(Please note that the next weekly review will be published on January 10th, 2023. We extend once again our warmest wishes for the holidays and the new year).
The worst year since the 1970s for investment portfolios is finally coming to an end. Judging from the price action of the last two weeks, it looks like it will not be a happy end, despite the November rally. Equities fell again, with both the US and Europe moving lower by about 3% during the week. The S&P500 is already down more than 5% since its recent peak, while Nasdaq's correction approaches more than 8%. But, we might finally start seeing the light at the end of the tunnel. After a few months of further volatility in financial markets in early 2023, we should expect finally bonds to start offering very good returns to investors and equities should find their bottoms and the next bull market will begin. Staying the course guarantees that investors do not miss out the eventual rebound, which is usually strong after such a dismal year.
The US inflation numbers continued to show a slowdown. Headline CPI inflation moved down to 7.1% in November, which marks the fifth consecutive month of slowing inflation from the 9.1% peak in June. The monthly increase was just 0.10%, which is almost half of the 0.20% average monthly increase of the last 4 months. If we were to have such low increases of monthly inflation in the coming months, we have calculated that CPI will fall close to 2.5% even before the summer of next year. The Core CPI increased by 0.20% in November , which was well below the 0.5% average pace over the prior twelve months and below the 0.27% increase in October. The annual core CPI inflation moved down to 6.0% from 6.3% in October and a peak of 6.6% in September. All in all it was a report which showed that inflation is moving in the right direction, albeit still at an uncomfortable slow pace.
A few more words on inflation: There are two parts in the inflation calculation: goods and services. The prices of goods have been declining for several months now thanks to lower demand, better supply chain flows and lower energy costs. But services inflation has been very sticky and is a key driver of "higher for longer" Fed rate policy. However housing, which is part of services, now seems to be moving in the right direction. Zillow (an online broker) said on Wednesday that asking rents declined 0.4% m/m in November, the largest sequential decline in seven-year history of the Zillow Observed Rent Index. Lennar, a major homebuilder, also said that net order ASPs (asking selling price) fell 10% sequentially in fiscal Q4. The company also guided for next quarter that ASPs will fall another 5%. Rents and wages's inflation will eventually slow down in the coming months as annual comparisons will be calculated with the already high figures of 2022.
The FED delivered the expected 50bps rate hike. The decision was very well telegraphed in the previous few weeks, after various talks by FED officials and the publication of the last meeting's minutes. The rate now stands at 4.50% and all attention is drawn to what the terminal rate will be some time in 2023. The FED officials raised their forecast to about 5.10%. However, the pace of rate increases will most probably slow down to the "traditional" 25bps, which are expected for the February and March Meeting at least. By that time we will have a much clearer picture on how the economy is faring and whether unemployment has moved higher to the desired levels of about 4.5%, from 3.7% currently.
The ECB put on its hawk costume again, as it hiked its key interest rates by 50bps, bringing the deposit rate to 2.0%. But what spooked the market was the guidance on the future path of interest rates, which was rather hawkish. It added the phrase that "interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target", a phrase which was later emphasized and repeated by Mrs. Lagarde at the press conference. The ECB also announced that it will start quantitative tightening (QT), ie reducing its balance sheet, at the beginning of March 2023, with a "measured and predictable pace", allowing the Eurosystem balance sheet to decline by €15 billion per month on average until the end of Q2 2023. Overall, this was a hawkish meeting, with the message being that the central bank does not worry about economic growth yet, but is rather laser-focused on inflation. According to Bloomberg, more than one third of Governing Council members argued for a 75bp rate hike and most probably the very hawkish guidance and presence of Mrs. Lagarde in the press conference might have been essential to achieve a compromise in favour of 50bps. Admittedly, Eurozone inflation has just had its first month of decline, while in the US we are already a lot lower than the peak of June. But it is also fair to say that the Eurozone economy and the fiscal situation of the periphery countries (Italy, Spain, Greece) cannot really tolerate much higher interest rates than the current ones. If we were to escape with a slowdown, now a rather deeper recession looks like the most probable scenario, which is a actually the goal of the ECB, as it seems. On a separate note, the Bank of England and the Swiss National Bank also raised interest rates by 50bps to 3.50% and 1.00% respectively.
