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September 25, 2023 - Reached the peak, but planning to stay there for long.



The message from the last round of central bank meetings was almost uniform. After the fastest and most aggressive interest rates hike campaign in living memory, global central banks seem to have reached the same point at the same time and have chosen to communicate it in almost a similar manner: their monetary policy tightening seems to have reached the end, but they are not willing to relax it (by cutting interest rates) any time soon. It is usually not wise to fight against the words and intentions of the central banks. And financial markets were quick to reprice the new interest rate expectations for 2024 causing volatility to spike again during a period (September) which traditionally is not friendly to risky assets. But as we have learned time and time again in the last two years, their predictions have not be adequately accurate in terms of inflation and interest rates. Were they to be wrong about having to maintain the rates so high for much longer, the current correction has created interesting opportunities again in bonds and equities. But if they prove to be correct, then it is wise to have sought these opportunities in companies rich in cash, low in debt and with resilient, "all-weather" business models. Shares (and bonds) of Technology, Health Care and Consumer Staples companies fit these characteristics, for example.


The Fed held interest rates unchanged at 5.25-5.50%, as expected, in a unanimous decision. The policy statement had very few changes from the July's edition, primarily noting that economic activity has been expanding at a "solid" (vs prior "moderate") pace, and that job gains "have slowed" (vs prior "have been robust"). However, what shocked the markets was the fact the 50bp of rate cuts have now been removed from their 2024 forecasts. Before the new announcements, the expectations were for 100bp rate cuts next year, starting as early as in the first quarter, but, surprisingly, the Fed now thinks rates will still be higher than 5% at the end of 2024.


But, the Swiss National Bank (SNB) and the Bank of England surprised on the dovish side. They both maintained interest rates unchanged against expectations for a rise by 25bp and it seems that they are now both done with their monetary policy tightening, at least for the next three months. The SNB mentioned again that it could use FX interventions to protect the economy from imported inflation, which means it would be selling its vast foreign exchange reserves and buying the Swiss Franc. The implication of this is that the CHF has a powerful force in its favor, and we would be buying it on any weakness and investing it at the same time in high quality Swiss stocks.


The Bank of Japan also left its monetary policy unchanged, and continued to be the only central bank in the world with negative interest rates. Although inflation has risen, after decades of deflation, the authorities do not consider this to be sustainable yet. The BoJ noted that employment and wages improved moderately, but July’s weaker-than-expected employment data suggested stronger wage growth is unlikely soon. And higher wages is a necessary condition for inflation to move and stay higher.


Mr. Powell also gave us some interesting "food for thought" in the press conference that followed. He referenced the need to get inflation back to target numerous times during his press conference and that the fact that the economy and inflation have slowed, isn’t good enough. The FED wants to see the labor market to loosen (job openings down and more people entering the workforce) and consumer spending to slow further and deeper. When asked about the potential damage of higher interest rates to the economy, he seemed rather unconcerned. "GDP isn’t part of the mandate", he said, and neither was soft landing his base case. This phrase might have been the closest he could get to say that a recession would solve the inflation problem more quickly and sustainably.


The week's US macro-economic data were mixed (as usual) with a tilt on the weak side. The US housing market index (NAHB) fell to 45 in August, from 50 in the previous month, and this was the lowest number since April of this year. However, this is still much higher than the low 30s figures we saw at the end of last year. The recent rise in mortgage rates close to 7.5% has put a dent on the market. The August Leading Economic Indicators fell by 0.5% on a monthly basis, as expected, and this was the 17th consecutive monthly drop, something that has never happened outside a recessionary period. On the contrary, the weekly initial jobless claims fell to the lowest level in almost one year, showing that the job market is still rather strong.


Eurozone September composite PMI (purchasing manager index) rose to 47.1 from 46.7 in August, helped by the Services industry. Both Manufacturing and Services indices remained below 50.0 which is considered the neutral level, but Services recovered to 48.4 from 47.9 the previous month. Looking at country details, France showed a remarkable drop both in manufacturing and services, now both below 44 , the lowest levels since the end of 2020, in the middle of the pandemic. Germany's Services PMI recovered to just below 50 (at 49.8) up from 47.3 in the previous month.

US Congress enters a make-or-break week for avoiding a government shutdown, with the October 1st deadline looming, for the passage of the budge. Republicans are again split among them, as was the case with the debt ceiling debates a few months ago. As a reminder, Republicans have a very tight majority (221-212) in the House and they cannot afford to have many lost votes. A short-term compromise should eventually be found for a last minute resolution, but the rating agencies of US debt are watching closely again. One is never bored with US politics.


Equities had another rough week. US indices fell more than 3%, with Nasdaq being the worst performer with a 3.5% drop, as Tech-related stocks are more sensitive to interest rates. Nasdaq finished the week at exactly the low of August. The S&P500 is now trading at levels last seen in mid-June, while a strong support can be found around the 4250 levels (about 2.5% lower), where the 50% Fibonacci retracement of the 2023 low-to-high rally can be found. The 200-day moving average is also located around the 4200 level, which means that 4200-4250 area should generate buyers and hence prove to be a good support. Europe also fell by almost 2%, on average, with the UK market out-performing with just a 0.5% drop.


Bond yields moved higher (prices lower), as the market repriced the new information it received by the central banks. The 10-year US yield reached a new high of almost 4.50%, but settled at 4.45%, while the 2-year failed to move past its previous high (5.20%) and finished the week at 5.10%. German yields also moved higher, but to a less extent, as the market now believes that the ECB is more dovish than the FED, and the Eurozone economy is showing signs of further deterioration in the 3rd quarter.


Chart of the Week : The Euro-Stoxx 50 is where it was at the end of January !



The above chart shows the evolution of the Euro-Stoxx 50 index since the start of the year. As a reference the index consists of the Eurozone's fifty most representative companies and it includes high quality names such as LVMH, Sanofi, Siemens, ASML, L'Oreal, Total etc. Interestingly , after the recent correction, the performance of the index is now about 11% for the year, which was the performance of the index in the month of January alone ! Taking into account that the prices of the stocks are about the same as in late January but the profits of the companies have increased by an average of 3.5%, according to Factset, it makes them cheaper than they were 9 months ago. The price to earnings ratio of the index is 12 times, which is considered rather attractive and it has only been cheaper during Covid or during the financial crisis of 2008 and 2011. The P/E was indeed 20% cheaper last year, when the Ukraine war erupted but it did not stay at those ridiculously low valuations for more than one month. Without implying that there is no downside risk, we can say that entering some high quality European stocks at these levels should provide significant returns on a 24 month horizon, and in some cases a high dividend income.


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: https://www.mountainphotography.com/

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