Welcome back and happy new year!
Major market events 9th - 13th January 2023
Highlights for the week
Mon: German Industrial Production (Nov), EU Unemployment Rate (Nov).
Tue: China New Loans, Fed Chair Powell speaks.
Wed: Germany 10-Year Bund Auction, Brazil Retail Sales.
Thur: US CPI, US Jobless Claims, China CPI, China PPI.
Fri: China Trade Balance, UK GDP, UK Manufacturing Production, US Michigan Consumer Expectations and Sentiment.
Earnings Calendar Highlights
Euro Stoxx 50
Please note: 2 Jan: Euro Stoxx 50; 3 Jan: Dow Jones, S&P500 and Nasdaq 100; 4 Jan: Nikkei 225
And we are back with a bang! It looks like 2023 started on an entirely different note relative to the year that's (finally!) gone. All markets were on a very sound footing, driven by the abrupt and significant reduction of yields (I refer to the 10Y benchmarks) across the board. Then when the market got skittish we had a not-so-bad Non-Farm Payroll on Friday with average hourly earnings (wage inflation) which declined from 4.8% in November to 4.6% in December, while the overall labor market remained tight. As the Fed is data dependent, once again we will have an ever-so-important CPI next Thursday, Jan 12, which will likely drive the markets near term. I am perplexed by the Central Bank's choice to track employment more closely than inflation, thus keeping the market (equities more than bonds) in check. It has been said time and again that Governor Powell does not want the equity market to rally and hence is increasingly hawkish in his comments; he speaks again on Tuesday, Jan 10. Meanwhile, if we look at the market's pricing of the terminal rate, the chart below shows that it does not rise meaningfully above 5%.
Source: The Daily Shot
The latest Non-Farm Payroll report has reignited the debate on what the Fed will do, with some market pundits (Bank Of America) hypothesizing that the Fed might raise the Fed Funds by 50 bp at their next meeting on Feb 1. On the other hand, legendary investor Jeffrey Gundlach has stated that he does not see the Fed going beyond 5% as the highest yield on the US Treasury Curve is the 6 months T-Bill at 4.8%. I do not think that there is a chance that the Fed might do 50 bp, barring a contrarian CPI which I do not foresee. The chart below helps to understand what could be a reasonable path for the US Central Bank and what is currently priced in by the market,
Source: Goldman Sachs Global Investment Research
This leads me to talk about my preference for bonds vs stocks at the moment. With the Fed almost finished, 10-Year yields have started to decline. I don't think that there will be a recession (and if there is one, it will be mild), but that would strengthen my case for purchasing bonds, even long-dated ones, at the moment. I do believe that equity will get back on its feet in 2023, but performance will be tricky as long as the Fed (and Global Central Banks) will continue to hike. Looking at valuations, this seems to support the above view, showing that bonds are cheap while equity valuations are still expensive.
Source: Topdown Charts, Refinitiv Datastream
The forward 12-month P/E ratio for the S&P 500 is 16,5x, which is below the 5-year average at 18.5x and below the 10-year average at 17.2x. Even considering the most bullish scenario, that of a 4.8% growth in EPS (as estimated by Factset) over the 2022 consensus of $221 per share to $231.60 per share and a rather improbable (under current circumstances) expansion of the multiple to 18.5x (the five-year average) we would get to a target for the S&P500 of roughly 4250, with would mean a 9% upside from current levels. However, the more bearish scenario is much worse: EPS would see a 15% contraction to $ 195 (as posited by Morgan Stanley), and the multiple might well contract to 16x. The result? 3120, or 20% downside. Not exactly the risk-reward you'd want to see. You can see clearly how the index is very sensitive to changes in forward earnings - for the next step up, the Fed should begin to stop and earnings growth will have to reverse course. The silver lining for all the bulls that were beaten badly in the past year, is that the secular bull market seems still intact.
Source: Real Investment Advice
We will definitely need a more benign inflation outlook and hence a more relaxed Fed in order to make progress in the equity markets; this can definitely happen in the back half of the year, once the top in rates will have hopefully been hit in May and the market might start looking at the potential cuts in 2024 and beyond. At the same time, this is also beneficial for Treasuries, as highlighted by the chart below.
Is the US Global leadership waning? The chart below shows me that the current overperformance is extreme, and hence it is quite possible that the US will give way to other markets in terms of what hopefully will be a positive performance in 2023. I also note that the Emerging Markets have started to outperform the S&P 500 in the last six months, possibly banking on the Fed to reduce and then pause its hiking cycle. While acknowledging this, I wholeheartedly share Warren Buffett's 'Never bet against America' advice. Over time, there are going to be your best results.