The preliminary December Eurozone PMIs painted a better than feared picture. Manufacturing rose to 47.8 from 47.1 in November and better than expected (47) and Services rose to 49.1 from 48.5 previously. Digging into the details manufacturing was stronger in France and Germany while Services in Germany rose by a whopping 3 points to 49 from 46. Overall they all remained below 50, which signals that a recession could be in the cards in the following months. Were the PMIs to move comfortably above 50, one could say that we have escaped this possibility.
The US PMI numbers moved significantly lower in December. Manufacturing PMI was down 1.5 points at 46.2 and at a three year low. New orders saw one of the sharpest declines since the financial crisis in 2009, but prices rose by the slowest pace since July 2020. The Services PMI fell 1.8 points to 44.4, the lowest in four months, dragged lower by further decline in new orders. All in all a new set of disappointing data, laying the ground for a recession coming in the next months.
US November Retail Sales also fell much more than expected. They were announced with a 0.6% decline vs expectations for a drop of 0.1%, and one should also consider that this drop is actually larger if we take out the help by the 0.1% consumer prices increase in the same month.
The bond markets were mixed. The ECB meeting made the bond market reprice up the whole yield curve by 25-30bps, as the market now fears that the central bank might not stop at about 3%, but could push it higher by another 0.25%. Hence, the yield of the German 10-year bond rose to 2.20% from 1.90%. However, the US bond market was rather stable, as the guidance is now much clearer and the recent macroeconomic data continue to show a deterioration that could lead to a recession. The US 10-year remained stable at around 3.50%.
The EURUSD continued its upward trend, but closed lower than its high of the week. The common currency reached a high of 1.0750 right after the press conference of Mrs. Lagarde only to be sold by investors again and return to 1.0650. Still, this is the highest level since early June of this year and represents a 10% increase from its low in September.
Positive news on Chinese companies listed in the US, as regulators said that they had finally been allowed to inspect the work of auditors in China for the first time ever. The announcement represents a significant breakthrough after a more than a decade-long stand-off between China and the US. US legislation bans trading in stocks whose auditors cannot be inspected by the Public Company Accounting Oversight Board and hence companies like Alibaba faced the risk to be delisted in 2024. But at last, the auditing work has finally started on Hong Kong territory and this should benefit the shares of these specific companies as well as Chinese equities more broadly.
Volkswagen shareholders approved the distribution of a special dividend, from the cash that the company received from the Porsche IPO. The special dividend is 19.06 EUR per share, which represents 14% on Friday's price . Shares will be trading today ex-dividend.
Chart of the Week :
It is easy to see what comes next, after the peak in interest rates.
The chart shows the FED's interest rates for the last 20 years. We see that the current cycle of interest rate increases is the fastest and sharpest in the last 20 years, having reached 4.5% in just a few months since being at zero still in March of this year. What history and economics of course are telling us is that such aggressive rate hike campaigns usually end up choking the economy, driving it into a recession. Then the FED intervenes and cuts rates quite aggressively. Even if a recession does not immediately occurs as was the case in 2018/2019, the FED had already started cutting rates well before Covid19 finally gave a big blow to the economy, which was already slowing down signficantly. Of course this time we have the inflation issue that haunts us and the sharp rate cutting of the previous two episodes might not be what one should expect. But for sure, after the peak in interest rates which should be close to 5%, the market will very quickly start dicsounting that interest rate will start to move lower at the end of 2023 and primarily in 2024. If we get a similar to 2008 or 2020 case of aggressive rate cuts, bonds will generate significant total returns to investors from current levels, making 2022 look like the best opportunity in a decade.
• 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.
• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.
• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.
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• Sources: Chart of the Week : KSH, Facset