Financial markets changed their minds on the US economy several times in the last three weeks. From the sudden scare for an imminent recession and the subsequent sell-off in equities at the beginning of the month, we now are back at party-mode because that was just a "bad dream". Global equities have now recovered most of the lost ground, with a further rally last week, primarily in the markets' darlings, namely the Nasdaq (+5.5%) and Nikkei (+8.7%). Europe also staged a decent rally of 3.5% on average and surprisingly the Swiss market, despite its shine primarily during turmoil, added almost 3%. The Swiss index is now the best performer in Europe among the major markets on a YTD basis, finally vindicating our stance to be overweight the region since the beginning of the year.
The debate whether the economy will crash or manage a soft-landing is, in our eyes, futile. Of course, the investment implications stemming from these two scenarios are quite different, but our view is that we should not miss the big picture: the US economy is going to land, period. Hard landing, soft landing, crash we do not know. The only certain scenario is that it will slow down because this is the only way to bring inflation further closer to the 2% target. If the plane suddenly makes a move higher again, then the control tower (the FED) will send orders to bring it back down (ie. raise interest rates further and create havoc).
It is not worth to take unnecessary risks and spend time, energy and money trying to bet on any of the above scenarios. Our long-standing view for 2024 has been to have portfolios adequately diversified for all these scenarios, with the common denominator being that economic growth will either soft-land or crash. We will have to pass a period of lower growth, higher unemployment, before the next up-cycle emerges. To this effect, long duration high quality bonds are an integral part in portfolios, as they will play out well in all these scenarios. In equities, a 70-30 type of tilt towards defensives (including large cap Tech names) is justifiable, but increasing exposure to economic sensitive sectors seems reasonable at these levels after the correction (see also chart of the week).
The US July inflation report showed further progress and appears to have solidified the case for a September rate cut. The headline CPI increased 0.15% while the 12-month CPI inflation edged down to 2.9% which is the lowest level since May 2021. Food-away-from- home (i.e. restaurants) prices increased 0.20% n July, which is close to their pre-pandemic monthly pace. The Core CPI rose 0.17% and the yoy change remained unchanged at 3.2%. Within the details of the report the most problematic was the owners' equivalent rent (OER) which picked up to a +0.36%, but at least it is still below the 0.4%-0.5% range that it had been in the previous 10 months. As we have mentioned several times, rents carry a big weight on the inflation calculation and hence they are closely watched. On a more positive note, consumer goods' prices declined for the 13th time in 14 months (falling 0.3% in July).
US July Retail Sales were much better than expected, but details present a less impressive picture. The headline retail and food services sales rose 1.0% in July, compared to expectations of just 0.3%. But June sales were revised down by 0.2%, so the beat is actually smaller because the calculation base was brought lower. Then, sales of motor vehicles and parts registered a whopping 3.6%, primarily due to a software meltdown at auto dealers in late June, which pushed some June sales into July. Excluding autos, retail sales were up 0.4%. We should also note that July included Amazon's Prime Day. Overall, it is a report which should alleviate some fears of an imminent recession, but does not alter the case for a September rate cut by the FED.
The annual Jackson Hole conference, this weekend, is not expected to produce any news. The forum which gathers the world's central bankers to discuss our monetary futures in a picturesque environment has been associated in the past with major announcements that brought volatility to markets. This time around, the FED and the market are more or less aligned, and September is probably the month that rate cuts will commence. The pace and the magnitude is still debatable of course, but there is no new data that would make Chairman Powell provide any new hints on that. They have no idea what they will do after September anyway.
Gold, the USD and the bond market are convinced about the rate cuts, too. The USD has lost significant ground in the last few weeks, with the EURUSD approaching 1.1050, the highest this year and perhaps approaching the 1.1200 resistance levels. Gold reached the 2500$ milestone for the first time ever. And bonds were volatile after the positive macroeconomic data and the equity party, but finished the week on a positive note. The US 10-yr remained close to 3.90% and the German equivalent finished the week where it started, at 2.25%. The bond market is now pricing almost 100bp of rate cuts until the end of this year. Of course market pricing has changed several times already this year and with another 4 months to go, we are not sure the participants will not change again.
The Swiss GDP increased by 0.5% q/q in Q2, after 0.3% in Q1, and above expectations. According to the limited information provided, an important contributor to growth was manufacturing, while the services sector also grew overall. This is a surprising result, given the continued weakness in the Manufacturing PMI, weak growth in the main trading partner Germany, and increased concerns about headwinds from a strong CHF. But the strength in Swiss industry primarily reflects the pharma sector, which is less sensitive to cyclical conditions and relatively price inelastic and the strong pharma exports in Q2 support this hypothesis. We remain very positive and overweight on Swiss pharma-related names (Roche, Novartis, Sandoz, Galderma).
Chart of the Week : European Consumer Discretionary stocks might have seen the (relative) worst.
The above chart shows the relative performance of the European Consumer Discretionary index (solid blue line) vs the MSCI Europe Index (dotted line) for the last 5 years. The European Consumer Discretionary Index has significant expsoure to the well-known luxury names (LVMH, Richemont, Hermes etc) but it also includes the auto makers, restaurants and any other sector whose business is not essential to the consumer but rather a "nice-thing/service to have". What we can see in the graph is that after the recent significant underperformance of the likes of Louis Vuitton and Hermes for example, we have reached the point when previously these stocks performed better in the months/years to come. These levels are highlighted in circles. A lot of bad news seem to be already in the prices. And although the debate about whether we are about to enter a recession or not, is not helping these stocks, their valuation is very compelling for the longer term. As a "wild card", any move by the Chinese government to really stimulate the economy will make these stocks sky-rocket from current levels, as their exposure to China has dragged their revenues and the stock priced down.
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/KSH , Photo https://www.fortrade.com/a/blog/how-to-day-trade-in-a-volatile-market..
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