Source: BofA Global Investment Strategy, Bloomberg.
I was a bit surprised to see Europe outperforming so meaningfully the other equity markets last week, and think that the decline in bond yields must have been the trigger. Recall that the ECB turned more hawkish in December, signaling that relative to the Fed they had much further to go. The market might think that the ECB will be stopped in its tracks by a more benign outlook on inflation and by the Fed's reaching the top of the cycle. I believe that for Europe to continue to shine, the rates outlook will be even more important. On the other hand, the Nasdaq underperformed, which leads me to think that in terms of a sustained market rally, we are not there yet. I'd definitely want to see technology regain its luster before pouncing on the broader market. But once again, with nominal yields in some developed markets closing in to 4%, I'm very happy to put my money there and wait for a better day to return to stocks. There Are Real Alternatives (TARA), after all.
Source: Thomson Reuters
Eventually share repurchases - one of the very few bright spots in the beleaguered 2022 - still continue to be strong and offer support to the broader market. It is positive that they have remained so strong in the face of a rising rate environment. Meanwhile, negative-yielding debt has gone to zero - the writing was on the wall. How distant are the times when I thought this would last for a while and was desperately searching for yield - just 2 years ago. You live and learn I guess.
Source: BofA Global Investment Strategy, Bloomberg
Let's have a look at sentiment, while I touch base on the 'January Effect', which in 2022 lasted for just 2 days - definitely an abysmal year. It was good to see the market start the year on a more positive note, although the perceived fear prior to the Non-Farm Payroll report tells me that the Fed isn't the only one to be data-dependent. If Thursday's CPI doesn't rock the boat, the market might have further to go in January, bearing in mind that Goldman's 3-months forecast for the S&P 500 is 3600 and hence more trouble is expected, even considering their rather benign scenario for rates (5-5,25%) and no recession.
Source: AAII Sentiment Survey
Honestly, I'm surprised not to see sentiment more positive, given the market's sound start. That however is another positive element - there's no fear of missing out, at the moment. Maybe next Thursday's CPI looks so ominous?
For 4Q22 the forecasted EPS decline for the S&P500 on aggregate is -4.1% - revised downwards from -2.8% just two weeks ago. If correct, it will mark the first time there has been a year-on-year decline since 3Q20, when such a decline was -5.7%. 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 4.8% year on year, again revised downwards from 5.5%. (Recall: Goldman is at 0% growth; Morgan Stanley is 15% below consensus in 2023 for a -12% growth over 2022).
Very few sectors are holding up estimates relative to just 3 months ago. The only sectors not to have their estimates cut further are Financials and Utilities; all the others are facing cuts. The banks will start the 4Q22 reporting season in earnest next Friday, and we will see if they are able to confirm the good expectations out there.
The same applies - once more - to revenue growth, with every sector having had its growth estimates cut relative to 3 months ago. As you can imagine, the ones which suffered the most limited declines were Health Care and Consumer Staples. Information Technology has almost got in line with the average growth, and I guess more clarity will be needed on rates and economic growth to see a chance, later in the year, to see its revenue growth go up again.
In this chart, you can see how EPS progressed over the year. It is somehow mostly stable in 2022, with 2023 taking the brunt of the cuts. Most of the decline started in June when the impact of the hiking cycle of the Central Banks became evident and continued at a steady pace ever since. The consensus for 2023 so far has held steady since mid-November when the first figures (229) were published; I look with much interest at further revisions by the end of the week.
This is the detail for 4Q22. I'd say that the market is more concerned about rates and recession than is about earnings at this point, even though this has kept falling and falling.
The earnings season is now entering in full swing its 4Q22 reports. Highlights this week include TSMC (Thursday, After Close), and then all the banks: Bank of America, Citigroup, J.P. Morgan, Wells Fargo, and BNY Mellon (Friday, Before Open).
Source: Earnings Whispers
A good start to the year for all major markets, with bond yields declining across the board for 10-Year securities. This has prompted a rally in Equities, that was particularly significant in Europe. A constructive Non-Farm Payroll has set the tone for a positive week, though Thursday's CPI is lurking in the shadows; for those with enough courage (and risk appetite to match), you might go long the S&P 500 ahead of the Thursday report, with a 2% stop loss (though I acknowledge that in these conditions stop losses are anything you can get) - just maybe wait after Powell's 10 Jan speech to make your move as often he's not that market-friendly. Once again I reiterate my preference for bonds rather than equities, largely because the top in rates is within reach and I cannot see yet the bottom in equities, despite a more positive outlook emerging. Do take all opportunities to lighten up in equities and reinvest in bonds at attractive (approx 4%) yields.
Happy trading and see you next week!
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