Giorgio "Joe" Vintani
"Transitory" Goldilocks, peak in inflation & possible turning point in the US-China relations. Equity markets continue to rally across the board, while yields are declining.
Major market events 16th - 20th January 2023
Highlights for the week
Mon: Martin L. King Day, China 1Y Lending Rate.
Tue: Empire state manufacturing, China Industrial Output & Retail Sales.
Wed: US Retail Sales, US PPI, NAHB Builder's Index, Beige Book, BOJ rate decision.
Thur: US Building permits and Housing starts, Philly FED, Japan CPI, Australia unemployment.
Fri: US Home Sales. China Loan Prime Rate.
To Watch The World Economic Forum in Davos, the BOJ's two-day policy meeting with the wild card of potential further adjustments to the yield control policy. Q4 Earnings results with year-over-year earnings from S&P500 are expected to have declined 2.2% for the quarter, according to Refinitiv data. If confirmed, that could be the first step into an earnings recession. You will find our earnings insight below! Stay tuned!
Peak in Inflation
Last three months' annualized inflation (CPI) rates:
Core Goods: -4.8%
Shelter: + 9.2%
Services less shelter: +1.2%
Source: Nick Timiraos
Since J. Powell flagged that core services ex-housing (ex-shelter) are a critical subset of inflation (a good proxy for wage-price pass-through), this figure got much attention. Excluding the housing component, core goods and services inflation is quickly reverting to the FED's 2% target. At the same time, a whopping 59% of CPI components are now flagging outright deflation. It would seem the bond market got it right as inflation seems to be undershooting both the FED and consensus view.
CME FedWatch Tool
The market is now pricing another two 25-bps hikes by the FED, with a third 25-bps rate hike priced by the summer with only a 30% probability.
Yo, bring me that horizon!
The terminal rate seems to finally be in sight!
Europe and Japan are the two wild cards!
While inflation data in the US seems to be indicative that the FED's policy seems to achieve its intended objectives, we should pay attention, first of all to Europe:
European core goods inflation is still rising while the US one is quickly dropping. Additionally, the ECB still has to engage in QT, while in the US started last summer! Second, Japan is also in focus as it finds itself on the other side of the moon, starting to tighten its monetary policy when the US is almost done!
I would not underestimate both dynamics, as they could impact the price action significantly and be significant headwinds for risk assets rallies! The contagion channel will be slightly different: ECB QT -> Peripheral spreads -> Credit channel, BOJ end of Yield Curve Control (YCC) -> interest rates -> bond market. The bottom line is that they are both key risks for risk assets.
Let's keep these risks in mind, however, they both seem macro themes that could play out a few months from now!
While inflation shows signs that - at least for now - is peaking out, growth seems pretty resilient. The Atlanta FED GDPnow snapped back and started the year with the lift:
The GDP nowcast is now back above 4%! It may not be extremely accurate, but the trend is clear: UP! The market narrative is that the current "goldilocks" market regime (resilient growth / declining inflation) is "transitory". The main rationale behind this view is that resilient growth will slow down the decline in inflation. This may well be true. On the other hand, also growth will find a few speed bumps along the way. For example, credit card delinquencies are half the charge-off rate of 2019, but banks (e.g. JPM) expect them to continue to go up.
Betting on goldilocks means walking a very narrow path where from one side there is the cliff of recession and from the other the steep slope of hawkish central banks.
Bottom in US-China relations?
It could well be wishful thinking, but the fact that China recently appointed Qin Gang, former ambassador to the United States, shows a sign that something is moving in the direction of a thaw in the relations between the US and China. Qin is considered a dove in foreign policy as he published a number of articles on American media outlets often emphasizing friendly collaboration and he called for ways to "explore a way to get along based on mutual respect, peaceful coexistence, and win-win cooperation". I don't expect a sharp U-turn in the US-China foreign policy relation as we start from a position of significant mistrust, but any positive sign could be well received by markets as it looks like XiJinping is trying to finally reset its economy and win back a more friendly relation with the West. If this happens, a recession in Europe and in the US will have to be probably be postponed! The market implication would be that resilient growth and more stubborn central banks could be the most likely scenario ahead of us.
