Major market events 21st - 25th November
Happy Thanksgiving ! Equities likely on the sidelines while awaiting the Fed
Highlights for the week
Mon: #China Loan Prime Rates 1Y/5Y, Taiwan Export orders (YoY%), DE PPI, U.S. 2y/5Y Auctions
Tue: CA New #Housing Prices, DE 5y Auction, U.S. 7y Auction, U.S. API Crude Oil Stock Change
Wed: RBNZ Rate, US Housing Data, DE 30Y Auction, CA 30Y Auction, #FOMC Minutes.
Thur: Thanksgiving, #ECB Minutes, DE IFO, ECB Schnabel speaks
Fri: JP Tokyo Inflation, JP 40Y Auction, DE GDP
Watch U.S. Earnings, Black Friday Sales (Mastercard Spending Pulse expects sales +15% from a year ago), Japan Inflation/Auction, and RBNZ in between 50/75bps hike.
Not to Watch The World Cup. Italy is not playing.
The latest #Mastercard Spending Pulse for October (+9.5%). NB: Numbers are not inflation adjusted. Notable weaknesses in Jewelry and Luxury. On the other hand, Apparel, Restaurants, and Airlines are strong. Retail sector sales are in general not so strong.
Mastercard SpendingPulse forecasts sales to be up 15% on Black Friday from a year ago and particular department store chains could be up nearly 25% year-on-year. I think it is worth keeping an eye on consumer spending trends. Consumer spending trends (vs. expectations) could be very telling on how the next CPI numbers may look like.
In other words, I believe the Federal Reserve wants to see some material slowdown in consumer spending, before holding fire and pause hiking.
Bond Auctions & Treasury Market Liquidity
The next chart plots order book depth, measured as the average quantity of securities available for sale or purchase at the best bid and offer prices. Depth levels again point to relatively poor liquidity in 2022. In particular, depth in the two-year and five-year notes has been at levels commensurate with those of March 2020, while depth in the ten-year note remained somewhat higher than in March 2020.
Source: BrokerTec, Fed NY
The next chart, instead, plots measures of the price impact of trades. The data also suggests a significant deterioration in liquidity. The following chart actually plots the estimated price impact per $100 million in the net order flow. A higher price impact suggests reduced liquidity. Price impact has been high this year, and again more notably so for the two-year and five-year note. However, the price impact looks to have peaked in late June and July and has declined since then.
Source: BrokerTec, Fed NY
Given the poor liquidity conditions, potentially amplified in a holiday shortened week, bond auctions may create significant volatility, providing interesting trading opportunities for patient investors!
Earnings Calendar Highlights
Euro Stoxx 50
Markets are on the sidelines after the meaningful upside of the previous week, triggered by a better-than-expected CPI. This week's much-expected PPI did oblige as well - and came in lower than expectations at 0.2% vs a forecast of 0.4%. While the reaction was positive on the day, the weekly performance was in line if slightly negative with the notable exception of Europe. Quite a number of Fed Governors spoke last week, highlighting that Fed Funds rates still have to run their course and were not sufficiently restrictive, hence projecting a peak in rates on a higher level than the market is currently expecting, to 5%-7%. I really doubt it will reach the upper end of the scale, which would be very negative for Equities. On a sector basis, much angst lies within technology, with significant layoffs announced in response to a slowing economy and a slowing advertising market. Technology does seem facing a few issues exacerbated by the violent hike in rates, while the broader economy seems to have adjusted better. Governor Powell will speak again on Nov 30th and while he will be driven by data, he will certainly be hawkish, which will likely temper any market sentiment for the classic end-of-the-year cheer. Meanwhile, skeptics abound, as shown by the below chart, which shows that the put-call ratio is back to extreme levels - if the Fed pivot does materialize at some point, that is bound to come down!
