Equity and Bond markets fell again, in a similar synchronized fashion as last week. Actually, the price action is so fast and furious that we do not know any more if equities are falling because of the fact that bonds are falling (yields moving higher) or because they are pricing a recession, in which case bonds should have been rising and not falling ! The Dow Jones closed at a new low for the year, as did the indices in Europe. The S&P500, with a 5% weekly drop, moved closer to the June low, creating thus the conditions for a bounce (double bottom probably today) as we are finally approaching the end of the treacherous September. Asia performed better with China and Japan posting moderate lossea of about 2% for the week.
But we see again opportunities emerging in both bonds and equities, after being cautious during the August rally. Perfect-timing the markets is an impossible exercise and 99% of the people who attempt it, evetually fail. Finding value among the various asset classes in times of stress and having the discipline to reduce at times when the valuations of certain parts of the market become excessive as in 2021, usually yields a better outcome. Admittedly, cash has been the king of 2022, as all asset classes are down between 15-20%, making the traditional balanced portfolio looking at losses in excess of 15% up to now. The good news is that our analysis shows that a lot of bad news has already been discounted in all asset classes. Under various scenarios (except for the "apocalyptic" one) a balanced portfolio is poised to gain a significant part of the lost ground in 2023.
On the equity side, we see long-term value again in the beaten-down Communications sector in the US (Google, Disney, Facebook) as well as the other large Technology names, which tend to do well in a recession, the new fear of the market. Healthcare is at very attractive levels, especially in Europe. Luxury brands also tend to perform well in an inflationary environment and names like LVMH now trade close to their lowest valuation in 5 years. In bonds, we see tremendous value in the 3-5 year duration range of high quality corporate bonds, both in USD and EUR. Yes, they are falling now at the same time as equities, but if the fear of recession finally materialzes, these bonds from current levels should provide significant returns for the next 12-18 months and partially off-set any further equity weakness.
It was a week that Central Bank action took the spotlight (again). The FED raised interest rates as expected by 0.75%, to a new range of 3.00%-3.25%, but it also offered guidance for the next 12 months through the publication of the new SEP (Summary of Economic Projections). The new element in these was that the FED is expected to raise interest rates to 4.25-4.50% by this year's end and perform one more, smaller this time, increase to 4.50%-4.70% early in 2023. It is interesting that despite this massive tightening of monetary policy in such a short time, the same projections see only a small impact on unemployment (expected to rise to 4.4%, from 3.6%) and low GDP growth (instead of a recession which is being priced by the market). Either a recession is coming, which means that bonds at these levels are a screaming buy or a recession is not going to materialize, which means equities are a screaming buy. Buying both is probably the best idea.
The Swiss National Bank raised interest rates by 0.75% to make them positive again. The Bank of England raised rates by "only" 0.50% , but this was widely expected, although there were voices within the committe that asked for 0.75%. The Bank of Japan continued to be the outlier, by maintaining its interest rates into negative territory (-0.10%) despite the recent rise of inflation to 3%, which is rather low compared to the western world. However, it also intervened in the currency markets to make the JPY stronger, for the first time in a few decades. The JPY is traditionally a hedge for bad markets, but even this has not worked this year. Maybe its time has come for 2023. The central bank of Sweden (Riskbank) was the "bank of the week", as it became the first to raise interest rates by a whopping 1%.
The UK government announced tax cuts and energy subsidies, one day after the central bank raised interest rates, in an attempt to alleviate the pain from the rate increases on the consumer. But then again, the purpose of the aggressive interest rate increases is to cause some pain to the consumer in order for him to curtail spending so that prices come down. Now the local market believes that because of the fiscal stimulus (tax cuts) the Central banks will have to raise even more higher the interest rates, with the government perhaps responding with more stimulus. The GBP fell to almost parity against the USD.
The European Purchasing Managers Indices (PMI) showed some resiliance in France but weakness in Germany. The French Services index jumped to 53.0 vs expectations for a fall to 50.5 and even better than the August reading of 51.2. On the contrary, manufacturing moved deep in contraction territory at 47.8, vs expectations for 49.9 and 50.6 in August. Germany's Services index was rather weak, announced at 45.4 vs the 47.7 reading in August, which was expected to remain unchanged. Manufacturing fell further to 48.3 vs 49.1 in August, but was in-line with expectations. With such readings in the PMIs (which are forward looking) the recent spike in the longer term (4-5 years) Eurozone bond yields should offer a unique opportunity.
The US Leading Economic Indicators (LEI) dropped for the 6th consecutive month, in September. According to historical data, the six back-to-back months of monthly declines has never happened outside of a recession. Or in other words this is another sign that a recession will hit the US economy in the next 3-12 months. A mild recession has been our baseline scenario for the last few months. However, its magnitude and its effect on corporate earnings are of course totally unpredictable for now.
Some positive news came out of China with respect to Covid19. The lockdowns in some cities have ended, while travel to and from the country is going to become easier with lighter restrictions. The first region to adopt these lighter measures was Hong Kong, which announced the relaxation of the "3+4 quarantine" requirement (three days at hotel and four days at home) to "0+3" and cancelled the requirement for a PCR test.
The bond market sold-off after the FED meeting. The 2-year yield rose to 4.25%, the highest level since 2008. As a reference, this yield was at 0.20% one year ago and 0.7% at the start of the year. Longer-term yields also rose significantly. The 10-year jumped to 3.75%, also the highest since 2010.
Oil prices fell below 80$, as it moves deeper in its own bear market. As already mentioned several times oil prices cannot move sustainably higher as long as the theme in the markets is recession. If China shows signs of a larger economic stimulus for its economy and/or lockdowns are lifted for good, this could be a short-term positive catalyst for oil too.
In corporate news, Microsoft raised its quarterly dividend again, by 10%. We are also fast approaching the reporting season for the 3rd quarter, which will also start to show the guidance of the companies for next year. Earnings expectations for next year must start coming down in the coming weeks, as the market is already pricing this scenario. The first reports come out after the 10th of October.
Chart of the Week :
US rents rate of growth might have already started to slow down
The chart provided by CoreLogic Inc. shows the annual rates of growth of the US rental prices for various types of residences (cheaper to expensive). As one can see in the summer months the indices have started coming down, which means a slower increase, albeit still at 12-14% higher levels than last year. Rents are an important part of the Core CPI (inflation) calculation in the US and in other parts of the world and have played an important role in the recent spike in inflation. But it is also an item in the calculation equation that takes time to show a decline. But we must take into account that next year, the rents indices will be compared to the 2022 levels, and their rate of annual growth looks almost impossible to continue moving higher at current speed. This comparison to a high level (called the basis effect) gives us hopes that in the middle on next year the annual inflation level could be in figures well below the current 8-10% in the western world.
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• Sources: Chart of the Week : Core Logic