Earnings Calendar Highlights
Euro Stoxx 50
The past week saw all equity markets continue on this year's uptrend, driven by a finally (more) positive macro background - and what a week that was! After a benign CPI on Thursday, the S&P managed to reconquer the 200-day moving average, and finally, the Nasdaq led the pack once again. As discussed in our macro/rates outlook, we are now facing a mini Goldilocks scenario that is supportive of a positive run in equities, coupled with the tailwinds of the January effect and positive earnings so far. I believe that the positive macro scenario and earnings will continue to drive performance for the markets; preference goes once again to the US (despite Europe's impressive performance) because it's closer to reaching the top in rates and because it's the economy with the best potential to recover from the 'mild recession' that market pundits are now expecting.
Source: Deutsche Bank Research
One of the more important themes of late has been China's reopening. I mentioned last week that Emerging Markets were recently outperforming the S&P 500. While I think that depends on the more favorable US Macro Outlook, China's reopening is indeed a major positive factor for equity markets. Furthermore, it has been recently mentioned that China was slightly distancing itself from Russia and slightly warming up to the West (and the US in particular). In a recent survey, most fund managers thought that MSCI China was likely to have the best performance in the short term.
Going back to the S&P 500 and having a look at earnings, these seem to be still over trend, as the chart below shows. Still, if the macro environment continues to be positive and if the Federal Reserve were to cut rates in 2H23 as the market is currently pricing, we might even see a positive surprise at some point.
Source: Real Investment Advice
At the same time, it's worth being reminded about the rule of 20, which sees the S&P 500 bottom when its trailing earnings plus the current CPI are less than 20. I expect the CPI to come down later in the year, and I think we might get a tradable bounce in 2H23. My fear at the moment is that as the market anticipates what happens in the future investors may get overexcited (see the fear and greed index below) and the current rally might fail at some point even in light of the strong resistance it has to face (see below for technicals). However, having a positive macro backdrop is very important, and the Nasdaq reacquiring its leadership underscores that.
Source: BofA US Equity & Quant Strategy, Bloomberg, FactSet
While it is too early to get a complete picture of how the year ended in terms of earnings and earlier still to get some guidance for 2023, it looks as though the market might be already discounting a less-than-rosy scenario, with a -10% EPS priced in. Recall Goldman is forecasting a 0% growth while Morgan Stanley is opting for a 15% EPS decline (which would account for -12% growth). This seems to be reassuring that - from an earnings perspective - the market seems to be partially insulated from a potential fall. Still, should that happen, multiple compression would inevitably follow, dragging the market down. For the S&P 500 to see further highs this year, corporate earnings must be resilient.
Source: BofA Global Investment Strategy, Bloomberg, Datastream
It has been pointed to me by a much-esteemed colleague that perhaps I haven't fully factored in the massive underweighting of portfolios at the start of the year and hence that there is a fear of missing out as well as a strong short covering - the move has been massive. The chart below certainly testifies that sentiment isn't doing particularly well at the moment, while it seems that asset allocation is correctly positioned. Considering that now we can get a more-than-decent yield from bonds, it certainly takes a lot of optimism to invest in equities, considering the initial move. While I believe this strategy will pay dividends in 2023, you'd better fasten your seat belts as we're in for a rather bumpy ride.
Source: AAII Asset Allocation Survey and AAII Sentiment Survey
As mentioned just before, technicals and 'fear and greed' aren't particularly positive for the market at this point in time. The technical picture has been there for a while, while the recent gain in stocks will of course have propelled the index into greed territory.
