Positive week for equities and bonds, with rates down after the surprising US CPI. The brave and not-so-brave could now invest in equities (with a 3% weekly stop), and start purchasing some bonds (max 10% of invested capital). Italy’s outlook raised by Moody’s is positive. Short week due to Thanksgiving, but watch out for Nvidia’s results on Tuesday night. The biggest tail risk is inflation staying high(er for longer), and triggering an increase in rates as just witnessed in August-October.
Major market events 20th – 24th November 2023
Highlights for the week
Mon: CN PBOC Loan Prime Rate, DE PPI
Tue: US FOMC Meeting Minutes
Wed: UK Autumn Forecast Statement, US Durable Goods Orders, US Jobless Claims, US Atlanta Fed GDPNow 4Q23
Thu: US Closed – Thanksgiving, SE Interest Rate Decision, UK Composite PMI, JP CPI
Fri: US 1/2 Day (Thanksgiving), JP Services PMI, DE GDP, DE Ifo Business Climate Index, US Services PMI
|Euro Stoxx 50||4,197.36||4,340.77||3.42%||12.57%|
* Here comes the sun, courtesy of a positive surprise from both the US CPI and the US PPI, which came below expectations. Yields were lower across the board, and that benefitted both equities and bonds. It does increasingly look like the Fed is ‘probably’ on hold and might indeed have performed its last hike for this cycle, though we will need further confirmation that the disinflation is indeed taking place and gaining speed. As for Chairman Powell and the Committee, they will have to grow confident that the current level of rates is restrictive enough to bring inflation to 2%. Equity was again the star of the week, with value surprisingly outperforming, and with our old friend the Nasdaq 100, stopping just short of 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. Based on the latest data 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 complex situation, with so many factors to keep track of, growth had a good week, even though it was trumped by a resurging value. Some of the technology bellwethers (Palo Alto Networks) could not live up to the market’s expectations, and there was quite an important warning on consumer spending by Wal-Mart. Furthermore, I have been highlighting small caps vs large caps if we are really facing a disinflation cycle, in the US but also in Europe, where many of these have been absolutely crushed by rising rates. 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. The current recommendation for equities was changed a couple of weeks ago, inviting the bravest of you back into the market; while it might be more prudent to wait for the November employment report, it also might be too late. So it is fine to be long equities (always with the weekly 3% stop!), and you could start putting some monies in bonds as well. Another notable event that happened on Friday after the market’s close was the upgrade on Italy’s outlook by Moody’s, which is very likely to have an impact next week, lowering both yields and the spread with Germany. Finally, we also might have arrived at a peak for the USD (if any of the wars do not escalate further from their current stance). I respectfully disagree with Tom, who thinks that the ECB will cut before the Fed; my take is just the opposite, though it is very important to remark that the yield on the 10-year Treasuries is more important for the markets than what the Fed might do. Both central banks will also be reluctant to cut rates too soon (ECB Head Lagarde has said ‘not in the next 2 quarters’) in order not to lose their credibility; but the bond market might indeed do the job for them. For bonds, don’t put all eggs in one basket, but reinvest periodically at rates available in the near to mid-term future.
* While America is on a roll once again, Europe struck back last week, with some small caps shining particularly. Rates came down across the board – including in Japan – and were greeted by a very solid performance by both equities and bonds. The CME FedWatch Tool now places the first cut in May. 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 around 1.5%. 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, triggering a more constructive stance towards both equities and bonds. 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 Michael J. Kramer – as the weakness in the jobs market is driving a further steepening in yields. On the positive side, this almost certainly would keep the Fed on hold. Finally, a very useful chart from Mohamed El-Erian shows how – post-Covid – the US Economy has been the real driver of global growth.
Source: Bloomberg, Michael J. Kramer
Source: Haver Analytics, Mohamed El-Erian
* So lower rates came back and are hopefully here to stay; last week there was a further move down, but if the deflation continues I anticipate a move towards 4% for the long bond. Earnings for 3Q23 – once estimated at -0.3% – climbed to a remarkable 4.3%, albeit with a small cut to 2023 and 2024 numbers last week. The current forward P/E ratio for the S&P 500 is 18.6x – and while it is higher than the 10-year average (17.6x), albeit lower than the 5-year (18.8x) 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 220.75. Last week’s CPI and PPI have completely changed the likelihood of the Fed’s moves. Let’s have a look: a hike in December and January has gone down to o, with 30% chances of a cut in March, rising to 76% in May.
* 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 2.0%, down 0.1% from last week, with the Blue Chips consensus still below 1%. The latter’s Nowcast, which produces an annual forecast, sees annual growth at 2.45%, down 0.06% 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 4.3% in 3Q23, compared with an estimate of -0.3% as of Sep 30th, and up 0.2% 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 2.4% in 3Q23, vs 1.6% as of Sep 30th. This progress, however, seems to have eaten 4Q23 lunch, as 4Q23 earnings are forecasted to grow by 2.9% 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
* Earnings are finally here – likely to overall meet/exceed estimates but watch out for the guidance. The current bottom-up estimate of $220.75 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 94% of S&P 500 companies having reported – is now drawing to an end, but there is still time for some heavy hitters! Here’s a list of companies reporting this week. Highlights include Zoom (Monday, After Close), and most importantly Nvdia (Tuesday, After Close).
Source: Earnings Whispers
Revenue growth estimates for 2024 are forecasted to grow by 5.4% (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 now even for the not-so-brave, 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 starting buying bonds in waves, keeping the overall duration below 10 years. Obviously, it still makes sense to invest 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 0.76% 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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