We wrote two weeks ago that "Markets look ripe for a correction". But, we did not know of course, that we would call the (short-term) top on that day. Fast forward to today and the S&P is down more than 5% and the Nasdaq closer to -7%, since then. We also said that 5-10% corrections happen more often than investors tend to think and do not endanger a bull market. Here we are, in this exact order of magnitude of a correction, but the problem is that it happened too fast and left investors really troubled. And the question remains if we are closer to the end of the correction or is something larger going to happen down the road. Unfortunately, no one knows the answer. What we do know from history is that in periods like these, the forgotten and unloved sectors and stocks, which the momentum chasers left abandoned in the previous months, can now help.
In a week that the S&P500 fell 3%, Nasdaq and Nikkei slumped by 6%, the Swiss SMI dropped less than 0.7% and Consumer Staples posted a mini rally of 1%. And lest we forget, the "hated" Chinese market posted another positive week with a 2% gain for the CSI300. To offer just two examples, valuations of solid franchises like Roche and Pernod Ricard are at the lowest level of the last 10 years, as the market has been only focusing on the likes of Nvidia and Rheinmettal. We have been advocating to become even more defensive, after the rally brought the differential between momentum and defensive stocks to very unsustainable levels, according to historical standards. This differential appears to be on track to close now. When stocks like Nvidia correct 20% in a matter of two weeks with no news, it confirms the unsustainable market equilibrium which we talked about two weeks ago. And at the same time, it makes us ready to revisit these expensive stocks that will become very attractive again, for the longer term.
We should avoid the mistake to confuse the Middle East tension with the current market correction. The markets topped out one week before the Israel-Iran debacle started. It certainly was a catalyst but not the reason. And in any event, the geopolitical situation appears to be rather contained, with all parties involved having no real desire to escalate. The main reason of the correction is that the market reached an unsustainable equilibrium, like when the wrong piece of Zenga is pushed out by the last (losing) player. But we do not want to paint the current situation like a Zenga tower that is coming down in pieces. It appears to be a healthy correction, which will wash out some momentum players and will lead to opportunities again. In the meantime we should remain vigilant and ready to act.
The week included more confirmation from FED officials that a June rate cut is probably dead. Mr Powell himself said in a speech that : "if incoming data suggest that inflation is more persistent than I currently expect it to be, it will be appropriate to hold in place the current restrictive stance of policy for longer". The violent change in the markets' expectations for rate cuts this year is also a major catalyst for the significant correction of growth stocks, as these are the most impacted by a change in interest rates (Technology lost 7% in the week). To offer our readers a perspective, the market is now pricing less than 50bp of total rate cuts by the FED for 2024, which is lower than the FED's own projections (75bp) and one third of what these expectations were just three months ago (150bp). The recent economic data in the US continue to show that the 150bp rate cut pricing in late December was just an aberration, as we had pointed out then.
US Retail Sales rose significantly more than expected in March. They were announced at +0.7%, vs expectations for just +0.3%. Even more impressively, this came after the prior two months were upwardly revised by a cumulative 0.5%. February's data was revised higher to show a 0.9% increase, relative to the previously published 0.6% gain, and January's 1.1% drop is now a 0.9% drop. Looking into the details one can see that higher gasoline prices played a role in the surprise and on-line sales were particularly strong. The latter could be explained by the presence of Easter holidays, in the month of March this year. But even with these caveats, the conclusion is that the US consumer remains strong and keeps spending, a fact that causes great concern when it comes to bringing inflation closer to 2%.
Bonds had a very volatile week, but finally finished lower. The strong macro data as well as the realization that the FED is probably not going to cut rates any time soon, caused a violent sell-off in bonds, primarily in the USD curve. The 10-year US yield rose to a 6-month high of almost 4.70%. Then the geopolicital situation caused a big rally in bonds, with the 10-year yield dropping all the way down to 4.50%, before rebounding to 4.62% late on Friday. The rally on Thursday is a great reminder that buying high quality bonds at current levels with duration of more than 4-5 years offers great protection against market turmoil. Unless this market turmoil comes from a realization of high inflation, in which case there is literally little to protect an invested portfolio.
We are entering perhaps the most crucial period for the first quarter corporate results. In the following two to three weeks, the Technology related companies will report their earnings, but most importantly offer their guidance for the next quarters. Already this week, we are going to hear from Tesla, Microsoft and Alphabet (Google) to name but a few. The fact that share prices have already corrected coming into the earnings reports is definitely a positive. But companies still have to impress investors with a bright short-term future, rather than post a better-than-expected result. As we saw in the price action so far, companies who post disappointing guidance see their share prices move down signficantly, even if their first quarter performance was stellar (JP Morgan, ASML, Netflix for example). Stocks are "priced-to-perfection" and the market wants nothing less ...
Chart of the Week : US Credit card delinquencies keep rising and are threatening the economy.
The chart shows the percentage of delinquent credit card balances as per total credit card balances outstanding, and it is produced by the Federal Bank in St. Louis, US. It is very obvious that the US consumers have been spending in the last couple of years primarily by bumping up their credit cards and the recent meteoric rise of interest rates has started creating trouble repaying those. The delinquency rate now has exceeded the 3% threshold, which is the highest since 2012. The latest announcements by the major banks during their first quarter earnings reports corroborate this picture, as they had raised the provisions for losses in their credit card divisions. It is also obvious by looking at the above picture that such a spike in the percentage of credit card balances not being paid, had been associated in the past with a recession hitting the economy a little after (these are shown in grey areas). Therefore, the flip side of the robust Retail Sales report is that although the consumer is still spending, their credit cards are becoming loaded and the interest expense is consuming much more of their disposable income (for those who have the courtesy to pay their credit cards...).
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• Sources: Chart of the Week : St. Louis FED, Photo:: investopedia