China's 20th Communist Party Congress started yesterday. The congress is not just a process that will further cement Xi's political dominance. It can tell us quite a lot more about where China is headed in the next decade. One of the most consequential decisions will be the choice of the country's next premier, as Premier Li Keqiang is planned to step down next March. According to various reports, Mr. Wang Yang, 67, an incumbent Politburo Standing Committee member who previously served as vice premier and party chief of Guangdong province, could be the next premier. Although not trained as a technocrat, Wang gained a reputation as an economic reformer in the early 1990s and rose quickly through CCP ranks and looks to be the most friendly choice for financial markets. The party may also choose to replace the heads of the People's Bank of China, the China Banking Regulatory Commission and other key economic agencies. Investors obviously hope that such positions will be filled by experienced technocrats or politicians seen as capable of addressing China's current economic challenges.
The UK did not avoid the spotlight again. On Friday, Prime Minister, Mrs Truss, sacked Kwasi Kwarteng and appointed as Chancellor Mr. Jeremy Hunt, the former health and foreign secretary and who is considered to be on the "left" side of the conservative party. The move comes as Mr Kwarteng's mini-budget almost brought down the UK financial system two weeks ago. At the same she announced that the planned increase of 18bn in corporate taxes in 2023 is finally going to happen, despite the rumors that she would scrap it. In a less than 10 minutes interview, Mrs Truss managed to make bond yields shoot up, equities to slump and the turmoil to spill over to Wall Street and the US bond market. Betting companies give her another 1-2 weeks at the job, maximum. The new Chancellor will make announcements today with regard to measures that would strengthen the fiscal position of the country (more taxes basically) and eventually calm the markets.
Eurozone equities managed to post decent gains, despite the weakness in the UK and US. Germany, which is trading at just 10 times foward earnings, closed the week 1.3% higher alongside with France with a 1% gain. Nasdaq was the worst performer with a 3% drop, while the UK market lost 2%. In terms of sectors, Healthcare and Consumer Staples moved higher by 0.5%, with Technology losing 4% at the same time. As mentioned before, we seem to be in a bottoming process among various asset classes, and October is traditionally such a month.
The September US inflation numbers were rather mixed. The headline CPI rose by 8.2% on an annual basis, a little worse than expected but remained lower than the August figure (8.3%). This marks the third consecutive month of the annual growth of inflation trending down. However, the Core CPI which excludes food and energy, rose to a new high of 6.6%, slightly worse than expected (6.5%). Digging into the details, one can see that the prices of consumer goods have started to moderate and move lower in some cases (used cars, apparel) but the prices of consumer services continued to move higher, such as rents and transportation. According to our calculations, rents contributed more than 60% of the monthly increase in the headline inflation number, as they account for about 30% of the CPI index. Given the troubles of the housing market, one should expect to find some relief on this front in the next 6-9 months.
The FED minutes of the last meeting were published on Wednesday. The main message out of the minutes was not something new, as these just repeated the desire of the FED officials to move interest rates to restrictive territory and maintain them there for a considerable amount of time. However, for the first time in this cycle there were voices who called for a potential slowdown of the interest rate increases, based on fears for a significant impact on the economy. In particular according to the text, "Participants observed that, as the stance of monetary policy tightened further, it would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation.... Several participants noted that, particularly in the current highly uncertain global economic and financial environment, it would be important to calibrate the pace of further policy tightening with the aim of mitigating the risk of significant adverse effects on the economic outlook." Our thesis for a peak-hawkishness scenario in the last months of this year gained some points after this. We should see FED officials starting to hint that the terminal rate of this rate cycle will be in the 4.5-5.0% range, which is what the market has already discounted. As mentioned last week, the peak is near and the lows of the bond market are also probably already registered for now.
US September Retail Sales posted zero growth on a monthly basis, vs expectations for a 0.20% rise and a 0.40% increase in August. As this number is not adjusted for inflation and given that inflation rose by 0.4% in September, the retail sales number is actually even weaker. This is in-line with the recent commentary by of major companies like Walmart, Costco and Target who all saw a large increase in inventories as consumer demand did not meet their expectations. Perhaps another sign of the consumer starting to hold back on purchases is the fact that Amazon launched a second Prime-Day this year (ie a day with significantly marked-down items/sales) for the first time ever in its history. The reduction in prices to get rid of unsold inventory is a clear positive on the inflation front.
Bond markets finished on a negative note, due to the UK's troubles. What the inflation numbers out of the US could not achieve, it was Mrs Truss that did. The fact that on Friday the mini bond-buying program by the Bank of England also ended, gave speculators the perfect excuse on a Friday evening to short bonds and make their yields spike higher. The 10-year US yield rose to 4% and the UK equivalent to 4.5%.
In corporate news, US banks posted very positive 3rd quarter results. Our favorite pick, JPMorgan announced 6% higher than expected revenues, boosted by the increase in interest rates and improved its capital adequacy ratios. Its CEO also said that it could resume the share buybacks in early 2023. At 1.2 price-to-book, 9 times forward earnings and a dividend yield of 3.5% the stock offers enough protection at these levels even for a mild recession. Volkswagen said it would propose to pay a special dividend of 19.06 euros per share from the proceeds of the listing of Porsche. The special dividend is due on Jan. 9, 2023, according to the EGM invite published on Friday. This represents a 15% special dividend on current price. LVMH (Louis Vuitton) posted strong sales for the 3rd quarter, with organic growth of more than 20%. European consumer discretionary, being down in prices by more than 25% this year, and in particularly luxury seem to be at very attractive levels, for long-term investors.
Chart of the Week :
The S&P500 retraced 50% of the previous rally
This is the chart of the S&P500 for the last three years. The recent sell-off stopped at around 3'500, which is considered a significant technical level according to the Fibonacci retracement theory. That level represents the 50% retracement of the whole move of the index from the Covid-19 low in March 2020 to the record high of December 2021. On a short-term basis and given the overall oversold conditions, one should expect that these levels should provide strong support. The catalyst for a more sustainable move higher until the end of the year will be the corporate earnings which are just getting started and most importantly the guidance that companies will offer for next year.
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• Sources: Chart of the Week : Factset