2024.01.08 Weekly

Finally… the reality check

Reviewing the last few months:

• 2023.10.03 — Tactically Bullish
  2023.10.09 — SPX to new all-time-highs?
  In October I entertained the scenario that SPX could make new ATH’s and held a dip buying bias in risk
• 2023.11.20 — Edge of the acceptable range
  2023.11.27 — Trading the pain trade
  At the end of November I went neutral on risk noting the overheated rally from the lows, and rates market at severe risk of being wrong-footed after the aggressive rate cut pricing and Financial conditions making one of the fastest and steepest drops on record. This made me lose conviction on further continuation for a strong December rally.
• 2023.12.11 — Big event risks into bulled-up OPEX
  I turned tactically bearish in December as markets continued to extend and go to further overbought extremes which was compounded by a very dovish FOMC with dot plots signalling 3 cuts for 2024. That only emboldened my tactically bearish view which was still wrongly too early. Nevertheless, I posited that SPX would be fairer at 4465 (235 EPS at 19x) and would decline to those levels if earnings expectations were to be pared back.
• 2024.01.02 Weekly — 2024 to have a bumpy start
  Finally, December concluded with some strong technical setups of exhaustion across the charts, and we begin the new year with a cross-asset correction.

What now?

I stand by my bearish risk view as the extreme market expectations on earnings and rate cuts are finally being questioned.

While half of the survey respondents see earnings expectations being too high with the economy expected to gradually slow, 40% still see it being about right. That’s still a high proportion of optimism which suggests, to me, that there is still room for expectations to pare back further, particularly if macro data fails to justify the seemingly lofty expectations.

Market went onto price in almost 7 cuts by late-December and has since been pared back to roughly 6 cuts for 2024. Market still leans towards a 25bps cut in the March meeting and while there is still a lot of data to digest til then, I think the Fed will be more inclined to stay well behind the curve than to risk a potential reacceleration as a result of their policy decision to cut in March. We would need to see a substantial deterioration in data by then, which would for now, seem highly unlikely while unemployment sits at historical low levels below 4%.

To add to the risks of earnings and policy rate expectations being pared back from extremes, fresh supply-chain disruptions are driving up shipping costs again, posing a problem for the rapid disinflationary trend over the past year that was driven predominantly by the easing of supply chains and commodity prices.

Finally we have some UST supply coming in which is likely to support the bounce in bond yields and USD to further act as headwind for risk assets.

NEWSFLOW

MARKETS

• US stocks end nine-week bull run to start year with sell-off — S&P 500 ends week 1.5% lower despite gains on Friday (FT). Holiday Hangover Grips Stocks and Bonds in Worst Start Since 2003 — S&P 500 ends longest streak of weekly gains in two decades. Treasuries, corporate credit suffer worst week since October (BBG). Credit’s $240 Billion Wipeout Makes Late-2023 Rally a Memory (BBG). Traders Wrong-Footed by Dollar’s Best Start to Year Since 2011 (BBG).
• Investors reduce bets on interest rate cuts in 2024 — Stronger than expected US jobs data helps weaken case for lower rates after sharp rally in bond market (FT). Traders Pare ECB, BOE Rate-Cut Bets Further After US Jobs Beat (BBG). Forget Rates, Now Worry About the Fed Unwinding Its Balance Sheet — Discussions come as funding market showing signs of angst, Minutes show officials trying to determine unwind guidance (BBG). Fed revives investors’ hopes of end to ‘quantitative tightening’ — Officials raise end of balance sheet wind-down at December meeting (FT).
• High-Flying Profit Forecasts Head Back Down to Earth — S&P 500 earnings estimates for 2024 are too optimistic, about half of survey respondents say, citing risk of an economic slowdown (BBG). Citi Strategists Say Buy Dips, Don’t Chase Stock Rallies in 2024 — See 8% upside for global stocks and 9% earnings growth (BBG). Goldman Says S&P 500 Earnings Forecast Could Rise Further — US growth, Fed pivot, weaker dollar may boost profits (BBG). Activist investors mount record number of attacks against companies — There were 252 new campaigns globally, according to a report by investment bank Lazard, a 7 per cent increase on the previous year (FT).
• JPMorgan Strategists See Treasuries’ Rally Resuming After ‘Rest’ — JPM’s Hunter, Kolanovic see 10-year yield moving up, then down. Goldman’s Korapaty says benchmark yield likely to be around 4% (BBG). Wave of debt sales adds to January nerves in euro zone bond markets — Euro zone to digest 150 bln euros of bond sales in Jan, Issuance adds to caution after stellar rally, ECB’s wind-down of asset purchases also in focus (RTS). Bond Sales Hit Record Pace as Emerging Markets See Year of Risks — Mexico drives $24 billion issuance spree with blockbuster deal, Many junk-rated borrowers remain shut out of primary market (BBG).
• Wall Street Is Already Cutting Oil-Price Forecasts for This Year — Morgan Stanley and UBS trimmed outlooks, following Goldman, Banks see US-led supply growth satisfying slower oil demand (BBG). Saudi Arabia Cuts Oil Prices to Asia as Market Weakness Persists — Aramco cuts Arab Light to Asia by $2/bbl for February, Aramco cuts prices to all regions amid market weakness (BBG). Russian Fuel Exports Hit Eight-Month High — Fuel oil exports jumped, with more going to Africa and Asia (BBG).
• Attacks in the Red Sea Are Reconfiguring Global Trade Again — Another supply chain disruption is brewing (BBG). Maersk reroutes Red Sea ships ‘for foreseeable future’ as container rates shoot higher — Shipping company says security risk ‘significantly elevated’ while economists warn of inflationary threat from disruption (FT). Shipping blues get a hand from Red Sea disruption — Rebel attacks on ships boost share prices (FT).
• Hizbollah vows retaliation against Israel after killing of Hamas official — Hassan Nasrallah, leader of the Lebanese militant group, says the ‘crime’ will not go unpunished (FT). Hezbollah says it hit Israeli observation post with 62 rockets (RTS). Islamic State attempts a comeback (RTS). Middle East violence tests US effort to avert regional conflagration — Secretary of state Antony Blinken visits region again this week as repercussions of Israel-Hamas war expand (FT). Russian missile attack kills 11 in Pokrovsk in Ukraine’s east, rescue efforts continue (RTS). Ukraine shows evidence Russia fired North Korea missile at Kharkiv (RTS). Russia to produce over 32,000 drones each year by 2030, TASS reports (RTS).

