Weekly Note 2022.07.04

It’s not often that a chart deck has me looking at a chart for more than a few seconds but I found JPM’s end of Q2 Guide to Markets to be very thought provoking as it spoke to a lot of the thoughts I’ve been having in recent weeks and months and helps to put things into perspective:

SPX now trading at 15.9x forward P/E is far less overvalued than it was at the pre-covid peak of 19.2x, and when comparing against prior cycle lows, the YTD correction looks to have adequately priced for a slowdown. Considering we’ve had 2 extraordinary years of growth, I think current levels are now looking about fair given this slowdown is more of a ‘reversion’ than a true ‘recession’ that is associated with severely depressed economic activity and high unemployment.

In addition to the Forward P/E’s falling below the 25 year average, other valuation metrics are also far closer to longer-term averages.

Lack of multiple growth has dragged down equities this year but earnings growth estimates remain strong for the years ahead.

While I’m hardly an optimist, I do believe the world has/is adjusting to the ongoing challenges presented in recent years and companies will maintain a decent level of profitability going forward.

Excessive inventory buildup from suppliers to retailers ensures goods inflation has peaked, but the persistence and consumer adjustment to higher energy prices could take some time to take the pressure off households. That said, considering we’ve had a record low UoM sentiment reading in June, one could/should consider this as an opportunity when taking a 12month view.

Despite the growing concerns of excess savings drawing down, households are still in decent shape with about 10% savings drawdown of the cumulative excesses built up over the prior 2 years.

There’s also concerns with Housing bubble risks, and not just in the US. I’ve maintained the view that GSIB regulators and institutions have learned much from the former GFC and the bottom right chart is evidence of that. Prices should continue to cool off as a result of higher interest rates and higher household debt servicing burden as well as constrained lending by banks vs prior years. But I (from a layman’s POV) have not seen evidence that the current bubble will induce a crash and the kind of systemic risks we have seen from the sub-prime crisis.

To put it all in perspective, everything looks very gloomy since the beginning of the year, but from a birds-eye level, I think recession fears are overblown and we will just see some slowing that would be reasonably expected after 2 years of easy-money fueled growth. For markets however, the general trend could be a slow bleed on an absence of risk appetite up until evidence of a incoming policy pivot or economic rebound.

MAJOR HEADLINES

US

  • Atlanta Fed GDP tracker shows the U.S. economy is likely in a recession (CNBC)
  • S&P 500 closes lower for fourth straight session as stocks cement worst first half since 1970 (MarketWatch)
  • 10-year Treasury yield falls to lowest level since May (CNBC)
  • Bond Holders Look to Recession for Salvation After Vicious Half — Yields have pulled back as economic contraction risks increase, Data on jobs and wages will be focus in holiday-shortened week (Bloomberg)
  • Drivers Endure Near-Record Gas Prices During July 4 Travel — Gasoline prices drop below $5 a gallon as a record number of drivers are expected to hit the road over July Fourth weekend, according to AAA (WSJ)
  • Americans Have Had It With Inflation — Consumers are cutting back on spending as they contend with historically high inflation (WSJ)
  • Home Sellers Are Slashing Prices in Sudden Halt to Pandemic Boom — The rapid rise in mortgage rates is cooling demand, jolting markets from coast to coast (Bloomberg)
  • Has US hiring started to cool? US hiring is expected to have slowed in June, as economists bet that higher interest rates, slowing growth and a sharp pullback in stocks will have bitten into labour market growth (FT)
  • Biden administration split on whether to remove China tariffs — Some officials hope the move could ease inflation but others fear political backlash in an election year (FT)
  • FTX agrees deal with option to buy BlockFi for up to $240mn — Exchange also extends $400mn revolving credit facility to lending platform amid turmoil in crypto markets (FT)

EUROPE

  • Russia claims full control of Luhansk region after seizing last stronghold — Ukraine general staff confirms loss of Lysychansk in significant military achievement for Putin (FT)
  • Global oil prices could reach a “stratospheric” $380 a barrel if US and European penalties prompt Russia to inflict retaliatory crude-output cuts (Bloomberg)
  • Eurozone inflation hits record 8.6% in June (FT)
    UK mortgage rates rise at fastest pace in a decade (FT)
  • There’s a massive pile-up of car, furniture exports bound for U.S. and it’s spreading across European ports (CNBC)
  • Fears of recession leave €40bn of European corporate bonds in distress — Rating agency S&P warns of ‘increasingly murky outlook’ for region’s credit market (FT)

