August has started on a negative note for financial markets, as a result of the extreme euphoria of the previous two months, especially in the US. The panic brought by the collapse of US regional banks and the fire-sale of Credit Suisse at the end of March was quickly followed by the artificial intelligence mania, sparked by Nvidia's comments about strong demand for its semiconductors. The sharp move higher of US equities in June and July was initially driven by algorithmic, automated trading programs (known as CTAs) and retail investors followed in the second half of July. The problem with that is that CTAs are machines which do not care about fundamentals but look at certain indicators to make decisions, one of which is volatility. The more volatility is moving lower the more the computers are buying into equities. But when volatility starts moving higher, the machines start selling automatically, something that has been taking place for the last three weeks.
The longer-term picture for equities is, of course, not determined by the computers, but by the flows of real investors, who are always focusing on fundamentals. When markets wake up from the current hangover, we should again be sober enough to look at the real state of the economies and the prospects of companies for the next 6-9 months, to determine whether this was a very welcome correction in a new bull market, or the beginning of something deeper. The scenario which now carries the highest probability is that a recession looks to have been avoided for the next 3-6 months. And although this should be seen as good news, inflation is still much higher than the central banks' targets and interest rates could continue to move even higher. As China's example has shown, a real slowdown in consumer demand is necessary for inflation to move lower.
The July US Retail Sales were much stronger than expected. They rose by 0.7% on a monthly basis, vs. expectations for 0.4%, but the June figure was also revised higher which makes the beat of the forecast even larger. We have to note that these figures are not adjusted for inflation, so a rise in retail sales is attributed to higher prices and also the July figures include the Amazon Prime day, when the retailer discounts heavily its merchandise and sales of that day are usually very large, compared to a normal day. And of course we cannot ignore the fact that the US consumers are increasingly maxing-out their credit cards again, as pandemic related extra savings have been depleted by now.
Americans borrowed more than ever on their credit cards in the last quarter, the New York Federal Reserve Bank said last week. According to the latest data, US credit card debt hit $1 trillion for the first time, as credit card balances rose by $45 billion to $1.03 trillion in the second quarter, the regional Fed bank said in its latest quarterly household debt and credit report. This comes at a period when interest rates on debt has increased significantly, the personal savings rate has dropped to a multi-year low and the excess savings from the pandemic era are now almost completely depleted. Consumers could soon find themselves struggling to make the credit card payments, with consequences on the economies and bank balance sheets.
And the debt rating agencies have now targeted the US banks for downgrades. Moody's proceeded with the downgrade of 11 several US small and medium sized banks last week and Fitch warned that a downgrade of US banks could be coming, as a follow-up on the US debt downgrade. "Many banks second-quarter results showed growing profitability pressures that will reduce their ability to generate internal capital," Moody's said in a note. "This comes as a mild U.S. recession is on the horizon for early 2024 and asset quality looks set to decline, with particular risks in some banks’ Commercial Real Estate portfolios (CRE)", it continued.
The minutes of the latest FED meeting did not offer any new information. They revealed what we already knew, that the committee is as confused about the economy as we are (we humbly admit it) and they have no clue of what is going to happen in the next few months, when it comes to macro-economic data and inflation. We want to highlight however that all members agreed to the "need for below-trend strength" in the economy, which is a nice way to say that a mini-recession will be welcome.
It would be interesting to see what J. Powell will speak about, in this year's Jackson Hole symposium which takes place at the end of this week. The markets will be looking for any clue of the FED's possible actions until the end of the year, but given what we know so far, it is very unlikely that he will take the risk to provide any guidance in any direction. The symposium, traditionally held at the end of August, usually brings volatility in the markets, but maybe this time it comes and goes without any new material information.
Equities fell for a third straight week. Both the European and US markets finished with losses of more than 2% on average and no particular sector was spared from the selling pressure. The S&P500 is now about 5% lower from its peak in July, while European indices have returned to levels they were in February/March of this year. Nasdaq has now corrected about 10% from its high. We are starting to see again some opportunities in select sectors and European stocks such LVMH, ABB, ASML and BAT have returned levels that we feel more comfortable owning them.
Gold fell below the 1900$ level, as almost everything is against the yellow metal at this stage. Higher yields, higher USD and the lack of strong physical demand from Asia are all forces which traditionally drag Gold down, and this time has been no exception. Actually, it is remarkable that it has not fallen any further. The 1850$ levels should be well supported for now, ahead of the wedding-season related buying which will start again in China and India in the next 2 months.
Chart of the Week : If history is any guide, the next 3-5 weeks could be volatile for equities.
The chart shows the S&P500 index in 2011-2012, right after the downgrade of US debt by Moody's. Coincidentally, the downgrade happened in early August and the immediate response was a drop of about 8% in a matter of days. Today the correction has reached about 5%, so far. Then as one can see in the highlighted area (circled) a period of extreme volatility followed, with markets whipsawing and a final low was put in place at the end of September, which was not significantly lower than the initial low. We should add that traditionally August and September have not been particularly friendly to equity markets . What we can also see in the above chart is that after the volatile first two months after the downgrade, a rally occurred for the next 12 months.
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• Sources: Chart of the Week : Factset
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