2023.01.30 Weekly note

Risk rally skating on thin-ice

Starting to lean bearish after what’s been a great start to the year…

Thanks to the few I’ve been having discussions with, here are just a few of the many discussion points guiding my change of view:

• Cost-cutting focus: from what’s becoming more apparent from the early half of the earnings season is that, companies are shifting their focus on preserving margins (even TSLA who is likely to be benefit from greater economies from the scaling up of production said their full focus is on costs and operational margins). Companies are clearly worried about future profitability with staff retrenchments being clear evidence of that, and if margin/revenue expansion is what drives stock prices, this does not paint a good picture for sustained stock returns.
• Rising wages: taking a broad look look at the global economy, real incomes have stayed too low for too long and the period of high inflation has brought about what I have referred to as ‘The Great Adjustment’ in my 2022.09.05 note. We are seeing these wage adjustments higher literally everywhere across the world particularly at low-income levels. Despite declines in recent economic data, consumer spending remains resilient particularly in service sectors where prices are much more resistant to coming down such that if wage inflation continues to persist even at a modest level, then inflation is likely to prove sticky and unlikely to drive interest rates lower.
• Too dovish too soon: with the rates market increasingly focused on the start of the next easing cycle with cuts being priced in for as early as mid-year, this sets the market up for a bigger disappointment then it would benefit from vindication. Add the growth-impulse from China to the above points and we have an even stronger case for economic resilience and sticky inflation. So at the current juncture, it seems too premature to believe in cuts with any conviction for 2023, let alone mid-year.

NEWSFLOW

MARKETS

• Stocks close higher Friday, Nasdaq posts fourth week of gains (CNBC). Short Sellers Feel the Pain in Stock Market’s 2023 Rally — Highly shorted shares are beating the S&P 500 this year, and short sellers are down by $81 billion (WSJ). NYSE Glitch Causes Erroneous Prices in Hundreds of Stocks — Trading in stocks of companies such as Exxon, McDonald’s and Walmart was temporarily frozen (WSJ).
• The Bond-Market Comeback of 2023 Is Heading to First Big Test — Treasuries rallied in January on bets Fed hikes nearing an end, Fed meeting, key economic figures will show if wagers correct (BBG). The Fed and the stock market are set for a showdown this week (MarketWatch). How High Will Rates Go? This Coming Week’s Fed Meeting May Offer Strong Clues (WSJ). It Won’t Take Much for the ECB to Crush Rate-Cut Bets Next Week — Optimistic pricing on rates is ‘not coherent,’ SocGen Says; ECB seen most hawkish as Fed, BOE also hold rate meetings (BBG). The Fear of Being J. Crewed Is Once Again Roiling Leveraged Loans (BBG).
• Tesla just had its best week since May 2013 (CNBC). Tesla Has Become One of the Hottest Stock-Option Trades on Wall Street — Electric-vehicle maker breaks record Friday, accounts for nearly 13% of all options trading (WSJ). Tesla Seeks Rapid Output Boost as Profit Beats Estimates — EV maker plows ahead with expansion, counters demand concerns, CEO takes umbrage with question about his use of Twitter (BBG). Tech stocks are having their best January in decades — here’s why that may not be a good sign (MarketWatch). Amazon, Apple, Alphabet Headline Another Busy Earnings Week — Ford, McDonald’s, Pfizer join tech titans in providing quarterly updates, as layoffs spread and growth slows (WSJ). What CEOs Are Saying: ‘The Consumer Is Under Pressure’ (WSJ).

US

• US economy beats expectations with 2.9% growth (FT). Spending Fell 0.2% in December as Inflation Cooled (WSJ). Recession watch: US economy is on shaky ground (MarketWatch). Jobless Claims Fall, Pointing to Still-Tight Labor Market (WSJ). The Jobless Rate Is at a Half-Century Low. In These States, It’s Even Lower (WSJ). Small-Business Hiring at Odds With Fed Strategy — “Small businesses are literally holding up the labor market,” responsible for all of the net job growth in the U.S. since the onset of Covid-19 and account for almost four out of five available job openings (WSJ). Fed Debates Whether Wages or Low Unemployment Will Drive Inflation — Easing price, wage data are at odds with concerns that the job market is too tight and the economy is operating above capacity (WSJ). The shock of mass lay-offs is only the beginning for companies (FT). Companies Cut Temp Workers in Warning Sign for Labor Market — Employment through staffing firms has fallen for five straight months; similar pullbacks have preceded recent recessions, a sign that broader job losses could be on the horizon (WSJ).
• Biden-McCarthy Debt Limit Meeting Set for Wednesday — Republicans have insisted they wouldn’t move on the debt limit unless they could cut spending, while Democrats have argued it would be irresponsible to tie contingencies to raising the debt ceiling. McCarthy said when it comes to spending priorities, he wants to work with Democrats to pass a budget. “You cannot continue the spending that has brought this inflation,” he said. “We’ve got to get our spending under control.” (Barrons). ‘I’m more angry now’: Trump returns to campaign trail for 2024 race (FT). GOP Leadership Battles Expose Divisions in 2024 Battleground States — Some Republicans are calling for a break from Trump-style politics after disappointing midterm election results (WSJ). Can the GOP Become a Real Working-Class Party? — Some Republicans want the party to break from its longtime free-market agenda and focus instead on the needs and frustrations of workers. Others see danger in moving away from the legacy of Reagan (WSJ).
• Microsoft Bets on AI as the ‘Next Wave’ Amid Slowing Growth (BBG). ChatGPT Spotlights Microsoft’s Early Efforts to Monetize AI — Company has pledged billions more for OpenAI, the company behind the chatbot (WSJ). OpenAI Needs Billions to Keep ChatGPT Running. Enter Microsoft — The enormous processing capacity needed to run modern AI systems is shaping their technical development and business model (BBG). Companies Tap Tech Behind ChatGPT to Make Customer-Service Chatbots Smarter — Some businesses are figuring out how to harness the buzzy technology to improve online chat functions, though executives are wary of AI’s tendency to get things wrong (WSJ). Intel stock tumbles after brutal results (CNBC).
• Meme-stock groups have raised $5bn in 2 years since trading frenzy — Cash bonanza enabled by retail investors fails to boost beneficiaries’ performance (FT). Bed Bath & Beyond Falters in Effort to Find Buyer in Bankruptcy — Company is preparing for bankruptcy without bidder in place, Retailer is on a path toward liquidation unless buyer emerges (BBG). Bed Bath & Beyond to Close 87 More Stores, Harmon Chain as Restructuring Options Narrow — Home-goods retailer is facing a cash crunch and is expected to file for bankruptcy soon (WSJ).