AMERICAS

• US job cuts fall back in December but nearly double for all of 2023 — “Layoffs have begun to level off, and hiring has remained steady as we end 2023, that said, labor costs are high. Employers are still extremely cautious and in cost-cutting mode heading into 2024, so the hiring process will likely slow for many job seekers and cuts will continue in Q1, though at a slower pace” (RTS). US economy cranks out jobs at brisk clip in December; wages increase — Nonfarm payrolls increase 216,000, Unemployment rate unchanged at 3.7%, Average hourly wages gain 0.4%; rise 4.1% year-on-year (RTS). US service sector slows in December as employment plummets (RTS). Weekly US jobless claims fall to two-month low — Weekly jobless claims fall 18k to 202k, Continuing claims drop 31k to 1.855 million, Private payrolls increase by 164k in December (RTS).
• Republican voters back Donald Trump overwhelmingly to manage US economy — FT-Michigan Survey underlines challenge for Nikki Haley and Ron DeSantis in bid for GOP nomination for presidency (FT).
• Canadian service economy shrinks for seventh straight month — headline business activity index edged up to 44.6 in December from a near three-and-a-half-year low of 44.5 in November (RTS). Canada’s jobs growth stalls in December as wages accelerate (RTS). Toronto Home Sales Surge Most in Eight Months With Prices Falling — Borrowing costs have moved lower after late-year bond rally, Home prices in December were the lowest since March 2023 (BBG).

EUROPE

• Sluggish UK economy gathers a bit of pace at the end of 2023 — Services PMI stronger than preliminary Dec reading, BoE data shows net consumer borrowing strongest since 2017, Mortgage approvals also above Reuters poll forecasts, Recession risks seen receding, Economy will be centre ground of expected UK election (RTS). Slump for UK builders eases in December on rate cut hopes — construction PMI rose to 46.8 from November’s 45.5 “expectations of falling interest rates during the months ahead appear to have supported confidence levels among construction companies” (RTS). UK household incomes temporarily boosted by higher interest rates, research finds (FT). One-quarter of UK buy now, pay later users hit by late repayment fees — Financial education charity warns over risks in rise in use of products that defer or divide payments (FT).
• Euro zone inflation jump cools case for ECB rate cuts — 2.9% in December from 2.4% in November, just shy of expectations for a 3.0% reading, mostly on technical factors, such as the end of some government subsidies and low energy prices getting knocked from base figures (RTS). German inflation rises to 3.8% in blow to rate-cut hopes — Energy subsidy phaseout pushes up prices in EU’s largest economy ahead of closely watched eurozone figures (FT). Euro zone business activity shrank again in Dec, pointing to recession — Composite PMI revised up for December to match November’s 47.6 after a preliminary estimate of 47.0, but remained below 50 (RTS).
• Freeze in Europe’s Far North Unleashes Chaos as It Sweeps South — Icy weather disrupts train services in Sweden and Finland, Finnish power prices surge to an all-time high on Friday (BBG). Swedish Bankruptcies Surge to Highest Level Since 1990s — Bankruptcies are increasing again after stabilizing in autumn (BBG). Swedish Landlord Oscar Properties Hit With Bankruptcy Claim (BBG). Norway’s Weak Krone Fuels Record Year for Seafood Exports (BBG). Norway Home Prices Grow for Third Month as Rate Peak Reached (BBG).

