance, AU RBA Interest Rate Decision, DE Industrial Production, EU PPI, US Trade Balance
Wed: DE CPI, US Fed Chairman Powell Speaks
Thu: CN CPI, CN PPI, US Initial Jobless US Fed Chairman Powell Speaks, US Fed’s Balance Sheet
Fri: UK GDP, UK Trade Balance, UK manufacturing Production, CN New Loans
|Euro Stoxx 50||4,014.36||4,174.67||3.99%||8.26%|
* Darkest before dawn: from pitch black to morning lights. We will remember last week – in all likelihood – as the week when the summit was touched and it’s easier on the way down. I am obviously referring to the peak in rates, particularly for the 10-Year Treasuries, whose yields declined by 33 bps, from 4.84% to 4.51%, bolstered by benign data from the ADP, JOLTs, Jobless Claims, and last but not least, Nonfarm Payrolls. Plus there was the Fed, with Chairman Powell acknowledging the higher yields on the long bond and beyond, and mentioning that they were doing the Fed’s job and, consequently, the US Central Bank needed to hike less than foreseen. More importantly, he reported as an open question whether the committee should hike again. The reality is that the Fed is probably on hold and – fingers crossed – the next move is down not up. Equity came back to the party in full swing, registering the best week of 2023 across the board, while the market witnessed another increase in 3Q23 earnings per share. Barring any incremental dramatic move or escalation, the conflict in the Middle East seems to have had a neutral impact on markets. The stabilization in rates had the effect of causing a rally in both bonds and equities and, while some GDP forecasts are being cut, this could be the turning point the market was waiting for.
* Never bet against America is one of Warren Buffet’s preferred quotes. And to be true it really shined last week, recovering all the relative performance lost against Europe the previous week. The Fed confirmed its pause – now on for two quarters in a row – and the BOE followed suit, albeit with Governor Bailey warning that higher rates are here to stay and a cut might only be seen in 2025. Of course, growth came back with a vengeance – and gained vs value, which anyway had a very respectable week. The big question is now if rates and yields are indeed headed lower, or at least can stabilize around current levels. While this is a difficult call, I am inclined to think that yes, it will be so, and therefore changing the current recommendation in equities (for the bravest of you). You can now test the waters once again, while always being mindful of my weekly 3% stop – if it’s triggered, please respect it – we are not quite there. While I am warming up on bonds, I’m not ready to make the same call yet, but I would buy on any meaningful rise toward 5% (for the long bond). Of course, the recent steepening, the strongest since the 1990s, has some calling for a recession – which would be positive for bonds but not for equities. Why the positive bias then? Seasonality plays a part in this, and some market participants believe that the end-of-the-year rally has already started. The positive changes to earnings are encouraging. And even Apple, with no revenue growth, managed to have a decent report as its weakness after hours was more than compensated on Friday.
Source: Game of Trades
* Last week I was speaking of the need for a catalyst and – unlike the legendary Godot – lower rates obliged us with their arrival. We also witnessed a very interesting upgrade to earnings – something I used to track bi-weekly on a company/sector level – but it is clear that the trigger was the beneficial economic data and the violent move in rates (this time down). The current forward P/E ratio for the S&P 500 is 17.8x – and while it is higher than the 10-Year average (17.5x), albeit lower than the 5-Year (18.7x) averages, it is not cheap enough to withstand such high interest rates. (Yes, back in 1999, multiples AND rates were both higher – but that is a past unlikely to return, as earnings for most of the magnificent 7 have disappointed so far). As mentioned before, earnings were strong enough to lift the 3Q23 estimates to positive territory, up to +3.7%, and to increase bottom-up EPS to 221.13. The Fed was on hold as forecasted, and there are interesting changes regarding what lies down the road. Let’s have a look: a hike in December has gone down to 4.6%, rising to 10.3% in January, while starting from March the chances of a cut, 24.1%, are greater than those of a hike, 7.6%. The first cut – with a 71.5% chance – has been brought forward to May 24. 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. And there is more to tell – the inverted US yield curve has recently seen a strong steepening, which predicts a recession.