Source: The Daily Shot
So far 94% of the companies in the S&P 500 have reported earnings for Q3 2022. Of these, 69% have reported EPS above estimates (which is below the 5-year average of 77% and below the 10-year average of 73%) and 71% reported a positive revenue surprise. While companies that are able to produce good returns even in a difficult macro environment are rewarded for their efforts, the discussion on rates clearly dominates the picture. We had another important data this week - the below trend PPI - which corroborates the below trend CPI of the previous week. While the picture for a Fed Pivot is starting to materialize, it obviously needs further confirmation to convince the hawkish board of Fed Governors, most of whom still think that interest rates have to run their course. We should start on a positive note, with a 50bp hike in December, which will mean that at least the Central Bank is starting to slow its pace.
The earnings season is now drawing to an end, but there are still a number of relevant companies which have yet to report, in a week shortened by Thanksgiving. Highlights this week include Zoom (Monday, After Close), Best Buy (Tuesday, Before Open), Medtronic (Tuesday, Before Open), Baidu (Tuesday, Before Open), HP (Tuesday, After Close), and John Deere (Wednesday, Before Open)
Source: Earnings Whispers
What has been so far the impact on the market of positive/negative earnings surprises? I find two charts particularly helpful in this regard. The first chart plots the average price change (from 2-day before to 2-day after the report) for different buckets of % earnings surprises.
The second chart, instead, plots the average price change around the report date differentiating between companies reporting positive EPS surprises and those reporting negative surprises. The data for the current quarter is plotted against the average price change % of the last 5 years.
On a sector basis, the two charts below highlight the average earnings and revenue change since 30 September. It is interesting to note that while EPS growth is slowing, revenue growth is holding up - so there seems to be more of an issue for the bottom line rather than for the top line.
It is curious to note that now that the Fed hiking has gone underway, companies seem to be less focused on a recession than just a quarter before. This is shown by the below chart, which sees the number of companies mentioning recession to decline relative to the previous quarter in all sectors except healthcare.
Source: Goldman Sachs Global Investment Research
Goldman Sachs has updated its forecast for the Fed Funds rate by introducing an additional hike of 25bp in May, bringing the top rate to a peak of 5%-5.25%. It mentions three reasons for this: 1) Fiscal tightening has finished 2) Inflation could remain higher than expected 3) Market overreactions might ease financial conditions. There seems to be a very strong correlation between monetary policy conditions vs the yearly returns of the SPX, which reinforces our view that the future near term of the equity world is firmly in the hands of the Fed, which is likely to dampen its enthusiasm in its fight against inflation.
Source: Real Investment Advice
At the same time, valuation has bounced slightly above the 10-Year average, with a P/E Ratio of 17.2 vs 17.1, while still below the 5-Year average of 18.5 as shown in the chart below:
The discrepancy between the GDP forecasts of the Atlanta Fed and of the Blue Chips is quite significant. The Atlanta Fed, on a macro level, still sees a much stronger growth than the companies see at a micro level, and hence is worried about inflation. At a certain point, the two forecasts will need to converge. So far the market has been in favor of the Atlanta Fed, with stronger than expected growth, in spite of the Fed's hiking cycle.
Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts
Finally, the CPI and the possible perspective of a Fed Pivot have turned the equities flows back in positive territory. Now there are real alternatives for investors, but equities will likely regain their lustre as interest rates get down.
Source: BofA Global Investment Strategy, EPFR
So a positive PPI followed in the footsteps of the CPI the previous week, giving equities some respite. The market traded sideways, digesting the significant upside of the previous week. Near term - before Governor Powell's speech on Nov 30 the market is likely to be dominated by the discussion on rates. On a tactical basis, we would advise closing the trade which we began prior to the CPI by the end of the week, in anticipation of some hawkish remarks from Governor Powell. On a single-stock basis, we would take advantage of any bounce in the market to reduce/sell the position and invest the proceeds in bonds. On a rule of thumb, bond yields getting to 4% or whereabouts increases our preference for holding bonds vs equities and vice versa. Still, we would highlight that the sharp decline of the equity markets (especially in growth) has been bruising this year, and we will expect them to make up at least some of the lost ground as soon as there is more clarity on rates, inflation and recession, and the Fed will reduce or pause its hiking cycle. Tactically we would advise buying bonds on any dips, which may be triggered either by the numerous bond auctions which will take place next week, or right in the aftermath of the FED's minutes. Probably a gradual approach would be the wisest.
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