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October 23, 2023 - Markets must soon decide what to be afraid of.

The investment environment is complex again and decision making is clouded by military conflicts, rising interest rates and high consumer prices. Equity markets started correcting in mid-summer as bond yields rose, driven by better macro-economic data and inflation which remained rather stable, than fall further as would have been an ideal scenario. Memories of the horrible 2022, when bond yields spiked and equity markets cratered were brought back quickly. Then the terrorist attack in Israel happened and the military conflict that has erupted since has created yet another issue to worry about. But the latter event and a possible escalation of the war should in principle alleviate the other fear, that of interest rates keep rising. In the case of a big escalation in the Middle East, bond yields should move significantly down (and bond prices significantly higher), something that the market choses to forget at this stage. Fear is abundant, and as always bad investment decisions can be made if risk is not correctly analyzed and quantified and at the same time opportunities can be lost, because of extreme fear.

Geopolitics is definitely a major drag on investment sentiment, and a potential risk that cannot be ignored. The situation in the Middle East is fluid and a war that will bring Iran or some other country can erupt anytime and this will create more turmoil in equity markets (of course not significant enough compared to the potential loss of human life). But markets have been through wars before. It was just a few days since the beginning of the Ukraine invasion in February 2022, that equities staged a major rally. Not to mention that the low of the 2000-2003 bear market ended in March of 2003, the very days that the US troops were invading Iraq. We cannot alter our investment thesis, waiting for a war that might not happen, or by loading up gold bars. We can only monitor the situation continuously, take advantage of opportunities and invest in the bonds and stocks of very solid companies in various sectors and, above all make sure we can liquidate any part of the portfolio with a "click of the mouse", if such a need arises.

We belonged to the camp that viewed the April-July rally with skepticism and considered valuations stretched, back then. We also thought that a recession would materialize in the US in the summer of this year, where we were obviously wrong. It has, however, materialized in Germany. But looking at how the investment landscape has totally changed in the last two months, we have started finding interesting opportunities, not only in bonds but also in select equities. Defensive stocks, like food & beverage, are trading at the lowest valuation in 10 years, and these are supposed to protect you if and when a recession hits. Even the economic sensitive stocks , like luxury and industrials in Europe are now trading as if a recession is around the corner. Even if it is, history has shown that stocks do not bottom after the recession, but while in it. Dividend yields have risen, as prices have fallen and are waiting to be captured by the long-term, income oriented investors.

The "beauty" of the current environment is that, at last, we can have insurance and get paid for it and handsomely ! It was just two years ago that an investor who wished to protect his/her portfolio from a recession or an unexpected geopolitical event, he would have to pay the German government about 0.5% per year to hold a 10-year German bond, the "mother of all insurance". But insurance usually comes with a price, so it was acceptable by some investors to receive negative rates on the bonds, or in other words paying the borrower. Fast forward to today, and the recent spike in yields has brought the same yield close to 3%. Investors can chose the safety of German government bonds (or US Treasuries for the USD investor) and protect/hedge the equity portfolio, earning at the same time a very respectable interest.

The FED Chairman's speech was probably intended to prepare markets for another pause in interest rate hikes. Speaking at the Economic Club of New York, just two days before the start of the blackout period ahead of next week's meeting, he sounded dovish on the margin. He mentioned the increased risks that geopolitics pose on the global economies and acknowledged the fact that rising bond yields have partly done the job for the FED, although he chose not to put a big emphasis on that. Given the fact that the previous meeting's message was that another hike should take place by year end, Mr. Powell along with other FED members recently, appears to have guided the market towards a no-hike at the next meeting. And there is only one meeting left this year, in December. We can safely assume now that the FED is done with interest rate increases for the foreseeable future.

