2023.11.07 Weekly Notes

A cushioned-landing?

Global equities have put in a momentous bounce — the best week in almost a year which begs to question — how far can it run?

This week I take a look at the technical structure of equity markets with their respective forward P/E charts to gauge what levels can we get to til they get questionably expensive, and particularly interested in prior pre-recession/fed-tightening periods as reference points. On a rough glance, I’d say there could be as much as a couple multiples of upside.

I also assume bad news will keep being good news for the market, though I suspect we are soon approaching the point where that changes and markets turn increasingly sensitive to growth concerns, impact of higher unemployment and housing bubbles unraveling, rather than simply the cost of money. So while bad news is good news, not so bad news is now probably great news.

My peers will know how I think US equities could put on a big rally (even possibly as far as new all-time-highs as discussed over the prior month) if the US economy can strike the right balance between data softening and inflation and wage pressures normalising in a moderate and timely manner — effectively leading to a ‘cushioned’ landing. Sure — that may be a tough ask since history has shown the inevitability of high policy rates feeding through to the real economy and ultimately leading to high joblessness and an economic recession. For the US however, this has yet to have materially manifested (as the hard vs soft data dichotomy has shown) nor shown much clarity about how severe the downturn would be. For other major economies, outlook may be far gloomier, but the question remains on how potentially brief and moderate that global recession might be in the post-GFC and Covid world.

For markets that has been very much focused on higher-for-longer, now seems to have found (higher-for-shorter) optimism on how soon rate cuts will come, and maybe just how brief and mild the eventual downturn could be. In my view, that seems to be the dominating sentiment for the moment and we’ll just have to roll with that as we await new market developments.

NEWSFLOW

MARKETS

• Wall Street records best week in a year after US jobs growth slows — Stocks and bonds rally on hopes that Fed will call time on raising interest rates (FT), S&P 500 has best day in six months after dovish messages from central banks (FT), European Stocks Cap Longest Winning Run Since July on Fed Hopes (BBG), Emerging Market Assets Have Best Week Since July on Fed Boost (BBG).
• US Federal Reserve holds interest rates at 22-year high (FT). The new question for the Federal Reserve: how long to keep rates high — Chair Jay Powell says US central bank will proceed ‘carefully’ with any change to monetary policy (FT). The risks are shifting — the softening is real, a hiring slowdown… without a layoff wave, wage Growth is close to where the Fed wants it (EmployAmerica). Slowing US jobs growth fuels belief that rate rise cycle is ending (FT). US Yields Dive After Jobs Data as Traders Move Up Rate-Cut Bets — Markets now see the Fed’s first cut in June, instead of July (BBG). Dollar Sinks to Lowest in 6 Weeks as Traders Trim Fed Rate Hike Bets — Soft US jobs report pushed markets to move up rate cuts, Gauge of US currency poised for worst week in three months (BBG).
• US Treasury to slow pace of longer-dated debt issuance — Borrowing plans announced over summer helped push government bond yields to multiyear highs (FT). Goldman Sees Bonds Beating Cash for the First Time Since 2020 — USTs start to offer attractive entry point (BBG). Franklin Templeton Sees US Yields Over 5% as Buying Opportunity — Manager started extending duration with yields at 5% (BBG). China leads record central bank gold buying in first nine months of year — Central banks in emerging markets look to reduce reliance on US dollar for reserves holdings (FT).

ISRAEL-HAMAS WAR

• Hizbollah leader says ‘all possibilities’ still open in hostilities with Israel — stops short of declaring all-out war after skirmishes along Lebanon’s border (FT). Hezbollah Warns on Escalation, US Discusses a Hostage Release Framework — ‘The temporary ceasefire when two American women were freed by Hamas last month was a template for a longer one’, Netanyahu Says No Cease-Fire Without Hostage Release, Blinken Says His Focus Is Protecting Palestinian Civilians (BBG). Hamas Demands to Get Fighters Out of Gaza Delayed Evacuation Deal (BBG). [Good summary Hezbollah leader Nasrallah’s speech]
• U.S. and Israel Split Over Gaza Goals, Muddying Endgame (WSJ). Biden hints at progress on persuading Israel to pause attacks; protests in major cities around the world (CNBC). Israel’s allies shift away from unconditional support — US, Europe and Latin America express rising concerns about humanitarian situation in Gaza (FT). Israel’s Fight With Iran Proxies in Syria Poisons Russia Ties — Israel steps up Syria strikes and isn’t always warning Russia, Strikes may also turn Syria into new front in Israel-Hamas war (BBG). ‘Bibi’s finished’: Benjamin Netanyahu loses core support after Hamas assault on Israel (FT).
• Goldman Sachs says the Israel-Hamas war could have major implications for Europe’s economy (CNBC).

