Equities got back to reality in August Equities got back to reality in August Equities got back to reality in August

Equities got back to reality in August

Equities 8 minutes to read
Peter Garnry

Head of Equity Strategy

Summary:  The brief rally in global equities that lasted two months is now over as equities have rolled over and recently taken a big hit as the Jackson Hole conference made it clear to the market that inflationary pressures are still way too high despite the much tighter financial conditions. As a result policy rates will be tightened further putting the economy at risk of a recession and pushing up interest rates which will likely further lower equity valuations. All of this is not positive for equities and thus we expect more headwinds for equities as we get closer to yearend.

Leading indicators suggest economy is headed for a recession

From 17 June to 16 August global equities rallied 14.7% as investors were convincing themselves that the world was turning a corner for the better on inflation. Speculative excesses that have not yet been slammed to zero by higher interest rate came bubbling back to the surface with meme stocks growing in fashion again. Then in August signs emerged that the nominal economy is remaining remarkably strong despite the tightening of financial conditions through higher central bank rates. The market suddenly felt less secure about its bet on inflation let alone bet that the Fed would begin easing early in 2023. Jackson Hole was the event that finally opened the door to reality for global equities and are now down 7.6% from the peak in August and down 4.2% for the previous month.

Equity valuations are still above the average since 1995 justified by the current revenue growth, operating margins, and cost of capital we are seeing. But one of these factors are about to become a key downside risk to equities, and that is the operating margin. It is right now historically high being around two standard deviations above the average since 1995. For now companies have been able to pass on inflation to consumers because their savings from the pandemic shielded them. As the global energy crisis has intensified with energy costs in percentage of GDP expected to hit 13% this year consumers might be less able to absorb higher prices. Companies will most likely feel this dynamic in the quarters to come as they will experience price increases having a direct negative impact on volume and thus ending destroying more revenue than thought. The only natural response will be for companies to eat into margins which will likely offset and more the gains from higher revenue growth.

The growing worry as we are rolling into September is that the economy is headed for a recession in real terms but not nominal terms also called stagflation. Normally central banks would begin cutting interest rates and loosen financial conditions but when you have recession while nominal prices are soaring you have an inflation problem and thus interest rates will not be cut but increased even more. Our hypothesis and best guess is still that structural inflation will be higher for longer than what the market is pricing in because energy deficits, deglobalization, and high nominal wage growth. The US leading indicators are now at 0% y/y raising the probability of a recession over the next six months. The 2007 recession started in December after leading indicators were down 6% from their peak, and if we apply the same methodology this time and extend the current decline then the US economy could be in a recession by March next year. The main catalyst is the soaring energy costs as they suck out GDP that would otherwise have been spent on consumption of various goods and services.

Our main equity stance is still defensive. We are still overweight themes such as commodities, logistics, renewable energy, defence, India, and cyber security. We have changed our view on semiconductors from positive to negative as the industry will go through a massive adjustment with the news today that Nvidia can no longer sell chips to China is an evidence of. In terms of equity factors value and quality will continue to outperform growth.

MSCI World | Source: Bloomberg
US Leading Indicators y/y | Source: Bloomberg

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged foreign exchange trading); Type 4 Regulated Activity (Advising on securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.