US Retail Sales rose 0.7% in September, much better than expected (0.2%). The figure appears to be even stronger if we take into account that August's sales were revised higher to 0.8%. Once again, the US data are confusing. The recent credit card data had pointed to softer sales, which failed to show through in the Census Bureau data, which publishes the monthly Retail Sales. The September strength sets up a much stronger trajectory for spending headed into Q4 than previously assumed, and 3rd quarter GDP forecasts are being revised upwards. A complex picture for FED voters next week.

China's 3Q GDP growth was stronger than market expectations with the quarter-on-quarter rate at 1.3%, a rebound from the very depressed and also downwardly revised, 0.5% in 2Q. The annualized change was announced at 4.9%, much higher than the 4.3% expected. Almost every aspect of the economy regained some strength. Consumption is recovering thanks to auto stimulus and reopening. Infrastructure investments are gathering pace on the back of stimulus. Exports are stabilizing. Housing is still wobbly, but at least demand and construction have stopped falling further for now. It remains to be seen how long the stabilization can continue. These data bode well for Europe's luxury stocks, which have taken a beating during the last three months.

Equity markets fell significantly, with European indices fetching a new low in this correction cycle, and the S&P testing again the recent levels off of which it rebounded successfully (the 200-dy moving average). The market is so "blinded" with all the fears around, that the Swiss SMI, which supposedly should provide some protection, had the worst performance of all major indices, down about 5%, driven down by the likes of Nestlé and Roche, whose results were more-or-less in line. US indices fell by 2.5% on average, with Nasdaq being the worst (-3%) as Tesla disappointed with its Q3 results and Nvidia fell after a fresh round of US restrictions on shipments to China. Consumer Staples lived up to their expectations this time, as a defensive sector and finished the week almost unchanged. Super results by PepsiCo and Procter & Gamble have helped sentiment recover. As explained in the chart of the week, Consumer Staples might be at an entry point that only comes once in a decade, in terms of valuations.

Bonds were volatile and also finished the week on a negative note, although yields were off the highs touched on Thursday. The US 10-year yield reached 5%, as the bond market is still in "traders/vigilantes" mode, ignoring of course the military conflict and not paying serious attention to the already huge short position that has been built by speculators on the 10-year Treasury. A mini rally in the bond prices will probably leave "no prisoners behind" , something that the long-term investor who does not really care about the day-to-day valuation of his bond, will enjoy.

We are moving into, perhaps, the most crucial part of corporate Earnings, in the next two weeks. Major Tech companies such as Microsoft, Meta Platforms (Facebook), Alphabet (Google) and Amazon are going to publish their 3rd quarter results this week and Apple will follow the next. Already we had last week two major Tech-related companies reporting with very different outcomes. Tesla posted lower profits than expected, despite meeting the volume expectations, as their operating margins collapsed to a four year low. Cutting prices aggressively in order to boost demand had a major impact on their profitability. Shares were down more than 10% in just two days falling below the mid-August low. On the contrary, Netflix posted strong growth of its client base (i.e. number of subscriptions), in a clear demonstration that the new strategy of eliminating the possibility for multiple users of the same account/password and increasing prices has started to work. Shares were up 16% on the day of the announcement, the biggest gain in almost three years.

Chart of the Week : Can history repeat itself ?

The above chart shows the evolution of Global Consumer Staples, i.e companies which belong in the most stable and defensive sectors such as food & beverage, personal care & household goods, retailers, tobacco etc. It is a 10 year chart and it shows a clear uptrend, with two periods of interrupted growth (the third is the pandemic-related drop which was also rather brief): In 2016-2018, in a similar investment environment of rising interest rates, the index was volatile and basically stalled for two years (first dotted box). The end of this period brought a significant rally in 2019 and beyond. Since the end of 2021, which makes again almost two years, we have an almost identical formation. The index had booms and busts but has remained within this box, as if a consolidation is taking place, before the next move higher. If history is any guide and taking into account the fact that their valuation is at a 10-year low, the likes of Nestlé, Pernod Ricard, L'Oreal and Diageo should currently provide an excellent entry point for long-term investors.


• 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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