Giorgio "Joe" Vintani
Stocks mostly resilient, rates fall, and bonds have a positive week; violent UST 2YR yield drop. Nasdaq shines. CPI and PPI point to declining inflation. Fed Interest Rate Decision on Wednesday, BoE on Thursday.
Major market events 20th March - 24th March 2023
Highlights for the week
Mon: German PPI, ECB President Lagarde Speaks.
Tue: German ZEW Economic Sentiment, ECB President Lagarde Speaks, US Existing Home Sales.
Wed: UK CPI, ECB President Lagarde Speaks, Fed Interest Rate Decision.
Thur: SNB Interest Rate Decision, BOE Interest Rate Decision.
Fri: UK Retail Sales, German Manufacturing PMI, UK PMI, US Core Durable Goods Orders.
Euro Stoxx 50
A crazy week with huge swings in both equities and fixed income; in the end equities are mostly up (with the notable exception of Europe, due to Credit Suisse's crisis) and bond yields are mostly down. Massive de-inversion in the US Yield Curve, with the 2Yr-10Yr spread moving in days from -107bps to -41bps.
So far growth wins over value, celebrated by the Nasdaq 100's staggering performance YTD; this does not point to a recession.
CPI and PPI did not spoil the party; core CPI was a touch higher but still, it was the slowest annual increase since September 2021. PPI was actually negative.
The ECB hiked by 50bps as widely expected to 3.50%; the terminal rate could fall between 3.75% and 4% unless there are other issues.
Goldman removed a 25bps hike in the next Fed Meeting on March 22 and repriced its terminal rate back to 5.25-5.5%.
A wide range of outcomes is expected for the upcoming Fed meeting on Wednesday. My opinion is still a 25bps hike. but anything is possible, from a cut (!) to a 50bps hike. Anything outside of a 50bps hike should be taken positively by the market.
As we speak, UBS has finalized an all-stock deal to purchase Credit Suisse for CHF3B, potentially backstopping the issues that have plagued the European market all of last week. Credit Suisse, which got a CHF50B financing from the SNB, decided to write down $17B of CoCos - or Additional Tier 1 - down to zero, angering holders and possibly creating further trouble.
China's Central Bank warns banking crisis shows the impact of rapid global rate hikes.
FDX misses on revenues, beats on earnings, with volume weakness offset by cost actions, rises FY 23's guidance to $14.9 from $135. Notwithstanding the relatively weak top line, this, too, does not point to a recession. The shares closed nearly 8% up on Friday.
Checking up on the economy: the good
The 'good' points to more sustained growth and no recession, albeit at the cost of higher rates (the 'higher for longer' moniker that is soon becoming a mantra). After the failure of Silicon Valley Bank, the fear spread over to Europe where troubled Credit Suisse was put under pressure once more. Because of the failure of SVB and the possibility that more will follow, some market pundits are thinking of lower rates on a worldwide basis (hence, fewer hikes: this regards chiefly the US, the UK, and the EU). Once again, there was not much to report on the good side, apart from the Atlanta Fed's updated forecast: GDPNow real GDP Estimate for 1Q23, which sees a growth of 3.2%, revised downward from 2.0% last week. I further note that the average of Blue Chip Consensus, while far away from that projection, has turned positive and so we are getting away from a recession, even though most of the narrative now speaks of getting one 'in the next 12 months', hence away from the first half of the year.
Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts
On the positive side, I can certainly highlight Goldman Sachs' forecast which sees both core PCE and CPI decline over the rest of the year.
Source: Goldman Sachs
Finally, if most US banks had to account for unrealized losses in their security portfolio, most would turn out to do quite well.
Checking up on the economy: the bad
There are still many signs that the economy might be headed to a recession, irrespective of the ongoing debate on rates. One such indicator is the US LEI, which signals a recession over the next 12 months.
Source: The Conference Board
Furthermore, we have seen the biggest 3-day drop in yields of the UST 2-Yr since Black Monday in 1987. On that occasion, a recession did not follow swiftly (also because the Fed cut interest rates later that year), but on many others unfortunately yes. There has been a gain of 75 bps in the space of a month, or of a couple of NFPs. Let's have a look at the spread between 2 Years and 10 Years - clearly indicating a recession - and at the US Government Bond Curve, where the short end moved in synch with the new expectations of further hikes by the Fed.
Source: BofA Global Investment Strategy, Bloomberg
Checking up on the economy: the ugly
Let's start from a recurring point: stocks are not cheap, and European and EM stocks still show a sizeable discount versus the US. That said, and even though EU stocks had better returns than their US peers on a YTD basis, so far, and at least in the US growth is clearly trumping value.
Source: Topdown Charts, Refinitiv Datastream
This analysis from Bank of America shows that in the past, selling the last Fed hike was a strategy that bore some fruits. My worry is that it will take us some time still to get to the last Fed hike (which could be in June or July depending on the views), and this environment could well signal another lost year for stocks (after the terrible year that was 2022).
Source: BofA Global Investment Strategy, Bloomberg
On top of that, there could be pressure for the traditional 60/40 portfolio to perform in the future (60% S&P 500, 40% 10-Year Treasuries ), and in fact, most flows point to treasuries and cash.
Source: BofA Research Investment Committee
And last but not least, a plot of Credit Suisse's share price and CDS. Despite both charts being horrible, I believe that this time a solution will be found (perhaps co-engineered by the Swiss Government, the SNB, and UBS) and it won't be a repeat of the Lehman Brothers fiasco.
