Giorgio "Joe" Vintani
Stocks up, rates fall, bonds have a positive week; violent Fed and BoE up 25bps. Trouble in Europe out of concerns for the banks. Stay long on US Equities, neutral on Bonds, and watch the upcoming data carefully.
Major market events 27th March - 31th March 2023
Highlights for the week
Mon: German Ifo Business Climate Index.
Tue: US Goods Trade Balance.
Wed: US Pending Home Sales, US Crude Oil Inventories.
Thur: German CPI, UD GDP, US Initial Jobless Claims.
Fri: CN Manufacturing PMI, UK GDP, EU CPI, US Core PCE Price Index.
Euro Stoxx 50
Another crazy week - they seem the norm - with an upswing in Equities, Bonds, and Rates only tarnished by renewed concerns on a possible spillover effect for European Banks (with Deutsche Bank being the main culprit).
Growth continues to do well over value; the unstoppable Nasdaq 100's staggering performance YTD continues to crush every other major index and has its Feb 2 top in its sights; this does not point to a recession.
The Fed eventually decided to stay the course and hike by 25bps to 5%; what cooled investors was the fact that they do not see any rate cuts this year (against the market's own pricing of approx 60bps in cuts).
The BoE had little choice but to hike by 25bps to 4.25% forced by inflation still in double digits and with few signs of declining; the Feb YoY increase stands at 10.4%, revised upwards from 10.1%.
The SNB also hiked by 50bps to 1.50% pushed by an inflation rate of 3,4%, revised upwards from 3.3% in January.
The Fed has expanded its balance sheet by $94.5 Bn to $8.734 Tn, its highest since last November. There is usually a positive correlation between an expansion of the Fed's balance sheet and the S&P 500's performance.
The German government will never let Deutsche Bank go astray - it is a matter of national pride and Chancellor Scholz has been very outspoken on the subject. In a nationalization (which I hope won't happen) the equity holders would take a hit, but the government's support will ensure this won't be a new Lehman Brothers.
A relatively quiet period for earnings, but it seems that 1Q23 won't be the disaster that many feared. Steady as she goes (the US Economy).
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). Rates are probably the most important aspect in that respect, as they continue to create both a ceiling and a headwind for the stock market. The tricky part to navigate is that the market has its views and the Fed has its own, which might be different from the market. Governor Powell has said time and again that the Fed is not worried to hike rates above what is priced by the market and keep them higher for longer if that happens to tame inflation. Without any update on the economy's side, we can start by looking at the modified rates pricing just after two weeks.
Source: The Daily Shot
There is also to consider the positive relationship between the expansion of the Fed's balance sheet and the performance of the S&P 500.
Source: Real Investment Research
The next chart is a bit controversial, and I debated with myself for a long time in order to decide where to put it. It shows that the current jobless claims are low if we compare them to recent years. On the positive side, high employment is beneficial and foretells a stronger economy; on the negative (Governor Powell's) side, it sadly means the opportunity to hike perhaps more than it is warranted, and given our current predicament this can be more negative than positive. It is what it is.
Source: The Daily Shot
Checking up on the economy: the bad
Let's start with this chart which shows that when the Fed hikes interest rates, something usually gives way. Have we seen enough? (I certainly hope so).
Source: Bloomberg, Haver Analytics, Deutsche Bank
Growth - or lack of it - is always one of the primary concerns of investors. So it's worrying that pundits have turned bearish on growth, as shown in the following chart.
Source: BofA Global Investment Strategy, Bloomberg
Last but not least, US Earnings look extended relative to the past, though I'd say so far 2023 was probably better than many would think in the US Corporates world.
Source: Real Investment Advice
Checking up on the economy: the ugly
The total and absolute nightmare would be stagflation. And that is soon becoming a consensus, at least for the next 12 months. Another reason why the sooner the Fed stops hiking, the better. We might have to wait until July for that.
Source: BofA Global Fund Manager Survey, Bloomberg
Coupled with that, and I spoke of this earlier on in my introduction, a bearish, nasty positioning against the (European) banks, seemingly started by US Hedge Funds which pressed with shorts.
Source: BofA Global Investment Strategy, Bloomberg
Finally, the true financial conditions are very tight. This certainly does not help!
Source: BofA Research Investment Committee
Sentiment and what the market is telling us
The Fear and Greed Index has improved from Extreme Fear to Fear, ending the week with a reading of 33, revised upwards from last week's reading of 25. Still, bears abound.
Source: CNN Business
According to the AAII Sentiment Survey, bears were in the relative majority last week, on the rise from the previous week, and almost touched the absolute majority. The survey reflects the uncertainties present in the market, which are particularly ominous for Equities. The bulls got some hopes back at the expense of those who are neutral.
Source: AAII Sentiment Survey
Goldman's own sentiment indicator is negative and points to a (very) light positioning.
Source: Haver, EPFR, FactSet, CFTC, Goldman Sachs Global Investment Research
Finally, the fear and frenzy sentiment is the only one giving a more upbeat view, which I feel is consistent with the actual state of the market: positive, with caution!
Source: True Insights
What are the Flows telling us?
Cash is being upgraded from king to emperor, or even tsar. Some say this is the next speculative bubble (!), which is why interest rates will fall. I thought the central banks' main mandate was to fight inflation, not to reduce yields of savers who, quite frankly, had it tough for so many years (remember negative yields?).
Source: BofA Global Investment Strategy, Bloomberg
There are a few signs of a storm brewing in fixed-income land. Max and I are undecided about going long duration at this point, particularly if the economy proves to be strong and Governor Powell continues to push the foot down on rates. It looks that sentiment is echoed in this J.P. Morgan survey.
Source: J.P. Morgan
Finally, it looks like households will put a lid on Equities this year. This is a source of supply and is understandable considering: i) the current yields paid; ii) a more defensive posture after the disaster that was 2022.
Source: Federal Reserve, Goldman Sachs Global Investment Research
There isn't a more recent version of Earnings Insight by Factset other than the one displayed here, so this section is unchanged since last week.
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 entering its early 1Q23 reports. Here's a list of companies reporting this week.
Source: Earnings Whispers
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 US Equities, 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. I would wait before pouncing on European Equities to see if the issue of a spillover from Credit Suisse can be avoided. Regarding bonds, the trajectory is that yields will eventually fall, albeit with a few bumps on the road. As we are still gathering data in that respect I prefer to stay on the sidelines for the time being.
For the less volatility prone of you, it may make sense to take all opportunities to alter the weights of your asset allocation by increasing the weights of safety assets at the expense of more risky assets by lightening up in equities and reinvesting 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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