ASIA

  • Supersized Outflows From Emerging Asian Markets Have Room to Run — Taiwan, South Korea, India saw biggest outflows last quarter, Investors will remain wary given current backdrop, abdrn says (Bloomberg)
  • China Covid Outbreaks Widen as Mass Testing Finds More Cases — Cases have surged in recent days, mostly in Anhui province, Macau faces crucial week in determining lockdown fate (Bloomberg)
  • Chinese Developer Shimao Fails to Pay $1 Billion Dollar Bond — Property firms have led record wave of offshore defaults, Shimao says it’s in talks with creditors, hires advisers (Bloomberg)
  • Xi Jinping’s Suppression of Hong Kong Democracy Pushes Taiwan Further From China — Support for unification slumps as Taiwan’s self-identity grows, China’s ‘one country, two systems’ lacks support in Taiwan (Bloomberg)
  • China’s rise pushes Asia-Pacific nations to embrace Nato (FT)
  • Tesla deliveries fall due to China Covid shutdowns and supply shortages (FT)
  • South Korea to Act ‘Preemptively’ Against Rising Economic Risks — Bank of Korea chief, finance minister meet to review economy, ‘Complex’ economic risks seen lasting for considerable time (Bloomberg)
  • Traders Face Showdown With Kuroda as BOJ Policy Rips Every Asset — Funds predict more yen, JGB selling ahead as BOJ stands pat (Bloomberg)

X-ASSET SUMMARY

Recession concerns taking hold — Equities turning away from highs of recent weeks, new weekly highs in Bonds with global yields lower, Commodities apart from Crude trading at new lows, safe haven USD JPY and CHF led major currencies.

EQUITIES

Another rough week for global equities to finish Q2.

MSCI World had it’s worst month (-8.95%) since Mar’2020 (-13.41%). Remains very oversold where the sell-off could find some reprieve off last month’s low that coincides with Jan/Feb’2020 highs and 50month/200week MA’s.

Developed and Emerging markets consolidating for the 3rd straight week is showing some sell-off fatigue since the bout of strong selling at the beginning of June.

US indices has been devoid of significant bid volumes but is showing tentative signs of support as it attempts to put in a right shoulder off the May lows with some positive divergence, and closing 2–3% off the lows on Friday into a major US holiday weekend.

Defensive sectors outperformed trading to new highs while Growth and Consumer discretionary performed the worst.

SPX gamma is still deep in negative territory -5.86% from neutral level at 4027.

There is a lot of net negative gamma at 3800 and price action could get a change of complexion if SPX reclaims and heads above 3850.

SPX 3month implied correlation has gradually trended lower in the latter half of June indicating higher dispersion of single stock IV which tends to give support to the overall index performance (Green series is 3day rolling change of SPX returns inverted).

I remain constructive on Equities for early July given strong signals and selling fatigue. There hasn’t been any of the anticipated EOQ buying and perhaps we may see some of those flows early June. I’m in 2 minds on the which index I prefer — I’ve gone with a 1–2 week long position in Dow, while trading around Nasdaq longs on intra-1-2 day basis.

COMMODITIES

Commodities has been on a downtrend through June led by Energy and Industrial metals as the recession narrative takes hold. Build of inventory along the supply chain for Industrial metals should keep demand muted for the near-future,while tightness in Energy and Agricultural markets could see price begin to slow, and Precious metals to get the support of weaker US yields and I particularly like the risk vs strong potential for extended reward in Gold:

RATES

US10yr nominal yield is more than 60bp and real yield less than 40bp from last month’s highs indicating the selling of inflation expectations. As @EffMktHype explains in great detail in this thread (gotta love twitter):

CURRENCIES

Safe haven currencies and CAD led gains.

Still some decent momentum behind the USD but slowing while JPY momentum is starting to pick up following weaker global yields.

Antipodes AUD and NZD traded through prior lows but I think there some good value trading off the May lows ahead of RBNZ and a potential relief rally in the very oversold Global equities. I also continue to like the CAD given its shared strength from the USD as well as Oil and USDCAD looks ready to seek out the 1.2750 handle I’ve been attempting trades towards in recent weeks.

EUR index has benefited from the continued risk and while the outlook for EUR remains weak, GBP looks to be in decent demand around current levels and given my mildly constructive risk view, EURGBP short looks attractive ahead of Tuesday Services PMI where I’d be inclined to bet on the upside:

UK SEATED DINER RESERVATIONS 111% OF 2019 LEVEL (PREVIOUS WEEK: 127%) — ONS

It’s been very difficult to touch EMFX but with US rates starting to ease, this could take some topside pressure of these currencies. ZAR is showing tentative signs of a reversal and should the US produce a strong UPvolume day for example, I could be interested is USDZAR short trade as it struggles at the 16.40/50 area while being very overbought.

Wish you a good start to Q3!

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