Positive week for Equities, with rates slightly up and bonds slightly down. Two hawkish speeches by Governor Powell threw the spanner in the works, but the Fed should indeed be on hold. For the bravest of you, it could make sense to deepen a toe in Equities, with a 3% weekly stop loss. Watch out for this week’s US CPI and PPI carefully. 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 13th – 17th November 2023
Highlights for the week
Mon: CN New Loans, EU Economic Forecasts, US Federal Budget Balance
Tue: UK Unemployment Rate, CH PPI, SP CPI, EU GDP, US CPI, JP GDP
Wed: CN Industrial Production, CN Unemployment Rate, JP Industrial Production, UK CPI, FR CPI, US PPI, JP Trade Balance
Thu: US Philly Fed Manufacturing Index, US Initial Jobless Claims, US Industrial Production, US Capacity Utilization
Fri: UK Retail Sales, EU CPI, US Atlanta Fed GDPNow (4Q23)
|Euro Stoxx 50||4,174.67||4,197.36||0.54%||8.85%|
* Morning lights slowly rising. After the week (30 Oct to 3 Nov) which smashed rates and yields, last week saw a consolidation pattern in the same direction. Yes, yields increased a bit across the board, and there was the infamous Governor Powell’s speech, but that didn’t prevent equities from having a positive week, helped by a turnaround late on Friday in the US. I wrote last week that the Fed was ‘probably’ on hold – and the Chairman, wishing not to be taken for granted by market pundits all over the world, made a rather hawkish speech saying that if the Committee thinks it is opportune to hike, they will not hesitate to do so. The reality is that the Fed is ‘probably’ on hold and – fingers crossed – the next move is down not up. Next week we will have some very important data, such as the US CPI on Tuesday, and the US PPI on Wednesday, which could swing the pendulum either way. Equity did have a solid performance as a whole, with highlights from Japan and our old friend the Nasdaq 100, which is chasing its top of the year at 15,841.35. Barring any incremental dramatic move or escalation, the conflict in the Middle East seems to have had a neutral impact on markets. We have started to witness some moderation in US forecasts which could be beneficial to the disinflation that was long awaited in 2H23, and that – like Godot – could never come. Still, I would like to think that the shift from monetary risk to macro risk, delayed by the surge in yields in late summer, is now underway. That would be definitely bullish for bonds – and it would be quite some news, given how long it has rained.
* In this immense confusion, growth managed to have a decent week, trumping value. Technology continues to do well and shone particularly in Friday’s rebound, but is very sensitive to any further rise in yields. While the recent employment report got me to be more upbeat about the upcoming earnings report, there is no question that interest rates will be in the driving seat for at least the possible 6 months, and everything else will be a reflection of that. Therefore the current recommendation is to be very prudent on both equities and bonds and prefer cash, the USD, and commodities. Don’t put all eggs in one basket, but reinvest periodically at what is likely to be higher rates available in the near to mid-term future.
* So America has definitely resumed its uptrend, which, thanks to its late trading hours (for Europeans), led to an expansion of its spread versus Europe. Of course, the Nasdaq and technology shone again, while value fell – in some cases, like for gold, quite in a significant manner. ECB Chair Christine Lagarde said that the European Central Bank won’t cut rates in the next couple of quarters – and indeed the CME FedWatch Tool places the first cut in June. Personally, I think that the Fed will cut first, followed by the Europeans later. Probably by that time, Japan will have reached a new balance in rates, with the 10-year JGB yielding between 1.5-2%. 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. While the yield curve steepening paused last week, we should be mindful of this powerful chart from Game of Trades – as the steepening in yields seems to be predicting weakness in the labor market. On the positive side, this almost certainly would keep the Fed on hold.
Source: Game of Trades
* So lower rates (hopefully here to stay) came back; last week there was a consolidation, but if the US data is good I anticipate a move closer to 4% than to 5% for the long bond. Earnings for 3Q23 – once estimated at -0.3% – climbed to a remarkable 4.1%, albeit with a small cut to 2023 and 2024 numbers last week. The current forward P/E ratio for the S&P 500 is 18.0x – 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). Bottom-up earnings for 3Q23 are now estimated at 220.74. Obviously, after Governor Powell’s hawkish speeches, the likelihood of a hike has risen a bit. Let’s have a look: a hike in December has gone up to 14.1%, rising to 28.3% in January, while starting from May the chances of a cut, 30.4%, are greater than those of a hike, 17.6%. The first cut – with a 57.0% chance – has been brought forward to Jun 24. Clearly, it was not a good week in rates and Chairman Powell’s speeches added fuel to the fire. I am looking very forward to re-examining the case next week, after the US CPI and PPI.
* So 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. Both Atlanta and New York Federal Reserve Banks are warning us of moderation in growth coming forward; however, some of the data has been unusually volatile lately. Looking at 4Q23, the former’s GDPNow model is forecasting growth of 2.1%, up 0.9% from last week, with the Blue Chips consensus still below 1%. The latter’s Nowcast, which produces an annual forecast, sees annual growth at 2.51%, up 0.04% 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 4.1% in 3Q23, compared with an estimate of -0.3% as of Sep 30th, and up 0.4% 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 2.4% as of Sep 30th. This progress, however, seems to have eaten 4Q23 lunch, as 4Q23 earnings are forecasted to grow by 3.2% vs 8.0% as of Sep 30th, and revenue is forecasted to grow by 3.3% 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 2.3%, vs 2.4% as of Sep 30th. Finally, it’s worth noticing that the chance of a recession, as calculated from the yield curve, according to the Federal Reserve Bank of Cleveland, has now fallen to 55.6%, given the steepening, from a peak of over 78% in April.
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
Source: Federal Reserve Bank of Cleveland, Haver Analytics
* Earnings are finally here – likely to overall meet/exceed estimates but watch out for the guidance. The current bottom-up estimate of $220.74 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 92% 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 11.6% (12.2% on Sep 30th), so the future looks 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 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 peak up their pace.
Both the S&P 500 and the Nasdaq 100 made progress last week; that of the tech-heavy index was remarkable. Both indexes look relatively safe, as long as the S&P 500 is above the Feb 2 support at 4179.76 and the 200 MDA at 4,256.63; the Nasdaq 100’s Feb 2 support is quite a bit further down (12,803.14). 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 and is now chasing the year’s highs. 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 in rates with yields 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 0.86% are currently on their way to the reference indicated by the BOJ (1%). Before the great fall to negative yields, 10-year JGBs were yielding 2%, and it might well be that is there that they are heading. Watch out for the JPY as it may slide further. Still, they might be the more investable part of equities right now, thanks to good economic performance (GDP above estimate) 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, 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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