Financial markets are currently pricing the "best-of-all-worlds" scenario, or to use a cliché, the "Goldilocks" scenario. Equities are priced for perfection (at the index level) , bonds are priced for inflation to return and remain at the central bank's targets (2%) and even oil prices are discounting slow growth but no recession, at around 70$ per barrel. No escalation of the on-going wars (plural) is also being priced in. We would be more than happy if the perfect scenario plays out in the next 3-6 months. But it is our fiduciary obligation as money managers to monitor and highlight the dangers that could derail this optimal outcome.
The main concern ahead is how central banks will react to the pickup in inflation, which is mathematically almost certain to happen in the next few months. Below we have highlighted the findings from the last meetings of the FED and the ECB, which clearly show that their willingness to cut aggressively is not as strong as the markets had believed. Bonds have already reacted to that with yields rising about 20-30bp across the curves. China's recent actions to provide large monetary and fiscal stimulus is also inflationary, a worry that was nonexistent until a few days ago, as the local economy was exporting its deflation. We , however, maintain the view that despite the upcoming rise in inflation, it should resume its downward move in the early months of 2025, especially in the Eurozone, where economic growth continues to be revised lower (latest example Germany last week).
Hence and until year end, the probability of an inflation scare or a growth scare is not negligible. In the first case, central banks will (at best) stop the rate cuts, bonds will sell-off, which will then spill into equities, a scenario which will bring the momeries of 2022 back. In the second case, bonds will rally as central banks will be slashing rates and economic-sensitive/cyclical equities will sell-off, as it happened in late July. Things are getting more complicated if we add to the equation the major event of the US elections in the beginning of November. Unfortunately, we do not have the magic recipe that would do well in all those scenarios. The wise investment strategy is to avoid concentration to any sector or theme , even if that is a very loved theme like AI and Technology. History has shown that themes change suddenly and investors are left wondering what happened. Diversification across sectors and geographical regions should curb volatility and offer the best risk-adjusted returns.
The published minutes of the ECB’s September meeting showed a committee concerned that inflation would remain persistent and that delays in reaching the central bank’s inflation target warranted some caution to avoid dialing policy back prematurely. It also said that it is “too early to declare victory”. As a reminder, we note that due to base effects the inflation is already expected to move higher again in the next 2-3 months, and above 2%. But, interstingly, the minutes also showed the beginnings of concern over economic growth, noting there had been some negative surprises in the PMIs. We also note that various geopolitical events and more data have since then influenced ECB officials to present a more dovish view than the minutes are suggesting. All in all, a rate cut is a done deal when the central bank meets on Thursday, but the press conference will be closely watched for hints.
The minutes of the last FED meeting leaned on the hawkish side as well. They emphasized that the magnitude of the September cut (50bp) should not be interpreted as guidance on the future path of easing, and also revealed a greater degree of disagreement among participants than Chair Powell expressed in the press conference. While the minutes noted: "a substantial majority of participants supported lowering the target range for the federal funds rate by 50bp", we also read that "some participants would have preferred a 25bp cut and a few others would have supported a 25bp cut". It is possible that some FED members saw the 50bp cut in September as a "make-up" for missing the cut in July as "some participants noted that there had been a plausible case for a 25bp rate cut at the previous meeting" . All the FED speakers since then, have hinted that rate cuts will be of the 25bp nature from now on and a pause cannot be out of the question.
US September inflation slightly disappointed, but with positive elements in the details. The headline CPI increased 18bp in September while 12-month CPI inflation dropped from 2.5% in August to 2.4%, the lowest level since February 2021 and a little below the 2.5% it was at in January 2020 just before the start of the pandemic. Core CPI prices rose by 31bp, an increase that was slightly above consensus. The most important news this month was in owners’ equivalent rent (OER) which slowed back to a 33bp increase in September after a surprising jump to a 50bp increase in August. The 33bp is the second-smallest increase in OER in a few years. With OER being the largest single component and one of the more persistent, this is a very important development for inflation continuing to ease. The upside surprise within the core CPI categories was entirely in consumer goods' prices which was their strongest move in some time after declining 14 of the past 15 months.
The Q3 earnings season has started and the estimated earnings growth rate for the S&P500 is 4.2%. This will mark the 5th straight quarter of year-over-year earnings growth for the index. We should note that on June 30, the estimated (year-over-year) earnings growth rate for the S&P500 for Q3 was 7.8%, so there has been a major downward revision which could help companies beat estimates. The largest downward revision has been with Energy stocks (-19% vs that expected just three months ago) while Industrials and Materials have also witnessed significant revisions (-9%). The estimates for Information Technology and Communication Services (which includes companies such as Meta and Alphabet) have remained unchanged in the last three months. The first major US banks' results were positive (JPMorgan and Wells Fargo). Tomorrow we will receive LVMH's Q3 sales, the first major luxury name to report. With the stock off its recent lows due to the Chinese stimulus news, but also 7% lower from its peak of one week ago, it would be interesting to see how it will react to the expected very slow growth to be announced.
The S&P500 and the Dow Jones registered new record highs, but Nasdaq remained about 2% below its own set back in July. The S&P500 rose by 1.1% for the week as did Nasdaq and most European indices. French stocks had a less positive week (+0.5) as the local index has a larger weight in consumer names which were the victim of profit taking after the previous (China related) big rally. Politics have also played a role as the French PM presented his first ideas of the 2025 budget, which call for a big reduction in spending and a rise in income and corporate taxes. Still he survived the first no-confidence vote. Chinese markets were off by about 5% on average, as the previous move was vertical and profit taking was to be expected.
Chart of the Week : Spooky coincidences with 2007 ...
The below data should not be taken as advice or become the basis for any investment decision, and we present it purely on informational basis. The above chart shows the price action of the S&P500 in 2007 and was created by UBS. It has highlighted, in red, three dates from that period. What is very "spooky" and striking is that in 2024 two of the above events occurred on exactly the same dates. If also the third date will be the same, is to be determined. a) The all-time high was registered on July 16, 2007 and the same happened this year (July 16th, 2024). Then a correction took the market sharply lower into August, in both years. b) The FED cut rates on September 18 of 2007 by 50bp, and then again the FED cut rates on September 18th, just two weeks ago, by also 50bp. c) In 2007, the new all-time high of that cycle was registered on October 11th, just slightly higher than the July high, and then the market slumped for more than a year, a drop which included the Lehman Brothers collapse. Moving to today, a new all-time high was registered on ... October 11th , , also just slightly higher than the July high... Lets see what happens next !
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• 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 : UBS , Photo: //www.asiainsurancereview.com/Magazine/Read
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