Global equities corrected after a long stretch of positive weeks. The S&P500 has risen already 9% since January and we just experienced the second worst week of the year. The broad US index fell by 1%, which would have been much worse, had it not been for the strong rebound on Friday. With the exception of the very first week of the new year when the S&P500 dropped 1.5%, all other negative weeks were in the -0.1 to -0.3% order of magnitude, or in other words almost unchanged. If we turn to the Euro Stoxx 50, the situation looks even more stretched. The index has risen 11% this year, and last week it dropped 1.5% which is the largest correction of the year, after the 1.4% that occured also in the first week of 2024. Since then, the EuroStoxx50 index has registered only one more negative week, when it dropped 0.7%. China, whose market seems to be on a sustainable recovery, was the only positive region for the week among the major markets, with Japans's Nikkei losing 3.5%.
There are many indicators that point to correction sooner than later. Starting with fundamentals, valuations are stretched by any measure and investor bullishness' indicators are at levels consistent with corrections in the past. The S&P500 is trading more than 10% higher its 200-day moving average, an event which has not happened in the last 20 years, and if history is any guide, this is not sustainable. Last but not least, defensive stocks (food, beverages, staples) have become completely unloved and left "rotting in isolation", as traders/investors flock to the more cyclical parts of the markets (Discretionary, Industrials, Banks), pushing their valuations to levels not consistent with the current economic environment. Finally, we should note that a 5-10% correction in global equities happens almost every year, but this will not change the narrative of a bull market.
Eurozone inflation fell more than expected in March. It fell to 2.4% y/y down from 2.6% in the previous month and better than the 2.6% expected. Encouragingly, core inflation also fell more than expected, to 2.9% y/y vs expectations for 3%. We now have both measures below 3%, and getting closer to the 2% target of the ECB. The decline in core inflation was solely driven by lower consumer goods inflation, while services inflation was unchanged for the fifth consecutive month at 4%. However, given the earlier timing of Easter, travel-related services have impacted the March data as prices tend to go up in the run-up to public holidays and then subsequently decline again. It is important to note that the improvement to 2.4% of the headline inflation number came despite the higher energy prices. Economists expect Eurozone's inflation to move even lower to 2.3% next month.
The ECB is meeting on Thursday, probably giving us a confirmation about a rate cut in June. The probability of the central bank cutting interest rates this week is almost zero, but the meeting's announcements and the press conference should offer more confidence that the first rate cut will happen in June. But as we have highlighted recently, it is very rare for the ECB to move ahead of the FED and to complicate matters more a rate cut in June by the FED is now starting to look less probable. Quite a few FED members last week emphasized that they are not in a hurry to cut rates and inflation in the US has not made any major progress this year. The dilemma that the ECB is facing is that if they move first and the FED does not move right afterwards, then the potential market action primarily on the currency will threaten imported inflation to move higher (lower EUR). But if they do not move in June, then their credibility will be dented, as in the meantime the recent inflation and growth data all point to a "must-have" rate cut. And financial markets will become very volatile.
Swiss inflation dropped to just 1.0% y/y in March, down 20bp from February and notably below consensus expectations of a small increase to 1.3%. This is the lowest level since September 2021. Looking into the details, private services (2.3%), housing (3.2%), energy (3.2%) and restaurants/ hotels (2.3%) were the only categories with inflation still above 2%. The recent weakness of the Swiss Franc could probably push inflation up again in the coming months and economists expect it to potentially rise to 1.3%-1.5%. These data together with the recent soft growth figures (PMI Services collapsed to 47) confirm the decision of the SNB to move first and cut rates two weeks ago.
The US March labor market data were strong, but there are some caveats. The non-farm payrolls rose by 303k in March, ahead of the expectations of 214k and the unemployment rate fell to 3.8% from 3.9%. However, much of the surprise came from government employment, which rose 71k over the month. Private employment expanded "just" 232k in March, and February was revised down to a gain of 207k, more in line with expectations. But economists also noted that the very warm weather of the week during which the survey took place must have influenced the data. Construction posted a strong gain in March and leisure and hospitality posted its largest gain since last October, which provides some evidence on the hot weather impact mentioned above.
China continues to show signs of recovery. The Manufacturing PMI rose by a whopping 1.7 points to 50.8 in March, the first reading over 50 after spending five months in contraction. Both new orders and new export orders bounced strongly by 4-5 points to expansionary territory. The Services PMI also improved further by 1.6 points to 53. The return from the Chinese New Year celebrations might have played a role in the jump of the two PMIs, but overall they are consistent with the overall sense that the drop in economic growth looks to have stabilized and it is now on a slow but stable recovery path.
Commodities continued to rally, as Gold passed the 2300$ mark and oil prices rose to the highest level of the last six months. The tension in the middle east gave a final push to oil prices last week, but current prices are clearly unsustainable under more normal circumstances. The warm winter has left the energy market oversupplied, and just to give an example the Texas Natural Gas prices have turned negative since March 11, and essentially producers are paying distributors to take their product, as demand has collapsed. Our call to invest in Energy stocks about two months ago has proven beneficial to portfolios, but it now looks a good time to take some profits perhaps.
Chart of the Week : German stocks' outperformance vs the Swiss reaches again unsustainable levels.
The above chart shows the relative performance of the German DAX (in blue) compared to the Swiss SMI (in green), for the last ten years. As it can be seen, the German market which is traditionally more volatile and cyclical in nature has had periods of significant outperformance over the Swiss, which we have highlighted in red circles. What we also see in the chart is that these periods of outperformance are followed by periods when the Swiss market behaves better than the German and the gap closes. Moving to today we see that this gap in favor of the German market has grown again to a huge differential, that seems to be unsustainable. If we were to follow again the "mean-reversion-mechanism", it is fair to assume that the Swiss market must perform better than the German in the next 12 months.
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.
• 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 : FactSet, Photo: propertyupdate.com.au