What a difference a week makes ! We had highlighted in the previous weekly review that equity markets should not move to new highs anytime soon, as there are no new catalysts after the failure of Nvidia to ignite a rally. But we did not expect so soon to get into a sell-off mode either. Nasdaq lost almost 6% and is back at 10% correction from its Juy high. Most European markets fell by 4% on average for the week and even the Swiss market retreated by a similar magnitude. Only the sector for which we expressed a "short-term love affair" a couple of months ago, managed to escape the carnage and gained ground, namely the Utilities. But the primary positive contributor to portfolios this week, was the big rally in bonds, as the market became again afraid (without any new reason) of a deeper slowdown than just a "soft-landing".
The question that arises is what to do now. First and foremost, even for the bond bulls like ourselves, we would not chase the market higher. Yields are now discounting quite a lot of bad news and many rate cuts by the central banks are already in the prices, which are yet to happen. The US 10-year dropped to 3.70% and the 2-year is now below that, at 3.65%. As a reference, the 2-year yield was close to 5% just five months ago and the 10-year was trading in the 4.30-4.60% range for most part of the year. The German yields are now almost below 2% in the 5-7 years and the 10-year fell to 2.15%. It was almost 3% a few months ago. We could see yields move higher from these levels in the coming weeks, as profit taking kicks-in and the central banks reveal their intentions in their September meetings.
In equities, as mentioned last week , we keep an open eye for opportunities that usually arise in this tricky September-October period. It is very tempting to get back to cyclicals (energy, autos, materials, small caps) that have been bombarded, as history says that when rate cuts happen these tend to outperform. But this is only part of the history and it all depends on what kind of slowdown we are talking about. For example, if the first rate cuts are then followed by aggressive cuts to stave off a recession cyclicals will suffer more. They bottom when the rate cutting is almost finished (not started). Having said that, if the few rate cuts manage to soft-land the economy, then cyclicals must have seen their lows and will rally.
Tired of sounding like a broken record, we emphasize the need for diversification with cyclicals playing a part in portfolios, but with a tilt towards defensives. And these days, we would be scooping up the highest quality in Consumer Discretionary names that are paying the price of the short-term negative environment but are great franchises to hold for the long term (Hermes, LVMH for example). Within the Materials sector which is also cyclical we would stick with quality growth and keep byuing Linde, Air Liquide and Sika for example. Another "hard core" Cyclical sector is Energy, which appears to be at attractive levels again. But as we mentioned above, any sign of recession will make Energy shares dip much further, otherwise they would rally back-up while providing decent income in form of dividens (4%-5%). A small position in the likes of TotalEnergies, BP and Chevron for example is warranted at these levels.
The US labor market data pointed to a continued softness, albeit without any significant worsening. First, the monthly non-farm payrolls increased by 142K in August compared to consensus estimates of 165K. At the same time, the previous two months were revised down by about 90k jobs, leaving the average monthly pace of gains over the past three months at a sluggish 116k per month. The JOLTS jobs openings number fell to a three year low, of 7.6mn , vs expectations for 8.1mn. Here the pace of softness is picking up speed, but again we will have to wait for the next two or three publications, before we really panic. What keeps the market able to sleep at night is the fact that the weekly jobless claims have not spiked higher and are stabilizing at 230-240k per week. A recession is usually associated with a spike in claims above 400k, but there are anecdotal reports that people are not filing for unemployment benefits and the weekly figure might be underestimating the true health of the labor market.
Interesting data were announced by the US Institute of Supply Management (ISM) for the month of August. As a reminder a bad ISM Manufacturing number in late July triggered the steep sell-off in equities. This time the ISM manufacturing was again worse than expected as it rose 0.4 points to 47.1, weaker than the 47.5 consensus estimates. The August data marks the fifth consecutive month in contraction (below 50) as the index rose above the 50 breakeven level briefly in March, interrupting a previous 16-month run in contraction. Looking at the main components of the index, the new orders component pushed further into contraction, falling 2.8 points to 44.6 — the lowest level since May 2023. Employment, however, showed some improvement.
The ISM Services index rose slightly higher than expected. It increased to 51.5 from 51.4 last month, a little better than the no-change expected by consensus. On the sub-index level new orders rose to 53.0 from 51.9, but the employment component declined from 50.5 to 50.2 (still above breakeven of 50.0). This is important as the Services industries had been the main contributors to the robust employment numbers in 2024 and weakness has perhaps started to show in these sectors too. Overall however, the respondents of the survey maintained a rather upbeat view on these sectors.
This week includes two major events, that could move the markets in both directions. On Wednesday we are going to receive the August US inflation numbers, just two weeks before the FED meeting. The headline number is expected to move lower to 2.6% from 2.9%, but the Core CPI is expected to stay unchanged at 3.2%. The FED is determined to cut rates, but whether it is going to be 25bp or 50bp also depends on this print. Then, on Thursday the ECB is prepared to cut rates again and offer some more color on what it is planning to do next. It is very unlikely that they will precommit to any specific path for the near future and maintain a slight "hawkish" stance. The ECB is not known to care too much about the equity sell-off until it does... Hence, one would expect that EUR bonds might lose some ground this week after the recent rally.
Chart of the Week : The US labor market is weakening: good for inflation , bad for the economy.
The above chart is produced by the US Bureau of Labor Statistics (BLS) and it shows the ratio of unemployed people per job opening. When this ratio is above 1, then the labor market is not very friendly for the job seekers as there are more unemployed people than vacancies. We can see this at its extremes during Covid or after the financial crisis in 2009, where this ratio reached its highest levels. For now, it signals that the US labor market is softening and perhaps is on the cusp of starting to being problematic. This would mean in the next six months a ratio significantly above 1 and flat or negative monthly non-farm payrolls. It is no surprise that the FED has only now decided to start cutting rates, reminding the public that it has a dual mandate : 2% inflation and full employment. It is obvious that they want to intervene now with small doses of rate cuts to provide some fuel to a slowing economy. We cannot forecast whether the labor market situation will continue worsening at the current pace, but we can safely assume that inflation should be positively impacted by much slower wage growth ahead.
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.
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• Sources: Chart of the Week : BLS , Photo: ww.forbes.com/advisor/investing/bear-market/
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