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3 October, 2022 - Fireworks from across the Channel

Equity markets finished the month of September with steep losses, as predicted. The US indices fell 9-10% on average for the month. The S&P500 is now 17% lower than the August high, and Nasdaq almost 20%. Europe performed little better, falling 6-8% on average while China fell by 6%. In terms of sectors, Healthcare performed better on a relative basis with a fall of 4%, followed by Staples with a 7% drop. All other sectors fell more than 10% on average. New lows were registered in most markets, with the exception of local Chinese equities, which have stabilized around the lows of this year. The Hang Seng index however (Hong Kong) fell to the lowest level since 2010.

The Bank of England became the first central bank to intervene in the bond market. It announced it will carry out temporary purchase of long-dated UK government bonds from 28-Sep to restore orderly market conditions. According to their statement, if market dysfunction was allowed to continue, it would be a material risk to financial stability and lead to unwarranted tightening of financing conditions and reduce flow of credit to real economy. The purchases of the long-dated bonds would be carried out on whatever scale necessary but would be strictly time limited until 14-Oct.

Even the IMF issued an unprecedented attack on the UK's fiscal policy, the first time in memory for a G-7 country. In a statement, it said the 23-Nov budget should be used as an opportunity to re-evaluate plans with the untargeted measures threatening to stoke inflation. The IMF said it was engaged with UK authorities and warned it risked undermining the BoE's efforts to curb inflation. Moody's also raised the spectre of a rating downgrade and said the budget was credit negative with economic growth unlikely to return to its potential until 2026 . It warned a sustained confidence shock over the credibility of the government's fiscal strategy could permanently weaken the UK's debt affordability. In another unusual move, recent UK turmoil also encouraged comments from US officials, with Treasury Secretary Yellen saying it was monitoring the situation. But the latest news are that the planned tax cuts which were recently announced will not finally be implemented, after a series of high-ranked Tory officials disagreed.

Overall, we could have seen the highs of the long-term yields, primarily in the US. This view is based on three main premises a) there is a "pain-threshold" on central banks and governments, which means that after a certain level of interest rates the cost of servicing their very high debts rises unsustainably b) a potential recession puts a natural cap on long-term yields and c) the speculative part of the bond market (hedge funds, traders etc) might be less willing to place aggressive short positions, having seen the experience with the BoE intervention and they also have to pay a significant cost to maintain them. It has become very expensive to short the long-term bonds. The stabilization of the bond market is necessary for the eventual stabilization of all financial markets.

China also issued a warning to speculators who wish to push the Yuan lower. The Central Bank announced that it plans to keep the exchange rate basically stable (this sounded like verbal intervention) while stepping up the implementation of prudent monetary policy. China reportedly asked state-owned banks to be ready to sell dollars to support the yuan. Also there were more headlines out of China about increased infrastructure spending and support for delayed housing projects, while cutting mortgage rates for and providing incentives to first-time buyers. The market now expects a more aggressive stimulus program in the last two months of the year and after the re-election of President Xi in mid-October. Local markets could rally into year's end, if this larger stimulus of the economy materializes, at a time when Europe and US are racing to move interest rates even higher.

More data from the US housing market showed that the steep drop in activity continues, which has started to also affect house prices. The S&P/Case-Schiller home price index showed the first monthly decline since 2012 and weekly mortgage applications fell to the lowest levels since the April 2020 pandemic low. All these are happening while the 30-year fixed mortgage rate hit 7% (!) last week. US Housing is a significant contributor of economic growth in the US and the results of this recession in this industry will start to spill into the rest of the economy soon. On the positive side, these developments are positive with respect to inflation.

Inflation in the Eurozone accelerated in September, according to the initial readings. In particular it rose by 10.0% on an annual level vs expectations for 9.5% and 9.1% in August. Looking in the details, there are reasons to smile as the biggest contributor to the worst than expected figure was a single country, Germany with a 2.2% monthly jump and a 10.9% read on an annual basis. On the contrary, in France and Spain inflation actually dropped on a monthly basis, bringing down the annual rate of change too. Core CPI in the Eurozone which excludes food, energy and tobacco rose by 4.8% on an annual basis, as expected, but showing a small rise vs August (4.3%).

The bond market had a volatile week, after the BoE announcement. Bond yields dropped from the recent highs (prices rose) and stayed at the lows of the week despite the inflation data which were published. The ugly Chicago PMI number (45.8 vs expectations for 51.8 and August reading of 52.2) helped bond prices to move higher, pricing a higher probability for a recession. The US 10-year closed at 3.75%, after touching 4% and the German equivalent at 2.10% after touching almost 2.30% on Wednesday.

Opec is meeting on Wednesday to discuss a production cut. Reports are speaking of a large cut of 1mn barrels a day, if not more. It seems that the cartel sees the 80$ on Crude as a bottom they want to preserve.

In corporate news, positive news from the tests of the experimental Alzheimer drug by Biogen made its shares rise sharpy by 40% and boosted also Roche higher by 5%, as the Swiss company is also experimenting on the desease (Roche is on our high conviction list). Starbucks, also a stock on our high convicition list, announced it raised its quarterly dividend by 8%, in another sign of financial strength of the company. It also announced the opening of its 6'000th store in China. Nike warned for increased unsold inventory which will have to be discounted and lower revenues because of the foreign exchange translation into the strong USD, and its shares ended more than 10% lower, at the lowest since the summer of 2020.


Chart of the Week :

Mid-term election years are always tough.

A very interesting chart by First Trust, which shows the maximum fall of the S&P500 during a mid-term election year in orange and its performance (in blue) for the next 12 months. It is very telling that the average drawdown during a mid-term election year is almost 15% and the average gains one year ahead are about 19%. Being down almost 25% this year until now, makes the performance of the S&P500 among the top-5 worst in its history since 1950. It is also clear from history that the biggest the drop, the sharpest the subsequent rally is. Mid-term elections are one month from now , but before that we have the Q3 season coming up, which could determine the how US equities will behave during the final stretch of the year. October is known for its bottoms...


• 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.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : First Trust


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