ASIA

• China’s Dec services activity expands at quickest pace in 5 months — Caixin services PMI rose to 52.9 in December from 51.5 in November (RTS). Chinese shadow lender Zhongzhi files for bankruptcy — Property market woes have spread to financial sector and hit savers after bad loans to developers (FT). Chinese Stock Indicator With 100% Success Rate Is Flashing Buy — risk premium of Chinese stocks has reached a level that historically leads to spectacular returns (BBG). China launches new blue-chip stock index to push growth sectors — More diversified CSI A50 index gives greater emphasis to priority industries such as renewables and chips (FT). China Markets Are Betting Big on Further PBOC Easing This Year (BBG). China Air Travel Rebound to Ramp Up With Push for More US Flights (BBG).
• Aussie Dollar Faces Inflation Test After Stellar Year-End Rally — Deutsche Bank sees Aussie dollar falling to 65 cents in 1Q, Australia’s consumer inflation seen easing again in November (BBG). New Zealand May Have Entered Recession Sooner Than RBNZ Expected (BNN).
• Yen Falls as Earthquake Raises Bar for BOJ to End Negative Rates — Yen to see fresh selling pressure as January move now unlikely, Even policy change in first half seems hard: Mizuho’s Karakama (BBG). South Korea sees slower economic recovery, inflation cooldown — S.Korea cuts growth forecast, inflation to ease more slowly, Economic recovery to be led by semiconductor exports, Policies to support domestic spending, manage real estate risks (RTS). Taiwan election poses early 2024 test of U.S. aim to steady China ties (RTS).

EQUITIES

Global equities have seen a turn in trend last week following a combo a DeMark countups. Correction looks set to restest the December breakout levels around the 38.2 fib.

The more rate-sensitive Nasdaq has led declines while the Dow has remained more stable as the market seeks quality and defensive value sectors.

Following the bearishly divergent highs, momentum in mega-techs has turned negative with RSI printing lower lows with sights set on the Nov-Dec range towards the 38.2–50fib area.

MSCI US Cyclicals has retraced about 50% of the December rally while the Cyclicals-Defensives spread is already well below levels seen mid-Q4.

How bullish or bearish sentiment is often well reflected by the most-shorted stocks index where momentum has rolled over — RSI breaking lower from overbought and finished the week in bearish territory.

VIX has come off extreme lows as demand for puts is beginning to pick up indicated by SDEX, though tail risk hedging via TDEX remains muted. VX front 2 month spread is also above its 1 year average where a push higher would signal that there is much more to the correction in the indices.

COMMODITIES

Bloomberg commodities index continues to trade heavy. Though there are early signs of an attempt to base out, it could take some time given the pullback in cyclical stock sectors and sentiment observed in equities above.

The broad decline in commodities is being led by the slump in Agriculturals and Metals, which is more than offseting the recent gains in Energy.

I still remain mildly positive on Crude and negative on Gold with each having broken through their respective trendlines and momentum in Oil/Gold turning higher.

Bloomberg commodity index is also changing their weights this week that results in 3% reduction in Gold. A good number of commodity index funds track the bloomberg index and the rebalancing of which is said to put 3 billion in Gold up for sale. With yields on the bounce again, coupled with UST supply incoming, Gold looks ready to firmly retest the underside of the 2k handle.

RATES

UST’s put in a sizeable move last week with yields from the belly out shifting almost 20bps higher and dragging up real yields by about 13bps. Green line is pre-December-FOMC levels which I think 10 and 30yr yields could retest in view of more sovereign debt sales.

Citi G10 inflation surprise index

Furthermore, while inflation pressures are still persisting in some major economies, latest supply-chain disruptions could slow the (goods-economy driven) disinflationary trend that would throw more doubt on the rapid decline in inflation and policy rates that the market is pricing.

Technically, 10yr yields is set up for a further rise with 10yr nominal breaking trend and 10yr real yield recovering the breakdown. We tagged the 4.1% handle last week which was my first target, and structurally we look set to test the pre-December-FOMC levels in Green.

CURRENCIES

USD (+1.19%) and GBP (+1.13%) was the strongest last week while JPY (-1.79%) was the weakest followed by AUD (-0.42%).

Accordingly, I favour more upside in USD and downside in JPY and Antipodes. GBP on the crosses also makes for an interesting choice against the EUR (structurally vulnerable to a breakdown) and Antipodeans (momentum reversing and eyeing the October range).

For USD, USDJPY and EURUSD is my top choice. USDJPY stalled at the 50 and 100ema’s but I favour dips above the 20 and 200ma’s on the rates view above. EURUSD the most convincing technically coming off a false breakout and selling off from the supply zone around the 1.10 handle with 1.0750 area in its sight.

Playing on the strong momentum in GBP and economic data proving much better than market had feared that a UK would enter a harsher recession, GBP longs is on the radar this week.

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