Investors received a nice treat last week, as both bond and equity markets moved higher. The scenario of "peak-hawkishness" that we have been claiming since a few weeks ago is starting to unfold. A series of bad macro-economic data coupled with the first signs from two major central banks that the process of monetary tightening will probably slow down or even stop by early 2023, led to a rally in bonds (yields down) which soon spilled over to equities. Even the huge sell-off in big Technology names in the US (Google, Facebook, Amazon) was not enough to curb the enthusiam of market participants. A rally until year end is probably the most likely scenario, even if the upside is rather limited to about 5-8% from current levels.
US equities out-performed globally, with the "old-fashioned" Dow Jones zooming higher by 6% and posting its 4th consecutive positive week and now standing at "just" -12% for the year, compared to the almost -30% of the Nasdaq. Europe also enjoyed a rally of about 4% for the week, but Chinese equities continued to fall (-5%) as investors are turning away from the region. In terms of sectors most of them enjoyed big gains, with the exception of Communications which lost gound, a sector that includes Google and Facebook which had a horrible week.
The ECB provided a "dovish" hike when it raised interest rates by 75bps to 1.5% but hinted that we might be getting close to the end. The announcement noted that substantial progress in withdrawing policy accommodation has been made. While today's statement underlined the Governing Council's expectation that interest rates will rise further, it dropped the (arguably hawkish September) reference that hikes will continue in the "next several meetings". In the press conference, Ms Lagarde refused to say how fast and how far rate hikes would proceed and reiterated that the ECB would decide in a data-dependent meeting-by-meeting approach, which would consider the inflation outlook, but also potential recession risks, the impact of policy hikes already delivered, and monetary policy transmission lags. To us (and finally to the markets) this was the first time that a major Central Bank hinted to a potential slowdown in the interest rate hike cycle. The market had priced a terminal rate of almost 3% before the ECB meeting, which now seems very high, with 2.25% to 2.50% being more likely. Were this to materialize, Eurozone equity and bond markets will rally hard.
Will the FED do the same this week ? Expectations are growing that the FED will also provide some hints that 75bps for December is not a done deal, even if they raise rates by 75bps on Wednesday. An admission of the recent significantly worsening macro-economic data in October as well as an acknowledgement of the "lagging effect of monetary policy on inflation", will do the trick for now and convince markets of "peak-hawkishness". On a seperate note, a few days before the ECB, the Bank of Canada chose to raise interest rates by only 50bps, against the expectations for 75bps. Pressure is growing among central bankers to deviate from the recent tough stance and move into a "wait-and-see" mode for the coming months.
Most data showed that economic activity deteriorated sharply in October. The Eurozone PMI numbers fell further into contraction territory, as German manufacturing was particularly weak, falling to 45.7 (vs expectations for 47). The Eurozone Manufacturing PMI, hence, fell to 46.6 vs expectations for 47.9. The Service sectors held up better, but also fell further compared to September. The Eurozone Services PMI fell to 48.2, as expected, but lower than the 48.9 of September. In the US, the deterioration was even more pronounced. The Manufacturing PMI dropped to 49.9 vs expectations for 51.1 and compared to the 52 of September. The Services PMI fell 3 full points, to 46.6 vs 49.9 of the previous month and expectations for 49.5.
Eurozone Inflation numbers for October rose to new highs for the core countries. German inflation rose to 11.6% on a yearly basis, up almost 1% for the month of October, while the French number came in at 7.1%, up 1.3% on a monthly basis. Italy's inflation rose by a whopping 4% on a monthly basis, reaching 12.6% compared to last year. Interestingly, Spain's CPI rose by only 0.1% on a monthly basis, with the annual rate of change at 7.3%, significantly down from the 8.9% in September.
Bond yields dropped significantly from their recent highs. The 10-year US yield found itself under 4% and closer to 3.90%, after its recent trip to almost 4.40%, but finished the week at 4%. The German equivalent dropped to 1.90% from 2.30%, but rose back to 2.10% on Friday after the preliminary inflation data.
US midterm elections are to be held next week, on November 8. The elections in the US should generate some volatility in equity markets, but if history is any guide the stock market usually finishes higher from the election day until year end. However the most recent one, in 2018, is a stark exception to this "rule". Republicans are poised to win at least one of the two chambers, while according to the betting companies, they have more than 50% chance to win both (Senate and House). In this case, the US will enter a two-year period where a lot of bi-partisan work will have to be done, for any legislation to pass under a Republican Congress with a Democrat as the president.
In corporate news, all big US Technology and Communications names revealed a slowdown in revenues and profit growth, as margins also disappointed. Stocks like Facebook, Microsoft, Google and Amazon dropped 10-25% in a single day. We should mention, however, that the actual results were not that bad to justify such huge moves. What really hurt some of these stocks was (a) the not exciting guidance for the next quarter (Microsoft, Amazon) and primarily (b) the willingness of companies to continue to invest (spend) in an environment where the probability for a recession is rising exponentially. Google (Alphabet) announced that it will cut its hiring plans by half, but this still will leave the end 2023 personnel count almost 8% higher than this year and with higher wages, due to inflation. Facebook (Meta Platforms) pledged for a flat personnel growth in 2023 but repeated its willingness to continue to invest heavily in the Metaverse, which is now seen as a "black-hole" by the market. Whether these bets/investments will bear fruit in the coming years, only history will tell. But one should trust the multi-year history of such companies to weather through recessions and difficult periods, only to emerge stronger and more profitable. Their valuations cannot be ignored any more.
Chart of the Week :
Big tech at dirt-cheap prices.
This chart shows the performance since January 1st for some of the biggest Technology names in the US (Google and Facebook officially belong in the Communications sector) and it is a clear illustration of how things have changed this year. The green line is Facebook (Meta Platforms) with a 70% drop year-to-date, while the other three show drops of 30-40% (Amazon the blue line 38%, Microsoft the black line 30%, Google the red line 34%). Valuations of some of these stocks are now at the lowest level in almost a decade, showing that investors have for now turned their backs on them. The once "must-have" stocks are now considered "better avoid" them, by the market. We find, however, tremendous long-term value to the likes of Google (Alphabet) and Microsoft. If Facebook is not a broken business model, at just 10 times earnings, it could prove to be the opportunity of the decade.
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• Sources: Chart of the Week : Factset