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March 18, 2024 - Are we going to party like it is 1999 ?


Our readers with a long history in investments will remember the steep rally of equity markets in the mid-90s that culminated to the "internet bubble" which burst in early 2000. Without wanting to freak anyone out, the peak of that bubble was in March, and in particular on the 10th. And for a second week in a row we are going to use a famous song by Prince to wonder ourselves whether we are indeed going to party like it is 1999. The market's collective mind thinks so and believes that we are not even close to the end of it. And this is the main reason why no-one wants to stay out of the party and people are rushing to buy equities at the most expensive level since the turn of the century with the rationale that if there is a bubble to be formed, it is a long way higher from here. And this could be true.


This time, the story is that artificial intelligence will improve productivity significantly, which will have a very positive effect on the economy and in turn will boost company profitability. This argument has indeed a lot of merit. Back in the mid-90s, it was the internet that would change the world that drove the stock market parabolically higher, and as a matter of fact the internet did change the world. But in the meantime, investors who bought the Nasdaq index close to the peak, had to wait fifteen whole years to see their capital returning to the initial value. Even those who bought 40% lower than the peak had to be patient for eight years to recoup their capital. We are not advocating that we have seen the peak of a bubble, but the risk-reward is deteriorating fast. At the same time, there are parts of the market which have been totally ignored by the party-goers who flock in the same stocks day by day. And as the recent troubles for Tesla investors (-30% year to date) have recently demonstrated, it does not take long before a fashionable and expensive darling turns into an unloved and undesired ex.


The US February inflation numbers disappointed and are threatening to kill the mood. The December scenario that the FED will start cutting rates in March and will cut by 150bp in total for 2024 has been dealt more blows, last week. Their announcements on this coming Wednesday after their two day meeting (19-20 March) will be closely monitored. The meeting comes just days after the consumer and producer price indices reports, which were both higher than expected, demonstrating once more than the "last mile" to get down to the FED's target of 2% will not be easy to cross. The more the economy is staying resilient the less is the probability that inflation can move significantly lower, as wage growth remains robust due to the tight labor market. But we also received data which showed that consumer spending is probably reaching an inflection point, where high prices and high credit card payments could be finally having a toll. As we have said before, good economic news will be taken as bad news for markets (higher bond yields --> affecting equities) and bad economic news will be taken positively by markets as rate cuts will be coming. Of course we have argued before that small rate cuts of an "adjustment" nature are positive for markets, whereas deeper rate cuts will be taken as a warning sign of an imminent recession.


The US February CPI was announced at 3.2%, higher than 3.1% in January. The core CPI prices rose 0.36% in February with the 12-month core CPI change edging down to 3.8% (rounded from 3.75%) from 3.9% in January and marginally worse compared to the 3.7% expected. Food away from home slowed to its smallest increase in three years and this was a promising development as this component is one of the better indicators of the inflation trend over the next year. Among the components, owners' equivalent rent (OER) slowed from the surprisingly strong 56bp increase in January to a somewhat-less-elevated 44bp increase in February. Prices for core services excluding rents appear to have risen 47bp in February — still elevated but well less than the 85bp increase in January. Overall and despite the headline numbers disappointment, the report was taken positively as it showed a deceleration with respect to the monthly change and that the January spike must have been a temporary blip on the path of inflation towards the FED target of 2%.


The US February PPI (producer price index) accelerated to 0.6% in February from 0.3% reported in January. A large increase in energy prices drove the acceleration and accounted for 24 bps of the headline PPI increase. The PPI excluding food, energy and trade services (Core PPI) reported a 0.4% increase. The latter decelerated from 0.6% reported in January as core services decelerated from 0.8% in January to 0.5% in February, but core goods prices rose at the same pace as in January (0.3% over the month). On a 12-month basis, headline PPI inflation moved up to 1.6% in February from 1.0% reported in January while core PPI inflation inched up to 2.8% from 2.6%.


The February US Retail Sales report showed weak consumer spending, in contrast to the "resilient consumer" theme which has been floating around. The monthly number was announced at +0.6% in February vs expectations of +0.8%, but the prior months were revised down substantially leaving a much weaker trajectory for retail sales than previously seen. Headline sales are now up just 0.1% in December, down 1.1% in January and up just 0.6% in February. At the control group level, which feeds into the GDP calculation, February Retail Sales were essentially unchanged (+0.02%) after declining -0.32% in January, and were up just 0.25% in December. These revisions are often more important than the actual month data, since the full sample of stores is rolled into the published data.


The Bank of Japan meeting could be a risk event this week. The central bank is the only one among the major ones which has kept its rates in negative territory, as the local authorities had suffered from the opposite problem of inflation for decades : deflation or in other words negative consumer prices growth. They have maintained their very accommodative monetary policy and ample liquidity in the system as the rest of the world was raising interest rates aggressively to fight inflation. But the time has come for Japan to change their stance. The latest data which showed that wages were negotiated with a 5.3% growth vs last year and higher than 3.8% increase in 2022 point to the Bank of Japan probably raising interest rates as soon as this week. The market had been expecting this to perhaps happen in April, hence some volatility could emerge both in stocks and currencies.


Equities had a mixed week, with profit taking hitting Technology related companies and Nasdaq (-0.7%). Europe managed to eke out small gains, albeit France rallied by 1.7%. Energy had a strong week (+2.3%) as Oil prices passed above 80$ again. We had increased our weight in Energy stocks a few months ago as their prices back then were signaling a good entry point. Although they are not as fun to have as Nvidia for example, they offer a hedge for an oil shock or a geopolitical event, they provide high income to investors and if technology falls out of favor, they will probably perform better if the market decides to rotate again into Value.


Bonds fell for the week and yields rose back to the 2024 highs. The worse than expected inflation data, but above all the anxiety of the market ahead of the BoJ and FED meetings this week led to selling of bonds. The US 10-year yield rose again to 4.30% and the German equivalent to 2.45%. These levels are again interesting to start buying longer duration, but high quality at the same time.


Chart of the Week : The S&P500 is expensive, but not in bubble territory (yet).



The above chart shows the valuation of the S&P500, in terms of forward Price-to-Earnings, (the so-called P/E) since 1999. The reason we are showing this is twofold : a) to make the point that the market is expensive vs its own history and b) that it is not a bubble, hence if someone would bet that a bubble will be created then the index has at least 20% upside from current levels. Currently trading at almost 21 times earnings, a lot of future good news have been discounted already. The market has not been so expensive since the pandemic years and if the 2021 bubble is any guide it burst when the valuation reached a very demanding 24 times earnings. Back in 1999 the bubble burst when the valuation reached a ridiculous P/E of 26. So, the math is very simple: we would need at least another 20-25% rally, all other things being equal, to characterize the stock market as a bubble, based on these historic data. This does not mean that the music cannot stop for a while with a 10%-15% correction, enough to wipe out the recent "weak" hands and make way for the longer-term investor to add to positions.


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 , Photo/weezevent.com/en-gb/blog/organise-successful-party/

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