US

• U.S. payrolls increased by 150,000 in October, less than expected (CNBC). US Continuing Jobless Claims Rise for Sixth Week (BBG). ADP Private sector payrolls rose 113,000 in October, less than expected (CNBC). Labor costs show surprise decline in the third quarter — Unit labor costs, a measure of hourly compensation against productivity, fell -0.8% (vs +0.7% expected) for the July-through-September period (CNBC).
• US Unemployment Rise Is on Verge of Triggering Recession Rule — Sahm rule posits the start of a recession when the three-month moving average of the unemployment rate rises by a half-percentage point or more relative to its low during the previous 12 months (BBG). Unions Are Winning Big for the First Time in Decades — For the first time this century, unions aren’t on the defensive. In fact, they’re winning big (BBG).
• US Services Growth Slips to Five-Month Low as Activity Softens — ISM services PMI decreased by 1.8 points to 51.8 in October, Gauge of services employment falls by most since April 2022 (BBG). US Home Prices Set Record With Seven-Month Streak of Gains — Cities including New York, Atlanta and Boston reached records, Tight supply has propped up prices in many US cities (BBG). US Housing Market Has Become an Impossible Mess — Americans with cheap loans don’t want to sell. Those without homes can’t afford to buy (BBG). S&P Runs Stress Tests on US Mid-Market Private Credit Borrowers — Report analyzed 2,000 credits in the US to test resilience, Worst case scenario sees 75% of firms struggle to make profit (BBG).

CANADA

• Macklem Says Neutral Rate Likely Drifting Higher in Canada — Cites higher deficits, aging societies and energy transition, Bank of Canada left neutral rate estimate unchanged in April (BBG). Canada’s Economy Is on Track to Enter a Technical Recession — Business confidence is at recession levels (BBG). Scotiabank’s Holt Says It’s Too Early to Call Canada Recession — after preliminary third-quarter gross domestic product data pointed to a second straight quarter of contraction (BBG).
• Canada Posts Meager Job Gains, Unemployment Climbs to 5.7% — Economy adds 17,500 jobs, missing expectations for 25,000 gain (BBG). Toronto Home Prices Fall Most in 15 Months as Rates Rise — Number of sales declines to levels last seen in market freeze, Large volume of listings may also be pressuring prices (BBG). Bank of Canada’s Rogers Urges Shift by Banks on Fixed-Payment Mortgages — Variable-rate mortgages with fixed payments need ‘close look’, Signs of mortgage stress add to downside risk for economy (BBG).

UK

• Bank of England warns UK faces stagnating economy as it keeps rates at 5.25% (FT). BOE’s Bleak UK Outlook Lifts Bets on Sharp Rate Cuts in 2024 (BBG). Andrew Bailey vows to hold the line on inflation in face of sickly UK outlook (FT). BOE Official Suggests UK Unemployment May Need to Reach 6% — Policy makers concerned tight labor market feeding inflation, Remarks underscore BOE’s bias toward further rate hikes (BBG).
• Company insolvencies in England and Wales at highest level since 2009 (FT). UK Property Slump Causes Surge in Firms in Financial Trouble (BBG). UK’s corporate profitability fell in second quarter — ONS data appears to back Bank of England’s view that ‘greedflation’ has not been behind higher consumer prices (FT). UK shop price inflation falls to lowest level in more than a year, data shows — declining cost of homegrown food behind improvement (FT). National Living Wage Could Rise by More Than Expected — Report (BBG).
• Starmer Shifts Labour Focus to UK With ‘Big Build’ Pledge — Sets out agenda days before government does in King’s Speech, Still faces questions about party splits over Israel-Hamas war (BBG).

