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November 13, 2023 - Can they sour our Christmas mood ?



Late on Friday, the US government debt outlook was downgraded by Moody's to negative, while the AAA rating was maintained for now. This move, however, is usually a precursor for a downgrade of the actual rating, as S&P (in 2011) and recently Fitch have done, depriving the US from its golden AAA status. The fiscal deficit and the meteoric rise both of the debt level and the interest rate that the US has to pay on its debt have been sources of concern for a long time, but the rating agencies have decided to act now. Moving forward, one should conclude that the Biden administration will have to cut spending, which means less stimulus in the economy at a time when the economy has been showing signs of a slowdown already. An election year ahead complicates things even more.


While we try to maintain an optimistic view on markets for now, these news are definitely an obstacle for the "Santa rally" to continue with the same momentum from the October lows. The S&P500 index has already reached the level (4400) which we thought it could rally to by year-end, after the summer correction which spilled into October. This downgrade could have an impact on bond yields as the demand for treasuries might weaken further, at a time when on the supply side of the equation there is significant issuance ahead. Foreign institutional investors such as sovereign funds have been reducing their exposure to US treasuries all this year, and are not expected to change this course. The FED itself is not only unwilling to buy any bonds, but on the contrary it is reducing its own bond portfolio, selling into a market where demand is falling continuously. The paradox is that US treasuries are still considered a safe-heaven and should rally in case of a recession.


The recent rally in bonds and the significant fall in yields caused some reaction from the central banks. Mr. Powell and Mrs. Lagarde spoke in different fora, putting on a slightly more hawkish face, than during their recent monetary policy meetings, in an attempt to stop this bond rally. Much lower yields mean looser financial conditions, which work against their intention to keep interest rates high. Of course all this came before the US downgrade and if a new sell-off in government bonds materialize, this should equally worry the central bankers. The situation has become very complex, and there is not much we can do about it, rather than stick with quality at this stage, both in bonds and equities.


More data showing that the US labor market is slowing further were released last week. In particular, the Continuing Jobless Claims rose to 1.83mn, the highest level since April 2023 and before that, the highest since early 2022, when the FED started raising interest rates. These data coupled with the information we received about ten days ago on unemployment, labor costs and non-farm payroll growth, paint a picture of the US job market finally becoming less tight, which has been the FED's major goal to begin with. A softer US job market means lower consumer demand, less pressure on wage growth and eventually lower inflation.


China fell into deflation (negative inflation) in October. Announced at -0.2% on a yearly basis, the Chinese CPI showed the world that there is at least one major economy that is not suffering from inflation. Of course we must note that negative inflation (deflation) is the by-product of weak consumer demand amidst the absence of any major economic stimulus by the government. The data are consistent with more stimulus ahead and rate cuts, which should help Chinese stock markets recover from the current low levels, with an attempt to break out of its almost 3-year bear market. But investor sentiment remains at very depressed levels.


US equities rallied further, while Europe had a volatile, but flat week. The S&P500 added 1.5% to close at our short-term target of 4400 and Nasdaq rallied by more than 2.5%. In Europe most indices were flat or slightly negative. Third quarter results by Richemont and Diageo were worse than expected, putting a big dent on the share prices of European consumer-related stocks (spirits, luxury etc) on Friday. Technology was the big winner among sectors, as investors are moving back to the sector which contains the world's highest quality companies, with huge cash balances, strong business models and structural growth potential.


Bond prices fell towards the end of the week, and appears they could be under pressure at the aftermath of the downgrade. Mrs. Lagarde mentioned that no rate cuts should be expected before the summer, while Mr. Powell even talked about another rate hike, if needed. These statements coupled with the the US downgrade forced the US 2-year yield back above 5% and the 10-year rose to 4.65%. German yields also rose by about 10bp, but as the Eurozone economic growth is almost at zero and with a high probability of a minor recession in the next 6 months, we would use any fall in high quality bonds' prices to add to the exposure, especially in the 3-5 years space.


Chart of the Week : Oil prices are discounting again a recession.

Despite the current two military fronts (Ukraine - Gaza), oil prices have collapsed again, at levels last seen in early July. The WTI crude oil peaked at almost 95$, when the terrorist attack on Israel sparked fears for a contagion in the area, bringing probably Iran and other oil-producing nations into the conflict. It is now trading 20$ lower, representing a more than 20% drop from that peak. In the meantime, OPEC has announced production cuts and the US is replenishing its strategic reserves, but these actions have failed to keep the price of oil elevated. Once again, oil prices are primarily driven down by the fear of a global recession materializing, as was the case in early 2023, when they fell to a low of 65$. Of course this recession did not materialize this year and it looks to have been postponed for next year. The optimistic view is that we can narrowly escape it, with a "revolving recession". What this means is parts of the economy are already in recession (real estate, manufacturing) but others are booming (technology, leisure), offering support to the GDP growth. And as manufacturing and real estate could start recovering, the booming sectors can afford to slow down, keeping the overall economy afloat.


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: Moody's headquarters

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