All asset classes fell again after the US inflation data. The sell-off in equities was rather global, but the US equities were the under-performer as they dropped by almost 5%. Europe managed to perform slightly better with 2-3% losses on average, same as the Asian markets. In terms of sectors, Technology was the worst performer, down about 5% with Energy, Financials and Healthcare posting much smaller losses of about 1.5%. The S&P500 is fast approaching its previous low of about 3650, making our fear/prediction for a bad September (unfortunately) accurate.
But, could this week mark the bottom, at least for now ? The low of the year, for the S&P500, was registered on June 16th, one day after the June 15th FED meeting. Back then, the market was selling off precipitously in anticipation of an aggressive FED, which finally delivered the 75bps hike that the market was afraid of at the beginning of June. A similar action was observed, to a much lesser extent, after the July 27th FED meeting, as the market was correcting for a few days before the meeting, only to recover significanltly right after and until mid-August. The meeting on Wednesday could provide again a short-term bottom for US equities, although from a calendar point of view, October is usually the month for bottoms.
The US inflation data did not show the expected improvement. In particular, the annual rate of increase came in at 8.3% vs expectations for 8.1%. However, on a positive side, it was still lower than the 8.5% registered in July, in a sign that we might have seen the peak annual inflation. But as we mentioned in our previous weekly report, the most important number for markets was the Core CPI, which excludes food and energy. The Core CPI rose by 6.3%, vs expectations for 6.1%, and showed a further increase vs July (5.9%). Overall, it was not a report so bad that it should have triggered such a market response. The problem is that speculative/fast money was bidding up stock prices ahead of the report in order to gain from a potential further rally and these positions were then cut aggressively.
The bond market sold-off after the CPI report. The 2-year US government bond yield rose all the way to 3.90%, up from 3.50% last week, while the market anticipates now a terminal rate of about 4.3%, up from 4.20% in June and much higher than a few weeks ago, when markets had started pricing a slower FED. Interestingly, the longer duration bonds fared rather well, with the 10-year yield rising "only" 15bps to about 3.45%. This behavior probably shows that the market is slowly starting to price again a recession next year, which will cause longer-term yields to fall (prices of these bonds to rise).
The rest of the macro-economic data in the US were actually positive. Initial jobless claims, Retail Sales, Michigan Consumer Sentiment index and the Empire State Index showed resilience in the US economy, a fact which, however, makes the bond market even more nervous. At this stage, the market takes the good news as bad news, as it means that the FED will keep raising rates until it sees the first major cracka in the economy, which will naturally cause consumer prices to cool down.
Gold fell to the lowest level of the last two years, at 1670$, as short-term interest rates rose. The move down is impressive if one considers that the USD actually weakened this week, albeit only slightly. Once again, the yellow metal has failed to offer any kind of sustainable protection either for equity market turmoil or for what is well known for : inflation.
In corporate news, Fedex shocked the market which its quarterly results. The company announced profits which were about 30% lower than expected, due to high costs but also lower revenues. Shares fell by almost 20%, to the lowest since the summer of 2020. These news sent shares of Deutsche Post (DHL) shares also down sharply by about 5% on Friday, but making them even more attractive on a 12-18 month than before. Volkswagen priced its Porsche IPO in a valuation range of 70-75bn EUR. VW shareholders are expected to receive a special dividend of about 12% (at current prices) when the transaction is completed. Porsche is expected to be listed at the end of this month.
Chart of the Week :
Maybe it is time to invest in the longer end of the bond market
This is the chart of the various yields (interest rates) of the US Government bond market, or in other words the "yield curve". Each dot on the chart represents the interest rate for a specific maturity (duration) of the corresponding bond, starting from just 1 month on the far-left side to more than 30 years at the far-right. We can see that for the bonds maturing in 6 months and for the ones maturing in 5 years, the interest rate the investor will earn is about the same, 3.7%. The normal question that comes to the mind of the average person would be why should I invest for 5 years where I can get the same interest for just 6 months. The answer is quite simple and has to do with , what we call, re-investment risk. When the investor decides to buy the 5-year bond at 3.70% annual return, he locks this return for the next 5 years. The investor who choses to invest for just 6 months takes the risk that maybe then interest rates might have fallen and he will reinvest at a lower rate. Especially if we have entered a recession if he wishes to invest then for the next 5 years, the interest rate might have fallen significantly, as the market will have started discounting the next cycle of the FED reducing rates. The time has come to consider investing in longer-term but high quality, rather safe bonds, locking-in very good returns for the next 5 years.
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• Sources: Chart of the Week : Factset