EUROPE

• UK Wage Inflation Points to Another Big Rate Hike This Week — Bank of England expected to raise key rate to 4% on Thursday, Policy makers are concerned about an inflationary spiral (BBG). Investors wait for signs the Bank of England’s heavy lifting is done — Rate rise is factored in but analysts are split on when the economy will have cooled enough (FT). U.K. Prime Minister Fires Top Official Over Tax Probe — Rishi Sunak removes Conservative Party Chairman Nadhim Zahawi for failing to disclose tax investigation (WSJ).
• ECB Rate-Hike Week May Feature Slowing Inflation, Stalling GDP — Consumer-price growth is predicted to have slowed this month, Euro-zone GDP splits economists over possible contraction (BBG). Germany Sees Its Economy Growing This Year Despite the Ukraine War — The government now thinks Europe’s largest economy might avoid a short recession altogether this winter (WSJ). Here’s What Can Go Wrong for Europe’s Powerful Equity Rally — Ukraine war, weak earnings, hawkish ECB may spur declines, Strategists also see risk from recession, uneven China rebound (BBG).
• Russia Tightens Grip Around Bakhmut as Ukraine Awaits Western Tanks — Ukrainian troops say Russia has numerical advantage as its invasion forces try to surround eastern city (WSJ). Defense Minister Wants ‘Game Changer’ Aircraft (BBG). Scholz rules out sending fighter jets to Ukraine (FT).

ASIA

• Adani shares plunge further as it weighs legal action against short seller firm (CNBC). Adani Faces One of Worst Billionaire Wipeouts With Empire Under Siege — The fallout from Hindenburg’s short-seller report is reverberating across the Indian tycoon’s sprawling business interests (BBG). Adani’s 413-Page Hindenburg Reply Aims to Calm Before Share Sale — Says Hindenburg’s conduct is ‘calculated securities fraud’, Calls it attack on India, Indian institutions and ambitions (BBG). Adani Risk Clouds Wall Street’s Star Emerging-Market Bet — Selloff in Adani Group weighs on nation’s broad market, Sensex index trades at a premium versus emerging markets peers (BBG). Ackman Says Banks Face Too Much Liability Exposure on Adani Deal (BBG). Record Adani Share Sale Seen Going Through Amid Hindenburg Claim — Abu Dhabi sovereign wealth fund among anchor investors in sale (BBG). Adani’s Abu Dhabi Backer Says Business Decisions Based on Facts (BBG). India’s Budget to Test Modi’s Fiscal Resolve Ahead of 2024 Vote — Modi’s been chipping away at subsidies, except during pandemic, Fiscal pressures could arise from elections: Fitch Ratings (BBG).
• Israel promises swift response to synagogue shooting (RTS). Iran Says Drone Attack Behind Blast at Defense Ministry Site (BBG). Drones target Iranian military site in Isfahan — Tehran acknowledges attack but stops short of attributing blame (FT). Israel appears to have been behind drone strike on Iran factory, U.S. official says (RTS). Israel to strengthen West Bank settlements and loosen civilian gun laws (FT). EU to consider listing Iran’s Revolutionary Guards as terrorists — France and Germany endorse policy push despite risk of scuppering nuclear talks (FT). Reports of Torture, Unfair Trials in Iran Trigger Fresh Alarm Over Fate of Protesters (BBG). Azerbaijan Accuses Iran on Security After Gunman Attacks Embassy — One security guard killed, two more wounded in Tehran assault, Azerbaijan plans to evacuate staff from embassy after attack (BBG). Drones attack convoy in east Syria coming from Iraq (AP).
• China’s comeback turbocharges base metal prices — Industrial commodities, led by tin, have surged more than 20 per cent in three months (FT). Bull Market Beckons China Stock Traders as Consumption Revs Up — Travel and box office data show recovery in consumer spending, Beneficiaries include hotels, restaurants and tour operators (BBG). China targets consumption in bid to drive growth (FT). China’s record $2.6tn rise in savings fuels ‘revenge spending’ hopes (FT). China PBOC Extends Monetary Policy Tools for Green Sector — extend the use of three monetary policy tools designed to encourage financial institutions to support green technologies and the logistics sector (BBG). China’s Top Nuclear-Weapons Lab Used American Computer Chips Decades After Ban — State-owned institute continued buying Intel- and Nvidia-made chips despite inclusion on a U.S. export blacklist in 1997 (WSJ). Netherlands and Japan join US in restricting chip exports to China (FT).
• IMF warns of market impact of abrupt Bank of Japan policy change — Fund points to ‘significant upside risks’ to inflation and calls for flexible approach to controlling bond yields (FT). ‘No margin for error’: Bank of Japan’s next chief faces daunting challenge — Haruhiko Kuroda’s successor must steer economy towards interest rate normalisation (FT). Amundi Fund Takes BOJ Capitulation Trade to Currency Market — fund manager at Amundi is scaling back a winning trade betting against Japanese government bonds even though he expects the central bank to eventually abandon its policy of keeping yields anchored (BBG). Rakuten Prices $1.9 Billion of Yen Debt in Liquidity Boost — sold 250 billion yen ($1.9 billion) of bonds on Friday, giving the company an important injection of liquidity after it was cut further into junk by S&P Global Ratings last month (BBG).
• South Korea’s pension fund forecast to run out in 2055 as demographic crisis hits — ageing population and underemployment add to pressures as Seoul pushes for reform (FT).

