A "Santa rally " has come early and it is very welcome. Our cover story two weeks ago was "another October, another low in place?" and November is proving us correct for the moment. We remind our readers that our "forecast" was primarily of a short-medium term nature as 2024 will start with many moving parts, not to mention the possibilty of a recession in major economies. But for the moment, and if there is not any major escalation in the Middle East situation, we see no reason for equity markets to establish new lows, than the ones seen in October, for the next 1-3 months. The S&P500 completed a 10% correction from the July high, which is a rather typical and not so rare drop within bull markets. The Euro Stoxx 50 recently traded at almost 11 times earnings, making it the most attractive in terms of valuation in many years (leaving aside the ridiculously low valuation of last October). With almost 50% of the S&P500 companies having reported, the blend expected earnings growth for this quarter is at a 2.7%, vs the initial expectation for almost zero growth. Expectations just one month ago were for zero growth at best. If the 2.7% growth proves to be correct, it will mark the first quarterly earnings growth since 3rd quarter of 2022. In other words, earnings also seem to have found a trough, for now.
But there is little value in trying to forecast with precision what next year will bring. The only certainty is that we should be very vigilant about the potential risks that lie further ahead and have primarily to do with the central banks' next move. Inflation in developed economies has fallen significantly from the highs, but remains much higher than the central banks' targets. The issue is that for inflation to move further down in quick steps, a significant drop in consumer demand must occur, which of course is another way for saying "recession". At the same time, central banks do not wish to be held responsible if they throw the economies into a crisis because of the high interest rates, which themselves imposed because of the inflation their own actions created during the pandemic. A tough job to be a central banker these days, indeed.
The FED kept interest rates unchanged for a second month in a row, and provided a balanced message to markets. It was a tough job for J. Powell to convey the message that the committee members do not really wish to raise rates any higher, but at the same time leaving the door open for a rate hike in December. In reality, he could not do otherwise given the recent strong macroeconomic data and their own official forecasts for another rate hike before year end. However, he offered some goodies to the doves as well, by acknowledging that inflation has made significant progress and that financial conditions have tightened already due to the rise of interest rates in the market, which essentially has done the job for the FED. All in all, the market's interpretation is that interest rates are going to stay at current levels for some time, as it would have to take a series of bad macro economic data for the committee to start considering cutting rates. And these are not in sight (yet).
The Bank of England also kept rates unchanged, as expected. They also tweaked their forward guidance by adding that "policy was likely to need to be restrictive for an extended period of time", which can be interpreted as rates having reached their peak. In a similar fashion to the ECB and the FED, Governor Bailey said that rate cuts for 2024 are not being discussed at the current stage, despite the markets' pricing which has already started discounting them as a possibility as early as the beginning of the second half. The Bank of Japan is the only major central bank left, which has not touched its interest rates yet, but announced that the 1% yield on the 10-year bond is not a "ceiling" anymore but a "reference". This means that the central bank is not obliged to keep buying its government's bonds so that yields do not rise above 1%, but rather be flexible about it and intervene when needed. The bond market was rather stable after the announcements.
Eurozone October inflation surprised positively. The headline CPI fell below 3%, to 2.9%, a significant drop from the 4.3% figure of September and the first time we saw a 2-handle in the last two years. Still victory cannot be declared as the Core CPI , which excludes food and energy, remained at 4.2%. The Swiss October inflation accelerated to 1.7%, up from 1.6% in the previous month, but remains rather subdued compared to the rest of Europe.
Eurozone's 3rd quarter GDP was announced at -0.1% q/q , but +0.1% on a yearly basis, which demonstrates a further slowdown from the previous quarter's growth. On a country level, Germany's GDP fell again (-0.1% q/q), but it was better than expected, Italy stagnated (0.0% q/q, slightly weaker than expected) and France grew modestly (+0.1% q/q, as expected). A positive surprise came from Spain, whose growth was the strongest (0.3% q/ q). The outlook for the coming quarters appears challenging, given the ECB's restrictive monetary policy, a weak external environment as well as fiscal tightening by the governments. The data are consistent with the view that the ECB is done with raising interest rates.
The US labor market showed some signs of weakness in October. The monthly non-farm payrolls were announced at just 150k vs expectations for +180k and with a significant slowdown from the 336k of September. Looking into the details the most striking element is that leisure and hospitality payroll gains were just 19k , in a clear signal of a slowdown as in September that sector had added a surprisingly strong 74k jobs. The unemployment rate rose to 3.9%. The continuing jobless claims rose to 1.82mn people, an equal number to April of 2023 and the highest numbers since early 2022. Overall, the jobs data of the week were consistent with a slowing economy.
Equities rallied back from the abyss, for their best week in almost a year. In a spectacular week, US indices finished 6% higher, while European market also rallied by 3-4% on average. The rally was broad across sectors, with a tilt towards interest rate-sensitive stocks such as Real Estate and Utilities, which had been performing really bad in the previous period. More importantly, the S&P500 and the EuroStoxx-50 broke out of their downward channels , which have been in place since the beginning of the correction at the end of July and approached again their 50-day moving averages. This is a sign that the short-term momentum can continue, but the final level of the indices at the end of the year might not be far from where we already are.
The "bond vigilantes", that we had mentioned before, had a very tough week. Bond prices rallied and yields fell significantly, as the FED announcements and the weak macro economic data pushed the shorts out to the exits. We had highlighted that the huge short position in long-dated US treasuries could lead to a "short squeeze", or in other words the shorts struggling to close their positions by buying back the bonds and pushing the prices even higher. For the owners of these bonds, like ourselves, this is a good place to be in. The 10-year US treasury yield fell to a low of 4.50%, down almost 50bp from the recent peak at 5%. The 2-year yield dropped below 5% and closer to 4.90%.
Chart of the Week : We have entered the best period for equities traditionally.
The above chart shows the average monthly returns of the S&P500 , since 1990. Although historical averages do not guarantee similar future performance, the market always has an eye on seasonal patterns. What we can see from the above chart is that after a strong July the summer finishes on a negative note for equities, which spills into September, as it happened also this year. Then, usually, the market rallies into year end, with November having the best monthly average return compared to all months. Given the steep correction of July-October and the relative attractiveness of current valuations, we see no reason why we cannot move to the finish line of this year on a positive note.
• 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.
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• Sources: Chart of the Week : Pictet . Photo: cnbc.com