Bonds and equities are finally starting to move independent of each other. In this horrible year, bonds and equities have fallen 10%-20%, leaving investors' portfolios totally unprotected and with no place to hide. Actually, the main reason behind the equities' significant drop was the dramatic rise in interest rates which mathematically brings down the prices of bonds causing capital losses, no matter if they are issued by very high quality companies or solid companies. So far this year, when bond prices were falling (yields moving higher) they were bringing down equities with them. And the inverse was holding true. Every time bonds rallied (and yields fell), equities rallied together.
But this week things finally appear to have changed. As the main scenario for next year is starting to be recessions in the EU and US, bonds moved higher in price. And at the same time, equities, especially in the US, were correcting lower, as recessions affect the earnings of the companies. High quality bonds should, at last, start offering protection against lower equity prices, which is the normal outcome of a recession. Bonds should be able to offer very good returns to investors in 2023, with positive equities being the "cherry on the pie".
Equities moved lower, especially in the US. The S&P500 and Nasdaq fell 3-4% on average, with all sectors finishing the week on a negative note, but Energy performing the worst with more than 6% losses. Europe did much better with 1% drops for its major indices while China was the best performer with a 3% rise, thanks to the news about Covid19 restrictions and the support offered to real estate developers.
A major week lies ahead in terms of central bank meetings : The FED, the ECB, the Bank of England and the Swiss National Bank are all meeting to decide the next interest rate increases.
The FED is going first on Wednesday and the market expects a 50bps increase, to bring the rate to 4.50% instead of the 75bps hikes of the last meetings, as also signalled by the latest minutes and J. Powell himself. Of course we (and the FED) will have the chance to see the November inflation numbers just one day ahead and things could change. Equally important is the fact the FED will publish an update on where its members see the terminal rate of this cycle, which the markets expects to move higher to 5.10%.
The following day, on Thursday, the ECB is probably going to deliver a 50bps increase after two consecutive 75bps, to bring the depo rate to 2.00%. There are voices within the governing council to hike again by 75bps, but for now this looks like a distant probability. The Bank of England is meeting on the same day and is also expected to raise interest rates by 50bps to 3.50%. The Swiss National Bank is also meeting on Thursday and is expected to raise rates by 50bps to 1%, although a smaller increase of 25bps cannot be ruled out. Switzerland does not have the inflation issues of the rest of Europe, but rather it is raising rates as a precautionary measure and to be in-line with its European peers.
China continued to dominate the news, as more relexations of Covid19 restrictions were announced, including Hong Kong's decision to reduce quarantine times and make travelling to the country a little more easier. It is now becoming clear that China is quickly adopting the West's 2021 decision to simply start living with the virus, accepting a wider spread of the disease and tolerating a higher number of hospitalizations and deaths. There was also an announcement by the Politburo, the governing council, which said that their primary focus is now the economy and that forceful stimulus is probably needed to jump-start the economy. All these developments show that China's Xi Jiping has chosen the path of common sense and pragmatism, rather than a return to a hardcore communist path, which many analysts and market participants had erroneously forecasted. The 2023 outlook for chinese financial markets looks brighter.
China also announced the CPI (inflation) for November, at just 1.6% on annual basis. This came in as expected, but it is worth mentioning that it still represents a big fall from the 2.1% figure in October. The very low inflation gives the local central bank plenty of room to stimulate the economy by increasing liquidity in the system, at a time when most western central banks are removing liquidity from their economies in order to drive demand down and ultimately cause mini (or larger) recessions. Equally important was the announcement of the PPI, which is the producer price index, and showed another fall on a an annual basis. It was announced at -1.3%, as was the case in October.
In the US, the PPI was announced slightly worse than expected on a monthly basis. In particular it rose by 0.3% for the month of November vs expectations for 0.2%, bringing the annual change to 7.4%. The Core PPI rose by 0.4% vs expectations for 0.2% and the annual change came in at 6.2% vs expectations for 5.9%. However, both annual numbers showed a significant deceleration from the October readings strengthening our hypothesis for peak inflation in the producer and consumer space.
The US Inflation data for November are due on Tuesday. The consensus among economists is for a monthly rise of 0.40% , same as in October, which will bring the annual inflation down to 7.3% from 7.7%. We mention again, as last time, the possibility of a much bigger annual fall in inflation if the monthly increase is lower than 0.40%. According to our estimations if the monthly change is below 0.2%, then the annual inflation will approach 7% which would be a major development. Similarly, the Core CPI is expected to drop to 6.1%, with the possibility of dropping below the 6% handle , if the monthly change is closer to 0.20% than the 0.3% expected. All in all, this report should most probably endorse further the argument that inflation has peaked.
Oil prices collapsed to the lowest level since January. As mentioned a few times already, oil prices usually do not do well during recessions, which is becoming the consensus scenario for next year. Of course prices will be volatile depending on the war in Ukraine as well as the weather in winter, but overall it is very hard to envision prices reaching again the 100$ hadle any time soon. WTI closed the week at 71.5$. If oil stays in the 70-85 range for the first quarter of 2023, it will have a significant negative effect on inflation, finally.
More companies in the US are announcing a reduction in their personnel headcount. The trend of announcing layoffs has spilled from the Technology sector to almost all others. Pepsico, which belongs in the defensive sector of Food & Beverage, is going to fire hundreds of employees in corporate positions. Also Morgan Stanley announced a 2% reduction of its workforce, the last time it had laid off people being in 2019. It is becoming clear that unemployment is set to rise in the coming months, which is actually the target of the FED, in order to ensure that inflation comes down and stays lower than today.
Chart of the Week :
Has a sustainable fall of the USD started ?
The chart shows the path of the USD Index for the last two years. The Dollar Index is a basket of currencies against the USD, and the biggest weight is carried by the EUR with almost 50%. The GBP, the JPY, the CHF and the Swedish Kroner are also used for the calculation of the index. The USD is almost 10% down from its high at the end of October and it has started trading around its 200-day moving average, which is the green line. It is very difficult to forecast its next move, but we can say that the USD remains overvalued by most macroeconomic metrics. An acceleration of the downward move would be caused by various factors including a potential stop by the FED of interest rate increases, a possible cease-fire in Ukraine or a continuation of the recent trend of European equity markets performing better than their US peers. The recent meetings between the Middle East and China for closer cooperation including transactions in remnibi could spark a further exodus out of the dollar in 2023 and beyond.
Disclaimer
• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.
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• Sources: Chart of the Week : KSH, Facset