The "peak hawkisness" theme, which we explained last week, gained further ground, among the investment community. Inflation data gave the markets a reason to cheer and this rally was rather expected and could have been traded (please see our Weekly Review of July, 8 titled : "Summers are meant to be good"). Equities rallied to the highest level since early May, driven primarily by two factors: a) the return of the retail investor, who started speculating again at the lowest quality stocks, just as in 2020 and in early 2021 (...lessons not learned) and b) hedge funds had built record short-selling positions (i.e. betting on further fall) in equities. These are now starting to be painful for them and they have to buy back the stocks. And this short-covering, as it is called, to close the short positions could lead the markets even higher in the short-term.
The FED is unlikely to slow down in September or October, given the information and data that what we have now. One should pause and consider again the fundamentals, before making any hasty decisions to chase the markets higher. The main questions to ask are: why has inflation peaked ? why is oil and other commodities down almost 30% from their recent highs ? but why we are still at 8.5% inflation with commodities having lost 1/3 of their value in one month. The answers are quite simple: demand is already coming down for goods (ie. commodities sell-off), as most companies have already stated in their recent announcements. But demand for services (travel & leisure etc) is high and wages keep moving higher, as well as rents and other items. Hence either a recession is in front of us (due to demand destruction) or inflation will stay very high as the services sectors are still hot. Both scenarios are not optimal for risk and one should be careful not to get overexcited (yet). We always prefer to buy more aggressively on severe fear and weakness, as in June.
So, the US inflation numbers for July were announced better than expected. In particular, the CPI (consumers price index) rose by an annualized 8.5%, vs expectations for 8.7% and "much" lower than the 9.1% figure of June, which is now considered the peak. The Core CPI, which excludes food and energy, rose by 5.9% vs expectations for 6.1% and exactly in line with the June figure. The July US PPI index (producers price index) was also announced much better than expected. It actually fell by 0.5% on a monthly basis vs. expectations for a rise of 0.3% and the Core PPI (ex food and energy) rose by 0.2% on a monthly basis vs a an expected rise of 0.4%. Following the announcement of the data, some of the FED voting members were quick to publish their opinions. Mr. Evans said that he remains of the view that interest rates should reach 4% and Mr. Kashkari repeated his strong will to raise rates to 4.4% by the end of 2023.
China's CPI for July was also slightly better than expected. It rose by 2.7% on an annual basis vs. expectations for 2.9%, but a little higher than the previous month (2.5%). Still, it remains significantly lower than any other major economy.
The USD weakened significantly against most currencies, in another sign that the market wants to position for a FED slowdown. After touching parity with the EUR , the USD traded as low as 1.0350, while the move has been even more dramatic vs the japanese yen (lower usd, higher jpy by about 5%) since mid-July. (see also below, the chart of the week).
But government bond yields actually rose (prices fell), after the announcement of the inflation numbers. However, one has to take into account that longer-term bonds were rallying since the lows of June and had already started discounting the fact that the FED will eventually stop in 2023 and might start reducing rates, as a recession was becoming more likely. The good inflation numbers was an excuse for investors to lock-in profits. The 10-year US bond rose to 2.90%, while the 2-year yield fell 10bps only to rise back close to 3.25% at the end ol the week. The German 10-year yield rose to reach almost 1& again. The fact that bond yields rose after such "good" inflation numbers, could mean that the bornd market is having some doubts about the theme of "peak hawkishness- FED slowdown".
Major semiconductor companies such as Nvidia and Micron Technology warned for lower revenues for the quarter and potentially the next one. The dramatic buildup of chip inventories due to supply being finally much greater than demand had led prices to fall significantly hurting both revenues and earnings of almost all companies in the sector. The semiconductor industry has traditionally been very cyclical in nature, ie very sensitive to the economic cycle. To have all semiconductor companies warn for significantly lower demand is definitely another sign of the tough quarters ahead, in terms of economic activity and a potential recession.
With the Q2 reporting season almost over, the S&P500 companies beat estimates both on revenues and profits on average. On the revenue side the announcements were better by about 4% while on profits the beat was slightly higher at 5%. This is positive news, as one of the most important factors for equity price development is the actual results of the companies. On a more negative side, expectations had already been lowered ahead of the results, meaning that the companies had a lower bar to overpass. The critical period will be the second half of the year and the guidance of the companies for 2023, for which the expectations are still very high. An earnings downgrade is yet to come.
Chart of the Week
The Japanese Yen: A "once in a decade" opportunity ?
This is the chart of the USDJPY, or in simple English the value of the US dollar against the Japanese Yen (JPY), for the last 20 years. When the line is high in the chart the dollar is very strong, and when the line falls it means that the yen is strengthening. One has to go back in late 1990s to find the japanese currency cheaper than today, when the USDJPY was trading closer to 150 (now at 133). The reason for the rally in the dollar (fall in yen) is the very big differential in interest rates since the beginning of the year, as the FED has begun its campaign for higher rates, while the BoJ has kept its policy of zero rates intact. We are by no means forecasters of foreign exchange moves. However, we have to look at two facts. One is that we are probably towards the end of this big interest rate differential, as the market has already priced in the FED's expected hikes and it will take a very serious, new rise in inflation to make the FED move significantly higher than the current market pricing. The second fact, the historical one, is that throughout the last decades the japanese currency was the best insurance protection for equity market turmoil. If one looks at the left side of the chart between 2007 and 2011, in the middle of the Lehman brothers and the Eurozone crisis, the JPY rallied by more than 35%. And then again in 2015 and the turmoil in China as well the equity correction of 2018 and 2020 the yen offered protection. Could current levels be a "once in a decade opportunity" to buy it and profit from its move towards the levels of 105-115$ again (15-20% return) ? History will tell.
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• Sources: Equity performace: Factshet, Chart of the Week : Factset