20 June 2022 - The Swiss National Bank surprises the world


The Swiss National Bank (SNB) announced a surprise rate hike by 50bps, taking the benchmark rate to (a still negative) -0.25%. In our little, peaceful Alpine country, surprises are not frequent but when they happen they are usually impressive. Investors still remember the surprise removal by the SNB of the EURCHF floor of 1.20 back in 2015, which caused chaos in the foreign exchange markets. Coming to today, the SNB chose not to wait for the ECB to move first. Even more surprising is their new stance vs the Swiss franc. They abandoned the phrase that the "CHF is highly valued" and also "threatened" to intervene in the markets in order to avoid a weakening of the currency, as it has happened with the Japanese Yen in the last few months. This has significant implications as the SNB looks prepared to start selling its massive foreign exchange reserves (1 trillion), which had been accumulated all these years when the SNB was trying the exact opposite, in other words to avoid a strengthening of the CHF. The CHF will most probably remain strong and Swiss stocks look increasingly attractive after their recent drop.


The FED meeting seems to have also shocked the markets. The announcement of a 75bps hike instead of 50bps was already "whispered" in the investment community one day before the meeting, as a response to the recent inflation data. However, J. Powell gave the market a clearer view of what is a probable scenario for the next few months: interest rates will have to rise fast, with a further 75bps perhaps next month and 50bps in September. The plan is to reach the 3% level (currently at 1.50-1.75%) by year's end and then assess the situation, with a potential 3.75% the maximum for next year, according to their projections. But again, these levels had already been discounted by the market. What spooked markets is the realization that a recession is probaly coming faster than initially thought and valuations of stocks should have to drop lower. And they did.


Equity markets fell hard for a second week and the S&P500 is now officially in bear market territory, as it trading below the 20% drop level from its record high. In a week of panic there was no place to hide, as even the Swiss stocks posted a drop of 6%, impacted also by the surprise SNB decision. China was again a "safe haven" with weekly gains, against the global negative sentiment. Uncertainty is very high, as one one hand the valuations of major indices such as the S&P500 and the Eurostoxx50 in Europe are already discounting minor recessions and can be seen as attractive. But on the other hand, it is very difficult to estimate the impact on corporate earnings, which are still expected to be growing next year, by 8-10%. A number which now seems almost impossible to achieve.


The ECB organized an emergency meeting to discuss the bond markets in the periphery countries which were getting out of control. Just the announcement of the meeting itself made Italian yields drop by 20bps (prices rallied), as the market remembered, the now famous phrase, "whatever it takes" by, the then ECB President, Mr. Draghi, back in 2012, referring to the bank's resolve to save the Eurozone and the common currency. The meeting did not actually produce any material announcements rather than showcase the bank's willingness to tackle the issue. The market will still wait of course for a detailed plan on how to make sure that Italy, Greece, Spain etc. do not see the yields of their bonds skyrocketing and making again their huge debt-load unsustainable. An announcement of a potential "cap" on these yields, with the ECB's intervention could do the job, at least temporarily, as the markets would probably chose to not test the ECB. Draghi was never tested in 2012, his words were enough.


The Bank of England raised interest rates by 25bps, to 1.25%. The bank chose to move slowly as it has already raised rates four times already and was the first to act many months ago. On the other side of the spectrum, the Bank of Japan maintained its negative interest rates (-0.10%), refusing to join the global "tightening party". At the same time, it made a strong verbal intervention about the JPY weakening further.


US Retail Sales for May dropped by 0.3% vs expectations for an increase by 0.2%. Even more worrisome was the downward revision of the April data by 0.2%. Given the recent announcements by major retail stores (Target, Walmart) of inventories being built up, it is no surprise that retail sales disappointed. We probably have reached the time where the consumer is becoming unwilling to chase prices higher and might moderate his spending, a positive catalyst for inflation, a negative for the economy.


Some good news from the US Producer's inflation index (PPI) in May, as it was announced as expected (+0.8% on a monthly basis) and not higher, as feared. The Core PPI which excludes food and energy prices actually rose by less than expected (0.5% on a monthly basis), showing a potential peak, as was the case with the Core Consumers price index (CPI).


Government bonds at last behaved as they were supposed to. As recession became the buzz word in stock markets, bonds had to rally and yields to fall, as we had repeatedly mentioned in the last two weeks when yields reached very attractive levels to invest. The US 2-year Treasury yield fell by a whopping 45bps, to 3.15% from 3.60%, which translates to about 0.9% rise in price in just two days. The 10-year yield fell to 3.20% from the high of 3.45%. We should be arriving at the point where government bonds and very high quality corporate bonds provide protection against a major recession. For the first half of the year both markets were falling simultaneously and significantly, and this should change.


The USD fell against most currencies, as the market is starting to bet that perhaps most of the FED's tightening is already in the prices of bonds and foreign exchange. The EURUSD closed above 1.0500 after reaching a low of 1.0380 during the week. Gold moved in a tight range, closing the week at around 1840$. Oil prices dropped significantly however, as you cannot have a "recession fear" theme in the markets and oil to remain as high as 120$. Crude finished at 108$.


In corporate news, President Biden sent a letter to the major oil companies' CEOs letting them now that the administration has now zoomed on them in terms of their fat operating margins and blowout growth of profits. The message was clear: they have to take actions (increase production and/or reduce profit margins) in order for the end-consumer prices to move significantly down. A one-off tax on their profits is also sitting on the table, as a potential threat.


Equities: Weekly Performances



 

Charts of the Week


EUR Investment Grade bond yields reach 10-year highs

This chart shows the yield of the EUR investment grade bonds (i.e. of higher quality) for the last 20 years. It is currently at 3.4%, having moved from almost 0% in less than one year and it is at the highest levels since 2012. When yields move down (as the blue line shows since 2011) then bond prices move higher, and the opposite (as in 2021/2022). It took the yield 10 years to move to almost 0% and just one year to go back to almost 3.5%, causing their prices to fall almost 15% during that period. The market has already discounted a very aggressive ECB monetary policy for the months to come, which could prove true or not. The issue is that investors suddenly have the opportunity to "lock-in" a very respectful return for the next 5 years, through high quality EUR bonds, an opportunity that has not been given to them in almost a decade. If one selects ultra-high quality companies (rated AA and above) a recession means that the bonds purchased at current prices will most probably offer capital gains in addition to the high interest, as they are seen as "safe-haven".


European Healthcare stocks are back at interesting levels

This is the chart of the price of the iShares Europe 600 HealthCare ETF (blue line) which includes the regions' largest pharmaceutical companies. After a big rally in April, the stocks have returned to levels that in the last 6 months have always provided support (red line) and a bounce. In terms of valuation, its Price to Earnings ratio (green dotted line) is back at the lowest levels since 2019, with the exception of the pandemic crash in March 2020. Healthcare is considered a defensive sector, which of course does not mean that during a bear market it will not fall, but they are expected to perform much better than the more economic sensitive ones.

 

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.

• 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: Equity performace: Factshet, Chart 1: Factset & Chart 2: Factshet