Major market events 14th - 18th November.
Is the peak in rates in sight?
Highlights for the week
Mon: CHF PPI, China Rates Policy, NY Fed inflation expectations.
Tue: US PPI, China Economic Activity, German ZEW.
Wed: US Retail Sales, UK inflation.
Thur: AUD unemployment report, EZ inflation.
Fri: Home Sales.
Watch US retail reporting earnings. G-20 in Bali, CB speakers: 10 Fed members, SNB Jordan speaks, and several ECB officials.
China Activity Data & Rates
The People's Bank of China is expected to keep the 1Y Medium lending Facility rate unchanged on Monday at 2.75%, with no change for the next liquidity injections. The bottom line should be no change in monetary policy. China will also release activity data on Tuesday. The picture should be no growth in retail sales, and slower industrial production compared to the previous month and property investments should continue to be in contraction. The silver lining could be a pick-up in infrastructure investments, which would be positive for commodities on the margin.
Looking at the bigger picture, the Chinese economy has weakened over the last few months and is now confronting its worst outbreak of Covid cases in six months. Nationwide, new cases topped 10,000, a number not seen since Shanghai was on lockdown for two months in the spring. The real question is, what will be the central government's reaction? In a previous post the 3 Pivots, we discussed the possibility of a gradual re-opening of the Chinese economy. We will get there eventually, but the central government will have first to find a solution for the rapid increase in covid-related deaths. They will either have to step up vaccinations or start importing mRNA vaccines for everybody. That will be the inflection point to watch out for!
Earnings Calendar Highlights
Wow - it all hinged on last Thursday's CPI and indeed it did. The core CPI below average increase - 0.3% vs 0.5% sent the market into a frenzy. Cash on the sidelines was being deployed frantically, ending with the S&P 500's and the Nasdaq's best returns on a single day for the past 2.5 years as yearly inflation returned below 8%. It looks like the Fed is finally having some success in taming inflation, though - no doubt - Governor Powell will be hungry for more data that supports this. As a consequence, all major markets had a very positive week - with growth outperforming value, and with the Nasdaq shining and recovering some of its heavy losses YTD, in spite of several companies reducing headcount or freezing new hires. Japan, the best market YTD, deserves a close look as possibly the only one of the major economies which did not have to face such a dramatic turnaround in inflation and hence did not need to raise rates aggressively. It is noteworthy that the Nikkei 225 is still sensitive to outside inflation and was able to almost recover all losses for the year, The flip side is that the Yen lost 20.59% vs the US Dollar on a YTD basis, giving the Bank of Japan quite a few headaches, even though they still continued with their dovish monetary policy - perhaps the only dove in a world dominated by hawks.
Euro Stoxx 50
As the year ends, attention will switch to what will happen next year in terms of earnings and of course, whether the US Economy will go into a recession or not. As you might recall, we embraced the view of Goldman Sachs' Chief Economist Jan Hatzius who sees only a 35% chance of recession next year. Looking at next year, we acknowledge the bearish view of Morgan Stanley regarding S&P 500's earnings, as displayed in the chart below. Consensus still expects a 4.5% in 2023.
Source: Refinitiv, S&P, MS & Co
So far 91% 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%. Relative to the past week there is a slight decline in the number of those companies that managed to report above estimates, yet the market had a very positive upside. 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 one very important piece of data this week - the below trend CPI - which however has to be corroborated by other indicators, starting with the PPI on Tuesday, to make sure that the trend is real. The naysayers are posing that a swallow (the CPI) doesn't make summer; while Max and I are more convinced that the trend is real. Fingers crossed.
The earnings season is now drawing to an end, but there are still a number of relevant companies which have yet to report. Highlights this week include Walmart (Tuesday, Before Open), Home Depot (Tuesday, Before Open), Cisco (Wednesday, After Close), and Alibaba (Thursday, 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.
The two charts below highlight the average price change of the positive (and negative) EPS surprises in the last 5 years against the 5-year average. We note that the market has rewarded the companies able to produce superior earnings and punished those which weren't able to at a greater rate than on average in the past 5 years, showing that while the macro environment is clearly dominating at the moment, the bottom line does indeed matter.
There are a couple of other signs which lead to our more optimistic - and constructive - outlook. We note that shipping costs are finally back to pre-pandemic levels, thus reducing transportation costs. Furthermore, buybacks could eventually re-start in 4Q22 to take advantage of depressed stock prices, particularly in the technology sector.
Source: Bloomberg, Lombard Odier
Source: Wall Street Horizon
G-20 in Bali (Tue-Wed)
The focus will be on geopolitics, with a potential meeting between J. Biden and President Xi. That will be the highlight as Vladimir Putin will not take part in the event in person. They will discuss Taiwan, international trade as well as the relationship with other countries (read was Russia-Ukraine). It is difficult to envisage any meaningful progress, and that's why any incremental surprise could be taken very positively by markets.
FED & ECB Speakers
For the FED, plenty of speakers this week, leaving very few members out! From the ECB, Nagel for the Bundesbank and ECB President Lagarde are the highlights. SNB president Jordan also speaks on Monday. The message they will most likely convey is that they see initial signs of peak inflation, but it is way too early for a victory lap. This will probably be a drag on fixed-income performance this week, although I remain of the opinion that rates are a buy-on-dips type of market.
Clearly, the CPI was a game changer and the market moved in synch. There was a previous attempt to bet on a Fed Pivot in August which was quashed by a stronger-than-expected CPI. At least now that has ticked the box. There is no question that some of the cash on the sidelines has been deployed, and in probably near term the market will have limited upside and will trade sideways (barring a further meltdown in crypto) until we see if the PPI confirms the positive data from the CPI.
Source: Breaking Stocks
Last Monday. In our last weekly, we recommended tactically to go long US Equity Growth. We continue to like that trade and despite the Fear & Greed Index highlighting an overbought market in the short term, we stick to it. To protect capital, we move our trailing stop-loss from the previous level up to 5% below last Friday's close. Now, the big question is:
What to do with rates?
Although one weaker-than-expected CPI report does not make a PIVOT, we feel that the peak in rates is getting closer, even though a decisive move lower by rates still feels like more of a theme for next year. For the time being, we prefer to stay long equity rather than long duration. In the rates space, we still prefer to stick to relative value trades.
One relative value trade that we like is Long 2Y US government bonds vs Short 2Y German government bonds. The interest rate differential (the spread) is plotted below:
There are a few reasons why we like this trade. First, the policy rate in the U.S is much closer to core inflation than in Europe/Germany. Second, net issuance in Germany should reach 45 billion euros in 2023, nearly three times the 17 billion euros originally planned. Third, collateral scarcity in Europe is easing. The swap spread in the Schatz (Geman 2Y bonds) has already tightened 25bps from the top, but it has still a long way to go to normalize.
And last but not least, US fixed income has a better chance to outperform in a recession scenario. From a portfolio construction point of view, we think this rates trade is complementary to our tactical long US Growth, hedging the portfolio in a recession scenario. We would allocate to this trade 20% of our risk budget for fixed income, setting a stop loss 30 bps above the current spread levels.
Wishing you a great start to the week!
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