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November 20, 2023 - Bonds are equities' best friend (until they are not).

Bonds continued to rally and equities followed suit. This positive correlation, in both upward and downward moves, has been in place since the beginning of 2022 and it goes against the long-held investment wisdom, that bonds and equities typically move in opposite directions. Last year, the realization that inflation is too high, and not transitory, led the central banks to embark in one of the most aggressive interest rate hikes campaigns ever, perhaps similar only to the ones in the late 70s. The end-result was the explosion of yields from negative or zero to today's levels of 4% to 6% in EUR and USD respectively. When yields spike this means bond prices fall significantly and this bond market sell-off was the main reason behind the equities collapse last year, as high interest rates usually lead to less capital expenditures, higher interest expenses, lower consumer demand, lower profits and consequently lower company valuations in the stock market.

We are now in an state of mind, where bad news on the economy will be taken as good news, because bonds will rally and the above-mentioned positive correlation with equities "guarantees" an equity rally too. But there is a limit to that. In principle, bonds perform better in an environment of slow growth or a recession, when equities usually struggle, as the companies' revenues and profits are impacted, by the combination of lower consumer demand. Equities perform better in environments of strong growth and good investor sentiment, although their best performance comes when they rebound from the low which has been established during the recessions and not before or after. History has shown that bonds and equities are usually negative correlated and their opposite moves help balance the returns of fully invested portfolios. As we are approaching the start of the new year, we should keep in mind that bad news will someday be taken as bad news. Owning both bonds and equities in equilibrium is the best strategy for 2024, for now.

US core inflation slowed more than expected in October, offering more support to the view that the FED is done with raising interest rates. The core CPI rose just 23bp (0.23%) in October and the 12-month change fell to to 4.0% from 4.1% in September, with consensus expecting it to remain unchanged. Among the core components, owners' equivalent rent (the largest and one of the most stable CPI components) slowed back down to a 41bp increase in October. Lodging away from home (primarily hotel) prices surprisingly fell 2.5% in October, after a strong 3½% increase in September. Headline inflation moved closer to the FED's target, falling to 3.2% from 3.7% in September and matching the expectations

Fresh US labor market data showed further weakness, offering more hopes that it will give reasons to the FED to decide that enough is enough, when it comes to rate hikes. The weekly initial jobless claims jumped to 230k, last week. But as these remain much lower than the 300k+ levels that usually signal a more serious situation in the labor market, our focus is on the continuing jobless claims, or in other words how many people continue to receive benefits. This figure rose to 1.87mn , which is the highest for the last two years.

US Retail Sales fell 0.1% in October, the first negative number since March and a notable softening in the pace of spending after the very strong summer months and September. Looking into the details, auto sales fell 1% in October, sales at gasoline stations dropped 0.3%, furniture sales posted their fourth negative month in a row and building materials sales fell for a second straight month. On the contrary, sales at food & beverage stores moved higher by 0.7%, in a sign that leisure and entertainment holds up well. Interestingly, Walmart, the world's largest retailer, alongside its 3rd quarter results mentioned that they saw a significant drop in consumer spending in the last two weeks of October and that they were more cautious than 3 months ago.

China's October Retail Sales grew much faster than expected, helping the shares of consumer-related stocks recover. The figure was announced at 7.6% growth compared to the same month of last year and vs expectations for 7%. This number reveals some acceleration in consumer activity, as the yearly growth in September was 5.5%. Of course these big increases are primarily due to the "base effect", or in other words the comparison with a low base of last year, when the economy was still emerging from the pandemic-related lockdowns. A robust stimulus to the economy and a sustainable solution to the weak real estate market are yet to be seen on the part of the authorities.

Chinese President Xi Jinping met President Biden in San Francisco in a much anticipated encounter that could alleviate fears for a geopolitical accident at least for now. The two sides said that (a small) progress was made and they agreed to resume communications between their militaries, cooperate on attacking the ever-increasing usage of opioids and other drugs and begin a dialogue on the risks of artificial intelligence. President Xi Jinping also delivered a message to US business that got a standing ovation: China is a big market and a friend. The likes of Tim Cook (Apple) and Elon Musk (Tesla) were there. We cannot declare that the relationship of the two super-powers has or can easily return to the pre-Trump years, but the mere fact that the two sides are holding constructive talks and actually met in person after many years at the most senior level offers some hope that the worst is behind us.

Equities had a third positive week in a row, and most indices are currently about 10% higher from their October lows. It was Europe this time which out-performed its US peers, as Q3 corporate results from semiconductor company Infineon Technologies and Siemens sparked big rallies of their shares. The largest US retailer, Walmart had a rough week as the company's announcements about a tough end of October in terms of customer activity was seen by investor as the a perfect timing to take profits. The shares were at record highs, the day before the announcement. On the contrary, big Tech continued higher with Microsoft and Apple fetching a new record high, despite some profit taking on Friday. Some caution is now warranted, and purchases of stocks should be made on weakness and we would not be chasing the markets.

As already mentioned, Bonds rallied hard last week. The 10-year US yield reached a low of 4.40%, which is a whopping 60bp down from the 5.0% peak just three weeks ago. To give our readers some perspective, this move in basis points (bp) equates to more than 4% increase in the price of the bond. The "bond vigilantes" for which we wrote about a month ago are definitely "licking their wounds" as we speak and were obliged to take steep losses on their short positions. The German yield curve also moved lower by about 20bp last week and the German 10-year yield is now below 2.60% again.

Chart of the Week : A similar pattern like last year means the S&P500 could end 2023 around 4400.

In mid-October we wrote that a the low of this correction should be found in that month, as it happened in 2022. That "prediction" proved to be correct with equity markets rebounding strongly from that October low again. The chart shows the S&P500 for the last two years and we aim to compare the rally of the lows of October 2022 with the current one. When we said that the markets can rebound from the October low we had thought that a viable target for the end-of-year rally would be the region of 4400. To our delight, the S&P500 zoomed through that level and has been consolidating at around 4500, representing an almost 10% rise from the October low. Last year the rally off the lows reached about 12%, but December proved tricky and the market retraced to an almost perfect 50% Fibo level. If history were to repeat itself, we could see the S&P500 rising to 4600 in the coming days and finishing the year around 4400, as worries about 2024 could surface in December as well as some tax-credit-related selling of losing positions.


• 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:


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