Strong ISM Services reading is a party killer
Head of Equity Strategy
Summary: The rally in equities since mid-October has put the equity market in a bad risk-reward situation with equities pricing a rosy scenario with no recession and inflation coming back to normal levels with the Fed cutting rates in 2023. This milk and honey scenario will be severely tested in the coming months as the ISM Services Index for November showed yesterday. The services sector is still strong and inflationary pressures are still high with all roads still leading to high inflation.
Has the rally in S&P 500 ended for now?
In a recent string of equity notes (see bullets below) we have laid out our thinking about equities, earnings, operating margins, inflation and the economy as 2023 is approaching. These views have been in contrast to the equity rally that has unfolded since mid-October when the market began betting hard on “peak inflation” leading to a Fed pivot in 2023. However, yesterday’s ISM Services Index fir November came out at 56.5 vs est. 53.5 and up from 54.4 in October suggesting the US services sector remains impressively resilient. Prices paid in the survey remained high at 70 (the level since July) fitting well with the 7.5% annualised in the US services sector excluding energy as we described in our equity note following the US October inflation print back in mid-November.
S&P 500 futures traded 1.8% lower on the figures as interest rates got repriced and investors scaled back. The important question is not whether we have peak inflation rate, as that is most likely the case, but rather what is the floor in the inflation rate related to the structural dynamics in the economy. Years of low inflation and below needed investments in mining and energy will continue to haunt investors with higher inflation coupled with a war economy dynamic around global supply chains reshoring manufacturing to more expensive places than China. As we say in the Saxo Strats team all roads lead to inflation from now on and the market is now prepared for that. We maintain our defensive view on equities and maintain our S&P 500 target of 3,200 as the earnings recession that is likely to occur in 2023 has not been priced into equities.
Recent Saxo equity notes:
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.