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June 10, 2024 - The first rate cuts are here, what happens next ?


The ECB delivered its first rate cut, as widely expected, to bring the deposit rate to 3.75%. This follows the similar Swiss National Bank (SNB) decision in May and came one day after the Bank of Canada decided to also cut rates by 25bp, to 4.75%. On Wednesday, the FED, however, will most probably keep their own rates unchanged, but we will get another glimpse of their thinking about what might happen in the next few meetings left for 2024. Next week, the SNB is meeting again to discuss rates and most probably will maintain them unchanged, and the Bank of England is expected to lower rates.


The ECB meeting can be characterized relatively hawkish, in the sense that the decision was not unanimous (Austrian central banker, Mr. Holzmann voted against) and Mrs. Lagarde's message was clear that a July cut has a very remote probability. But the main surprise came from the ECB’s new macro forecast about inflation which was was larger than-expected. The ECB increased its 2024 and 2025 forecast by 0.2pp each to 2.5% and 2.2%, respectively, citing higher energy and core inflation as the main drivers. The 2024 and 2025 core inflation forecasts were lifted +0.2pp to 2.8% and +0.1pp to 2.2%, respectively. The ECB attributed these upward revisions to higher-than-expected inflation outcomes in recent months, especially services inflation, and higher inflationary pressures from energy and labor costs.


It is becoming clear that interest rates are not going to come down as fast as expected at the end of last year. This could have implications on equity valuations primarily in the already expensive growth stocks, as the bond market continues to be repriced to higher yields. It is also now very clear that the key data to watch are the labor markets' health status which will also determine the wage growth, as well as the real estate market situation, which impacts rent growth. Any signs of weakening in those two sets of data will make the bond market reprice again more aggressive rate cuts by the world's major central banks.


The US labor market is still sending mixed signals. With the risk of sounding like a broken record, we must mention again that the data that we receive from the various labor market surveys cannot be considered credible anymore. How can we explain that the May non-farm payrolls, a widely watched metric estimated by the so-called Establishment survey rose by 272k, vs expectations for just 170k, but the Household survey which calculates the unemployment rate showed a very weak labor market for the same month. According to this survey, the May figure was -400k (!) jobs and the unemployment rate rose further to 4%, which is the highest since 2022. The JOLTS jobs openings number collapsed to just over 8mn, vs the 8.4 expected and previous months were also revised down. The private jobs data, provided by ADP, showed a weak growth of 150k, vs 175k expected.


The May US ISM Services spiked to 53.8 vs expectations for a smaller rise to 50.8, complicating matters even more. As we have mentioned several times, consumer goods prices have behaved well during the last few months, bringing their inflation down to almost 0%. But the consumer services industries remain strong, maintaining wage growth at relatively high levels and causing the headline inflation number to remain above 3% in the US. The May CPI number will be published on Wednesday , a few hours before the FED decision. Expectations are for the headline and the core to have made little progress if any.


Equities had a positive week, but with mixed performances among countries and sectors. The US main indices (S&P500, Nasdaq) rose to record highs, but lost some ground on Friday as the Nvidia and semiconductor party has been gaining steam. Nvidia reached the 3 trillion dollar valuation mark and joined the other two (Apple and Microsoft) in this elite club. This means that just three stocks now comprise a whopping 20% of the S&P500, and 80% of the index is the other 497 or so companies. One can hardly say that this is a healthy market situation. In Europe, Swiss stocks managed a comeback again, with the SMI index gaining 2%, as France and Germany finished the week almost unchanged.


Bonds lost some ground after the ECB meeting and the US labor market data. The German 10-year yield rose to 2.60%, and the market is eyeing the previous high of about 2.70%, as speculative positions against the German bonds rose to a two-year high. Of course this could set the stage for a major rally, if the short positions have to be cut abruptly. The US 10-year rose to 4.45%, ahead of this week's FED meeting which could spark further volatility. Our strategy remains to buy high quality bonds on such weakness, to prepare for the next phase of rate cuts, probably happening more aggressively in 2025.


Chart of the Week : The concentration in the S&P500 is more extreme than ever.

The above chart shows the percentage of the S&P500's total market capitalization which is attributed to the top-10 stocks. Back in the bubble of the early 2000s, that percentage had reached a high of little over 20%. The precipitous underperformance of the Tech-related names for many years after, brought this percentage to as low as 10%. Since the Technology boom of the Trump years and the pandemic era, that percentage grew closer to 30% in November 2021. Again, that proved unsustainable and in 2022 Technology massively underperformed the broader indices. Since early 2023, concentration has been increasing again and has now reached a new high of 35% ! Would this prove unsustainable again or will the market keep concentrating in the top-10 stocks, which eventually will become 40% or 50% of the S&P500 ? We do not have a clear answer of course. All we can do is rely on large historical data which show that this percentage has a large probability to shrink again closer to 25% or 30%, which means that the top-10 names will underperform the rest of the market for this to 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.

• 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 : Apollo Management, photo:. https://www.mpamag.com/

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