* The recent fall in rates contributes to lower the risk of a hard landing for the US economy, choked by the powerful double whammy of higher rates, and higher crude prices. Secretary of the Treasury Janet Yellen, a former Fed Chair, said that she sees a healthy slowdown for the US Economy. Still, she does not see it entering a recession (and any discussion about the recession that should have happened this year is now postponed to 2H24, to say the least). Both Atlanta and New York Federal Reserve banks are warning us of moderation in growth coming forward. Looking at 4Q23, the former’s GDPNow model is forecasting growth of 1.2%, down 1.1% from last week, with the Blue Chip consensus below 1%. The latter’s Nowcast, which produces an annual forecast, sees annual growth at 2.47%, minus 0.11% from last week, and up from 2.21% in September. Even more interestingly, there is no recession forecast in their model, up to one sigma. Earnings are expected to come in at 3.7% in 3Q23, compared with an estimate of -0.3% as of Sep 30th, and up 1.0% from last week. If confirmed it would be the first quarter of yearly earnings increase since 3Q22. Revenue growth is faring a little better, at 2.3% in 3Q23, vs 1.6% as of Sep 30th, up 0.2% from last week. This progress, however, seems to have eaten 4Q23 lunch, as 4Q23 earnings are forecasted to grow by 3.9% vs 8.1% as of Sep 30th, and revenue is forecasted to grow by 3.5% vs 3.9% as of Sep 30th. For 2023, earnings growth is forecasted at 0.6%, vs 0.8% as of Sep 30th, with revenues coming in at 2,4%, in line with the forecast as of Sep 30th.
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 overall meet/exceed estimates but watch out for the guidance. The current bottom-up estimate of $221.13 matches with the following forecasts: $224 from Goldman Sachs, $205 from J.P. Morgan, $200 from Bank of America, and $ 185 from Morgan Stanley. However, geopolitics and rates are likely to obscure everything for a while. Hang tight!
Earnings, What’s Next?
The reporting season – with 81% of S&P 500 companies having reported – is now drawing to an end. Here’s a list of companies reporting this week.
Source: Earnings Whispers
Revenue growth estimates for 2024 are forecasted to grow by 5.5% (5.6% on Sep 30th) and earnings growth estimates for 2024 are predicted to grow by 11.9% (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. Now that we are almost past September and October, which have been as horrible as feared, we are entering the last period of the year, which traditionally is more constructive, after making allowances for wars and rates (a big ask!).
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.
The S&P 500 had a dramatic comeback last week – conquering both the Feb 2 support at 4179.76 and the 200 MDA at 4,247.61 and went on to close beyond 4,300 points. 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, did hold. And even though the overall market is without leadership and with even some of the Magnificent 7 having an issue or two, it managed to climb above 15,000 points once again. For the bravest of you, and while respecting the weekly 3% stop loss religiously, it could make sense to deepen a toe (or two) in the equity market. Obviously, watch rates and yields very closely.
Regarding bonds, the expected disinflation in 2H23 might be coming, although more slowly than expected. Once again, until we have more clarity on any peaceful resolution of the conflict between Israel and Hamas, or further progress with rates on the US long bond going < 4.50%. I advise staying on the sidelines and investing any liquidity in the money market (up to 1/2 years).
Regarding the stock markets, Japanese equities might well be more defensively positioned, but they are facing an increase in rates as 10-year JGBs at 0.92% are currently on their way to the upper band indicated 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 small tweak of the BOJ to their Yield Curve Control before the end of the year got rates to increase (the only country within G7 last week) but did not manage, at least for now, to stop the decline of the JPY. It is still the safest part of equities, as long as you hedge the JPY.
Happy trading and see you next week!
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