Source: The Daily Shot, Bloomberg
Sentiment and what the market is telling us
The fear that came after the demise of SVB and what might happen with Credit Suisse in Europe highly impacted the market after a tumultuous week. The Fear and Greed Index has barely moved from Extreme Fear, ending the week with a reading of 25, level with last week's reading of 25. This will chill some spirits for a while.
Source: CNN Business
According to the AAII Sentiment Survey, bears were in the relative majority last week, and almost touched the absolute majority. The survey reflects the uncertainties present in the market, which are particularly ominous for Equities.
Source: AAII Sentiment Survey
What are the Flows telling us?
As it could be easily predicted, in this environment cash is king. It is even well-remunerated in the US and the UK. Europe hasn't quite reacted on that front yet, while its banks are enjoying ever-expanding NIIs.
Source: BofA Global Investment Strategy, EPFR
But the preference for bonds is equally strong, given the great yields offered. There was a flight to quality witnessed in fixed income last week.
Source: BofA Global Investment Strategy, EPFR
The forward 12-month P/E ratio for the S&P 500 is 17.1x, down from last week's reading of 17.2x, which is below the 5-year average at 18.5x and below the 10-year average at 17.3x. Reporting for 2022 is now complete, and we are looking forward to 2023. The present, bottom-up level is more or less level with Goldman Sachs' top-down $224 forecast. As we have been going down steadily for a while, I just wonder if at some point down the year the US Corporates will find in them what it takes to reverse this trend, as forecasted to happen in the back half of the year.
For 1Q23 the forecasted EPS decline for the S&P500 on aggregate is -6.1%. If correct, it will mark the biggest decline since 2Q20, when such a decline was -31.8%. The revision to 1Q23 earnings growth has been brutal as it was only -0.3% on Dec 31. Despite the concern about a possible recession next year, analysts still forecast a positive growth in earnings for the overall market in CY 2023 of 1.9% year on year, stable from last week, versus 4.5% on Dec 31, while revenue is forecasted to grow by 2.1% vs 3.2% on Dec 31. The cuts on the S&P 500's earnings growth are getting significant: earnings growth has more than halved in just 11 weeks since December 31st. Ouch!
Very few sectors are holding up estimates relative to 31 December. The only sector not to have its estimates cut further is Utilities and - perhaps surprisingly - Communication Services; all the others are facing cuts. After a few disappointing earnings reports Technology has seen its earnings estimates reduced to a mere 0.9% from 3.5% a little more than two months ago.
The S&P 500 has its revenue growth estimates stable from last week at 2.1%. Financials are still leading the pack in terms of revenue forecasts, but the only sectors with higher revenue growth than on 31 Dec 22 are Real Estate and Consumer Staples, with all others being down. Information Technology revenue growth has been cut to 1.9% from 3.7% two months ago. The sector seems to be doing better on the top than on the bottom line, perhaps signaling the reason for some of the layoffs; Meta has continued with another round of 'thousands' after the reductions in November.
Let's take a look at EPS for 2023 and 2024, which last week has the first upward revision in quite a while. The forecast for 2023 has now been updated to $222.75 from last week's reading of $222.92; while 2024 is currently forecasted to be $248.74, compared to last week's reading of 249.06. I look with much interest at further revisions as the 1Q23 report season gets underway in March.
This is the detail for 1Q23. While the market might be more concerned about rates and recession than earnings at this point, the latter's deterioration is continuing to get me worried as the downward revisions have been relentless and guidance very muted. It seems almost a miracle that the market managed to stay afloat with these shrinking earnings. 4Q22 is over, but 1Q23 looks to start much in the same fashion, with a significant earnings decline. March will see the beginning of the reporting for 1Q23, and I will be looking at it with much interest.
Earnings, What's Next?
The earnings season is now wrapping up its 4Q22 reports. Highlights this week include Nike (Tuesday, After Close), and Accenture (Thursday, Before Open), which I'm going to look at very closely to see if there is any sign of a weakening economy in 2023 in their reports.
Source: Earnings Whispers
Source: Carson Investment Research
Revenue growth estimates for 2024 are forecasted to grow by 5.0% (4.6% on Dec 31st) and earnings growth estimates for 2024 are predicted to grow by 11.9% (10.2% on Dec 31st), so the future looks to be bright. While we continue to debate whether the US economy will fall into a recession or not and what will be the peak rates for Fed Funds, we should take note that almost every strategy has seen a more defensive positioning in the last month.
With the Nasdaq not far from conquering its previous peak of 12,803.14 on 2nd February, tactically I suggest going long on risky assets, keeping in mind the S&P 500's 5th January bottom of 3,808.10 as a level which - if broken - would prompt me to cover the trade. A solution for Credit Suisse now seems to be found, and I believe that the Fed will be mindful of what is going on in the global markets, though its primary mandate is still to control inflation. For the less volatility prone of you, it may make sense to take all opportunities to lighten up in equities and reinvest in bonds at attractive (approx 4%) yields. For those willing to look besides US treasuries, investment grade bonds (LQD ETF) could also be a valid compromise: 1.2% pickup over government bonds for the safest part of the credit complex may still be compelling. 10-Year yields were turbulent last week, both in the US and Europe, though the ceiling should be near for both. For those wishing to keep their money in Equities with lower volatility, suggest switching to Japan as the company with the most stable outlook(the country with the more precise picture of rates at the moment) until rate perspectives become clearer in the US and Europe.
Happy trading and see you next week!
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