EUROPE

• Euro-Zone Inflation Sinks to 2-Year Low as Economy Contracts — Consumer prices up 2.9% from year ago in October; est. 3.1%, 3Q GDP fell 0.1% from previous quarter as rate hikes weigh (BBG). Eurozone inflation falls more than expected to 2.9% — Lowest rate for more than 2 years bolsters expectations that ECB will not raise rates further (FT). Eurozone unemployment rises from record low to 6.5% — Signs of weakness in labour market could relieve inflationary pressures in 20-member bloc (FT). ECB Can’t Close Door to Further Rate Hikes, Schnabel Says — ‘Inflation expectations fragile’, ‘may take about two years to get inflation to 2%’ (BBG). ECB’s Knot Says Current Policy Is ‘Good Cruising Altitude’ (BBG). Europe’s Great Housing Crisis Is Only Getting Started — A collapse in home building threatens to intensify shortages for years to come (BBG).
• Norway Keeps Rate Steady and Signals Last Hike in December (BBG). Norway House Prices Rise, Defying Central Bank View — prices rose for the first time in three months in October, in contrast with the central bank’s projections of continued weakness until next year (BBG). Norway Seafood Exports Hit Record as Krone Boosts Salmon Income (BBG).
• Swedish Bankruptcies Hit Highest Level Since at Least 1999 — Construction, retail and hospitality are the worst hit sectors, Higher borrowing costs have hit the Swedish economy hard (BBG). Swedish Home Prices Fall Again in October, Down 14% From Peak (BBG).
• Swiss Inflation Holds at 1.7%, Boosting Case for Rate Pause — Consumer price growth matches prior month, economist estimate, Central bank has warned that more rate hikes can’t be excluded (BBG). SNB’s Jordan Warns That House Prices in Switzerland May Drop (BBG).

ASIA

• China’s factory activity contracts in blow to economic momentum — Stronger growth figures for third quarter had buoyed hopes that recovery was turning a corner (FT). China’s Caixin PMI Drop Adds to Signs of Economic Fragility — Survey mirrors official gauge showing factory activity shrank, weak data reinforces case for more stimulus (BBG).
• BoJ announces 1 per cent cap on 10-year yields would now be understood as a reference rate — muted investor reaction to its decision has been a relief to the central bank, which has to loosen its grip on bonds gradually to avoid causing ructions in an international market worth trillions of dollars. But there is still a long way to go before the BoJ gets out of another policy that is now considered an anomaly: negative interest rates, which make it the last big central bank still clinging to one of the tenets of its ultra-loose monetary policy. UBS expects the BoJ to lift negative interest rates in April while Goldman Sachs forecasts the change to occur in October (FT). Japan’s FX Chief Says Still on Standby to Take Action If Needed (BBG). Japan’s PM Fumio Kishida bets on $113bn stimulus to tackle inflation pain — Tax cuts and cash handouts fail to convince public and could complicate central bank’s policy unwinding (FT).
• South Korean Exports Return to Growth in Boost to Outlook (BBG). Bank of Korea Sees Inflation Outpacing Projection as Risks Rise — Price pick-up contrasts with earlier expectation for slowdown, Mideast conflict adds to uncertainties over inflation (BBG).
• Australia seeks reset with Xi Jinping while balancing ties with US — Anthony Albanese makes state visit to China as tensions over trade ease (FT). IMF Urges Australia to Tighten Policy Further to Quell Inflation — Says fiscal-monetary authorities need to coordinate efforts, Calls for state, federal governments to slow infrastructure (BBG).
• New Zealand Unemployment Rises to Two-Year High, Wages Slow — Kiwi dollar falls on weaker labor market inflation impulse, It’s ‘further evidence that no more rate hikes are needed’ (BBG). RBNZ Says Full Impact of Interest-Rate Hikes Still to Be Seen (BBG).

EQUITIES

ACWI retraced back to its key long-term averages, and trading slightly above the key pivot and 15x which looks reasonable for the time being based on my opening comments.

ACWX also has some room until nearer the 15x level. Could it be that 1yr+ ex-US growth expectations are around the lower-end for now? Don’t see why it can’t be if US yields and dollar continues to ease off.

SPX put in a monster recovery which coincided with one of the biggest weekly falls in long-end yields. And like it has done in recent history, the rally tends to have legs in the following weeks. Both a recovery of the breakdown of trendline support starting from Oct’2022 and, breakout of the nearest observable trendline implies a technical objective above 4500.

As expensive as PE multiples are atm, can these strong valuations be justified? Is there a better market to invest in than the US and paying a premium for doing so? Outside the mag7 there’s plenty of good value out there too, so why not?

Valuations could be considered expensive by historical standards, but while other economies are far less resistant to the rapid tightening in monetary policy, strong US valuations on a relative basis could well be justified, pariticularly if data continues to point in the right direction.

EAFE developed markets chart has the feel of high retracement risk, but a look at average fwd-P/E suggests to me it could go back towards 15x before it can be firmly questioned by further incoming data.

European equities makes up the biggest portion of the EAFE index and on it’s own, looks far less convincing technically. P/E looks reasonable given their far gloomier economic data and prospects for next year and perhaps a return above the 12x region where it has been roughly averaging over the past decade is not completely out of the question should data not overly surprise to the downside. In fact, EUR economic surprise index has been coming out of extreme pessimism since July.

