In our last weekly review in mid-July we said that volatility has remained abnornally low, positioning is very stretched and the summer months are always tricky. Three weeks later and we had a one of the most volatile weeks since the pandemic years, with Japanese stocks losing 13% in one day and gaining an equivalent amount just the next, while the US stocks volatility index (VIX) exploded momentarily to 60 from just 12 before settling around the 20s level on Friday. (Our last "chart of the week" had highlighted exactly this lack of volatility as a potential danger for a sharp drawdown). The market's darling, Nvidia, has already lost about 30% of its value from its peak and Nasdaq is down more than 10% in the same period. These drawdowns are not rare and have happened in the recent past, quite a few times.
The question has arisen, whether this is the start of something bigger or a typical short-term correction in a raging bull market. The current technical conditions are set for a rebound, in the same sense that we were due for a correction before. Stretched leveraged positions were wiped out in a matter of hours, algorithmic trading programs sold aggressively and are now almost at zero exposure in equities and a few big Tech names are sitting on their important 200-day moving averages (Microsoft, Amaton for exampe). But what happens next after the short-term rebound is anybody's guess.
In the period that will follow there are catalysts for the market to rebound further or dip to a new low. In two weeks time the technology bellwether, Nvidia, will report its quarterly earnings, and this will be a big event, as always. Then September come and we will have again central bank meetings and we will have received more data on inflation and the health of the economies (labor market data primarily). But an equally important milestone is the US elections in early November that could create again some volatility, as Trump is a wild card and Ms Harris is not the most market/business friendly person in the world.
The final stretch of the year will depend whether the US economy and the rest of the world are moving into a recession or this was just a growth scare. There had been been many flashing signals all along this year, which we had highlighted and we had remained defensive in positioning and stock selection. This strategy may have proven too conservative until a month ago, but it is going to work in the scenario of a recession and it did provide a lot of cushion in the portfolios during the last three weeks. The fact that we had increased exposure to high quality long duration bonds also proved very beneficial, as these rallied. We see no point in changing this strategy now, but we have open eyes for opportunities in the more cyclical and economic sensitive sectors such as consumer discretionary, energy and industrials, as we are moving into the rate cuts period.
It was the recent US labor market data that primarily triggered fears for a recession, although seasonal effects and a hurricane in Texas could have impacted the data. The July nonfarm payroll employment expanded only 114k below expectations for 175K. That left the 3-month moving average of nonfarm payroll employment at 170k which is still far from recession levels, but unemployment rose to 4.3% which is 0.5% higher than just four months ago. This spike has made economists remember the "Sahm rule", which says that when unemployment rises by 0.5% above the three-month average of the previous 12 months, it signals recession. Of course these rules do not always hold, as we had many similar warning signs in the last two years, which should have already brought a recession, but proced to be a false alarm.
The US initial weekly jobless claims fell more than expected and provided some short-term relief, last week. In particular they fell back to the 230s level, after having spiked to 250k during the week that the unemployment data for July were also announced. It is very easy to get carried away from the noise that these weekly data provide, so we monitor primarily the continuing jobless claims number, which remained elevated at 1.875mn, the highest in the last two years. The fact is that the US labor market is weakening. Nobody knows whether this weakening is a "soft landing" or that there will be a sudden switch to mass layoffs and unemployment would rise to above 5%. At these levels the FED will definitely act decisively, but it is usually late.
The 31st July FED meeting gave a clear message that a September rate cut is very likely. And this was before the recent panic that swept through financial markets. According to Chairman Powell's own words: "The broad sense of the Committee is that the economy is moving closer to the point at which it will be appropriate to reduce our policy rate. The question will be whether the totality of the data, the evolving outlook, and the balance of risks are consistent with rising confidence on inflation and maintaining a solid labor market. If that test is met, the reduction in our policy rate could be on the table as soon as the next meeting in September". The jobs data that came after the meeting have for now solidified the market view that the cut is a done deal and the debate is whether there will be a 25bp or 50bp cut. The Retail Sales and CPI number this week could provide further proof or as usual make the market participants change their minds again.
Eurozone PMIs disappointed again in July. The Composite PMI fell by 0.8 points to a 3-month low of 50.1, which is only marginally above the neutral level of 50. The Services PMI declined by 0.9 points to 51.9, a new 4-month low and the Manufacturing PMI fell deeper into contraction territory to a 7-month low of 45.6. Looking at the country level, the German Composite PMI dropped by a whopping 1.7 points to a 4-month low of 48.7 as both the Services PMI (-1.1 points to 52) and the Manufacturing PMI (-0.9 points to 42.6) weakened. On the contrary, the French Composite PMI held up better, rising 0.7 points to a 3- month high of 49.5. This was driven by the Services PMI, which rose to 50.7, while the Manufacturing PMI dropped 1.2 points to 44.1. The press release mentions the "end of the election period" and a positive impact of the Olympics as reasons for the higher activity in services. By contrast, manufacturing firms reported weaker current output and much weaker domestic orders, similar to the results in Germany.
Eurozone inflation edged up to 2.6%, marginally higher than expectations for 2.5%, and 0.1% higher than the previous month. The rise in the headline number can solely attributed to higher energy inflation (+1.1pp to 1.3% y/y). Core inflation stayed unchanged at 2.9% which came as a disappointment against expectations of a slight decline to 2.8%. But looking at the details, encouragingly, services inflation edged down 0.1pp to 4.0% Overall, these slightly higher-than-expected inflation data should not provide any worry to the ECB ahead of the September meeting, where they are expected now to cut rates again by 25bp.
Bonds spiked higher during the turmoil, but gave up some ground as equity markets partially recovered. The US 10-year yield dropped to a low of 3.70%, down more than 50bp in a matter of two weeks which in price translates to a gain of about 3.5%. The 10-year German bund dropped to a low of 2.15%, also about 50bp down from its recent high. We now know almost for sure that more rate cuts are coming from the ECB, and the FED will start cutting in September. Although the current levels of bonds already discount a series of rate cuts, we would keep the positions that were established in much higher yields earlier this year, as these provide an excellent hedge against market turmoil and produce significant income for portfolios.
Chart of the Week : Is Nvidia the Cisco of the 2020s ?
Back in the late 1990s, for those who might remember, Technology companies became the "trade of the century" which brought their valuations at unsustainable levels, as the internet was becoming an every day reality. Cisco rose to the be the company with the highest market capitalization (500bn back then), with a mind-blowing rally that lasted 2-3 years. Then it collapsed and has never recovered to the March 2000 price, although the company is doing just fine. In the above chart, we superimposed Nvidia, which briefly became the world's most valuable company about a month ago, with Cisco's price evolution back then. The paths are strikingly similar ! But then again this is not intended to be investment advice or a hint to act upon this information. It is just shown for illustrative purposes and would be interesting to redo the graph in one year from now and see if history repeated itself or this time it was indeed different. We have no view on what could happen.
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.
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• 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.
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• Sources: Chart of the Week : FactSet/KSH , Photo https://www.fortrade.com/a/blog/how-to-day-trade-in-a-volatile-market..
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