Source: BofA Global Research, Bloomberg
In the current scenario, my preference goes definitely to the large caps, given that they have much more capital to use to try to become insulated by macroeconomic headwinds. It is worth pointing out that, bruised and battered as they are, small caps offer significant value at this point.
Source: BCA Research
The forward 12-month P/E ratio for the S&P 500 is 17,3x, which is below the 5-year average at 18.5x but above the 10-year average at 17.2x. While guidance has been mixed, with roughly 2/3 of US companies reporting negative guidance for 4Q22, 80% of companies reported a positive EPS surprise in the same timeframe, and approx 70% reported a positive revenue surprise. Earnings from the banks were largely positive (see below a snapshot for Bank of America and JP Morgan), but even Citigroup, whose earnings did not stand out, managed to have a positive day last Friday,
Source: Economy Insights
Source: Economy Insights
Finally, please find a chart on the value of the most important American brands - an impressive lineup. It is worth noting that 4 in the top 5 and 6 in the top 10 belong to technology. Were we to include Visa and Mastercard as stalwarts of payment technology, then they would account for 8 in the top 10, leaving McDonald's and Nike as the lone non-tech representatives.
Source: Economy Insights
For 4Q22 the forecasted EPS decline for the S&P500 on aggregate is -3.9% - revised upwards from -4.1% a week 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 4.6% year on year, again revised downwards from 4.8% last week.
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.
Regarding revenue growth, comparisons are now with 31 December. The S&P 500 has its revenue growth estimates slightly trimmed to 3.2% from 3.3% one week ago. Financials started on a strong foot on the back of very solid earnings reports, and so far the picture is barely unchanged, with Energy being the sector that has suffered the worst revisions this year.
Introducing EPS for 2023 and 2024, still under pressure but less so in the last 3 months. The forecast for 2023 so far has held steady since mid-November when the first figures ($ 229) were published; while 2024 has had a slight cut in the same period of time from $ 254. I look with much interest at further revisions as the 4Q22 report season gets under way.
This is the detail for 1Q23. I'd say that the market is more concerned about rates and recession than is about earnings at this point, as testified by last week's rally and in absence of a meaningful revision to earnings.
The earnings season is now entering in full swing its 4Q22 reports. Highlights this week include Morgan Stanley (Tuesday, Before Open), Goldman Sachs (Tuesday, Before Open), Alcoa (Wednesday, After Close), Procter & Gamble (Thursday, Before Open), and Netflix (Thursday, After Close).
Source: Earnings Whispers
An amazing 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, which was particularly significant in Europe, although the Nasdaq has managed to regain its lead this week. From the Equity standpoint, I'd focus on countries with a positive macro backdrop, so the US and Emerging Markets (for the bravest out there). After a benign CPI and before the Fed at the end of the month the market may well pause and take a breath, I'd think. To those who were invested since the beginning of the year, congratulations - I'd probably take some short-term profits here, looking to re-enter the market if there is a slide of 4-5% in the S&P 500. While Europe is cheap, I'd avoid Japan which is the country with potentially the highest imbalance in rates and signs of inflation not yet tamed. The very impressive rally in equities has somehow changed my previous preference for bonds, but I still think that long (US) bonds is probably the easier trade here with less volatility, while for those who can stomach higher volatility and a longer investment timeframe it might make sense to test waters in equities. Certainly, this year won't be a normal one, and will either go very well or very badly - keeping my fingers crossed for the former! Just to mention that it is way too early to call this the bottom in equities - we definitely need more confirmation on the outlook both from the macro and the micro perspective. 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 3.5%) yields.
Happy trading and see you next week!
All views expressed on this site are my own and do not represent the opinions of any entity with which I have been, am now, or will be affiliated. I assume no responsibility for any errors or omissions in the content of this site and there is no guarantee for completeness or accuracy. The content is food for thought and it is not meant to be a solicitation to trade or invest. Readers should perform their investment analysis and research and/or seek the advice of a licensed professional with direct knowledge of the reader's specific risk profile characteristics