EQUITIES

Equity markets are back to key technical areas that could offer a potential pivot back towards a bear-trend …

Global equity markets have retraced ~50% of the last sell cycle …

Developed markets (EFA, mostly weighted towards Europe and Japan) and Emerging ex-China (EMXC) are also around fib retracement levels, 61.8 and 38.2 respectively …

European equities now not too far off all-time-highs are showing some vulnerability having struggled to extend gains since mid-January …

China equities are back to the 50fib region potentially offering technical reasons to take some profits after the big rebound.

US equities have been putting in a stern test of the recent area of interest going back to the middle of last year …

Dow Transports, and Homebuilders relative to REITS (as ‘cyclical’ indicators) is showing signs of peaking …

while relative performance of Financials and Industrials against the S&P are already on the turn …

furthermore, the strong correlation between ES and the ‘Most Shorted Index’ shows the rally to be a short squeeze rather than an organic one.

COMMODITIES

Momentum in commodities turning lower with the Bloomberg commodities index stalling for the back half of the month, largely owing to the slump in Energy prices as supply-side news points to maintaining a robust level of output by producers, as well as warmer weather after strong production growth impacting Henry Hub natural gas prices.

Rally in Precious and Industrial metals also looks to be running out of steam, while food prices have rallied strongly which appears to be attributable to adverse weather conditions and Avian flu in the US.

RATES

Nominal yields moderately higher last week while TIP yields softened resulting in higher inflation breakevens.

Price action in Treasury ETF’s showing signs of rolling over with head and shoulder patterns visible on the lower tf’s, and …

similar observations can also be made in Credit ETF’s.

CURRENCIES

Broadly seeing indecision in the price action of the equal-weighted G8 indices:

• EUR upside continues to be in a stall
• CHF trading heavy into recent support
• USD drifting lower but in noticeably smaller increments
• JPY heavy despite hawkish BOJ expectations
• GBP unable to push higher after a strong rally the prior week
• AUD strong rally but into resistance area
• NZD printing a weekly doji

Charts suggest to me that USD is ready for a rebound with the trading range contracting and DXY putting in the 2nd consecutive Doji last week.

JPM EMFX indices also showing signs for a correction in EMFX after the breakout rally from of it’s 1.5yr trendline at the start of the year.

TRADE VIEWS/IDEAS

To wrap up, Newsflow has been generally been on the negative side in view of rising tensions in the Middle East, as well as the intense scrutiny on India’s Adani Group which, if allegations turn out to be true, could wipe out $10’s of billions in market cap that would put it on the scale with some of the world’s biggest bankruptcies.

Charts are also offering a potential inflection point for risk — Equities looking increasingly vulnerable to a pullback, Commodities stalling, Rates showing signs of a potential sell-leg, and Currency charts look poised for a USD rebound.

Given the techincal picture ahead of what will likely be a very volatile week, I see downside risks being significantly greater than upside risks to new market developments and also expect Powell to pushback aggressively on the idea of rate cuts, much of which (among other reasons) has fueled the optimistic sentiment in US equities. As a result, I expect the USD to lean on the front-foot from shorts unwinding this week, and will be focused on short Equities and long USD themes heading into the new month.

That’s it for this week —have a safe week trading!

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