Japan is the other major EAFE developed market index component has recovered to within a few% of all-time-highs with fwd-P/E holding up around its 10yr average. New stimulus measures (tax cuts and cash handouts) as well as the possibility of repatriation flows from the potential exit from NIRP could act as positive tailwinds for Japanese markets.

Emerging markets are now trading above a very critical level around the $38 mark and think there is potential for a recovery towards the 12.5x region so long as broad USD strength continues to ease off and China keeps the pedal on its stimulus initiatives.

China equities are historically cheap below 10x and the chart is showing great potential for a recovery — a breakout of the closing basis trendline on the daily chart would imply a technical objective to ~3473.5 which coincides with the 200ema and 50% retracement level. Latest factory and PMI numbers have failed to keep up the momentum from prior months, but I would expect China to continue inching off rock bottom as well as hear of more stimulus measures than not.

India is a curious market not that I have much to comment on, but probably worth observing given how exceptionally strong it has been trading in recent years and as it looks to cover above this key pivot zone around 19300.

Korea equities found a strong bounce from this key pivot region after selling off almost 15% from the July peaks. Earnings expectations has greatly improved making it appear considerably cheap within a short space of time.

RATES

Big move in bonds yields dropping more than 25bps last week.

BERT model has move into the Recession quadrant as a result of the big move lower in 10yr nominal yields, but …

5yr 5yr-forward inflation expectations holding up well against the move suggests growth expectations hold firm against the fall in real yields. This should help to keep USD strength under wraps and support the bounce back in risk.

COMMODITIES

Bloomberg commodities index is carving out a bullish consolidation …

and appears to be stemming from Agriculturals and Industrial metals making breaks higher while precious metals and energy has been broadly sideways the past month.

My interest is drawn to the more constructive action in metals as I question whether AUDUSD can recapture the early-2023 range above the 0.66 handle and 50% fib. Inflation still persists in Australia and a hawkish RBA this week could certainly help to support another >1 handle move higher while CFTC speculators are still deeply net short.

I’m also drawn to Crude which I think is approaching the lower end of its eventual trading trading into year-end to look at potential dips to buy into, as well as its implications for long petro-currency ideas.

Expectations for narrowing supply/demand gap could soon be seen to have been fairly priced given the reversion of backwardated prices in the front 2month contracts and could find a footing while USD pullsback and risk rebounds. For petro-currencies, MXN trades well but understandably less so for NOK and CAD where I think there is already a lot of negativity in the price. If Crude finds support while Norwegian Salmon exports continue jump to higher record levels, NOK might just muster a rebound in the aftermath of last week’s weak data and Norges bank.

CURRENCIES

• USD the weakest performer last week and I expect the pullback to continue as longs cover and fresh shorts come in on recent developments.
• JPY weakness is rather telling after last week’s move in yields. I noted last week that I am beginning to warm up to the idea of JPY longs, but the reaction has splashed some cold water on that sentiment while the BoJ continues to take their sweet time to exit NIRP.
• CHF looking very toppish though there is the risk it can go bid again should the Isarel-Hamas conflict heat up dramatically. That is, however, looking highly unlikely and I’d expect the pullback to have legs as sentiment firms up.
• EUR has been favoured to fund higher betas but I’m still torn on whether to go completely with the USD or with the EUR for the short side. I do think broad USD strength is done but I also think it won’t make too much sense for the EUR to meaningfully outperform the USD with ECB looking far more likely to cut sooner than the FED. On the other-hand and perhaps more critical —strong risk appetite and equally weak appetite for the USD could see EURUSD continue higher until that fades. I therefore now lean more towards USD funding than I did EUR previously and could see EURUSD make its way towards 1.09s.
• GBP index is proving resilient despite the data and BoE painting a very gloomy outlook. GBPUSD long and EURGBP short continues to be of interest to me and I can see a cable heading towards 1.26 and EURGBP towards 0.86.
• AUD I continue to like for reasons mentioned in the commodities section above. NZD could also perform following the rebound in risk assets and dairy prices, but with Kiwi growth picture proving more challenging, I maintain a preference for AUD.
• CAD could be a viable candidate for the shorter-term mean reversion trades post a data release or dovish BoC minutes this week for example but as with NZD, it is difficult to get behind a currency that is skittering towards recession.
• EMFX being sensitive to US rate moves should continue to rally. JPM EMFX index chart suggests to me that there is still ample room above:

• MXN starting to look a little extended and my preference is towards ZAR for fresh positions. Mexican inflation data is expected to come in on the soft side and I would consider buying dips should there be one while equities stays poised to push on higher.

That’s all for now, good luck trading!