Equities: New extremes and a challenging opportunity set
Discover insights on the future of equity markets in Q1 2024 and navigate the potential recession with strategic investment choices.
Summary: Markets traded sideways yesterday as we await today’s US September CPI data. The FOMC minutes out last night generally failed to move the needle as Fed members generally indicated they feared doing too little to get ahead of inflation more than doing too much. USDJPY traded to new 24-year highs, so far failing to elicit a response or intervention from the Bank of Japan, which intervened previously against JPY weakness at a lower USDJPY level some three weeks ago.
The decline in US equities continued yesterday with S&P 500 futures closing at a new low for this drawdown cycle and this morning the index futures are trading around the 3,590 level. Today’s US September CPI figures are the key event today with a negative surprise (worse than expected inflation) adding to worsening sentiment in US equities as the market in that case would price a higher policy rate. The Q3 earnings season is also ongoing with PepsiCo reporting yesterday (see summary below) and earnings today from Walgreens Boots Alliance and Delta Air Lines. The levels in S&P 500 futures are still standing at the edge of the cliff and under the right circumstances US equities could slide lower in a fast clip.
Hong Kong and mainland China equities retreated, Hang Sent Index down 1% but mid-day and CSI300 lower by 0.3%. HSBC (00005:xhkg) outperformed and gained 0.7%. Worst performers in Hong Kong included China developers, Chinese banks, sportswear, electronic hardware, and China Internet names. In A shares, technology and healthcare stocks outperformed. The Chinese Communist Party (CCP) concluded yesterday a 4-day session in preparation for its 20th national congress, in a communique, the CCP said it had established comrade Xi’s core position on the party and hailed the party’s pandemic control strategy a success. In its first National Security Strategy white paper, the US Biden Administration named China as the only competitor with both the intent and the power to reshape the international order.
Traders abandoned their reluctance to take USDJPY higher and risk a fresh blast of intervention from the Bank of Japan/Ministry of Finance yesterday, taking the pair to new 24-year highs just shy of 147.00. The 147.66 level from 1998 is the highest level for the pair since the early 1990’s. The USD action was generally muted elsewhere as EURUSD is finding the 0.9700 area sticky and GBPUSD bobs around near 1.1100, with the market mulling what will happen after the Bank of England halts its emergency QE measures, supposedly on Friday. (more below). The next event risk is the September US CPI release later today and whether it moves the sentiment needle and more importantly, US treasuries, where yields have consolidated below the cycle highs of two weeks ago and near 4.00%.
Gold remains rangebound around $1670 ahead of today’s important US CPI print, and following last week's aggressive short squeeze, potential sellers have turning more cautious at this stage where the market has been left pondering how close we are to seeing peak hawkishness, a development that may signal a low in gold. In our latest gold update we highlight the reasons behind our medium-term bullish outlook but also why the ducks are not yet lined up properly for the recovery to begin. Support at $1658, the 61.8% retracement of the recent correction, with resistance at $1687 and $1695.
Crude oil traded steady overnight after falling for a third day on Wednesday in response to a report showing a large crude build last week and OPEC and EIA both slashing their demand outlook for 2023. In addition, a hawkish set of minutes from the Federal Reserve also weighed ahead of today’s US CPI print for September. The API reported a 7 million barrel build in crude oil inventories with official data from the EIA following later today. The US led plan to cap prices on Russian oil sales remain a focus with detailed talks about to begin, but the risk it could lead to higher, not lower global prices may still prevent it from being introduced. Following two downbeat oil market updates from OPEC and the EIA, both lowering 2023 demand by around 0.4m b/d, the IEA will publish its report during the European morning.
Wheat prices in Chicago dropped by 2% on Wednesday after the US Department of Agriculture cut its demand forecast, primarily due to a downgrade in exports to the lowest since 1971. A revision that still left ending stocks at their lowest since 2007 but higher than analyst forecasts. American wheat is too expensive – due to the strong dollar - and sales have been slow, the USDA wrote in its monthly WASDE report. Corn futures (ZCZ2) meanwhile dropped after the report signaled bigger inventories before settling unchanged. Soybeans (ZSX2) jumped sharply before ending up 1.3% with a lowering of US production leading to much lower-than-expected US ending stockpiles. A development being partly offset by increases in Brazil’s soy harvest and export outlook.
US treasury yields continue to trade not far below the cycle highs near 4.00% in the 10-year treasury benchmark. An auction of 10-year T-notes yesterday saw tepid demand and lower interest from foreign bidders. A 30-year auction is later today, but the important catalyst of the day is the US September CPI release and whether even a soft print can make much of an impression on the bond market, given that the Fed has indicated it will continue to hike even as economic growth weakens, inflation falls and unemployment begins to rise.
Not a huge surprise to markets to receive this message late yesterday, as Fed rhetoric has consistently pointed in that direction and the market expectations for Fed policy finally now reflect the Fed’s own “dot plot” forecasts of rates continuing to rise a bit more beyond the end of this year. This came after many months of the market expecting that Fed rates would end next year below their level at the end of this year, likely figuring that the economy would weaken significantly from the policy tightening. “Many participants emphasized that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action.” Late yesterday, MIchelle Bowman of the Fed’s Board of Governors argued for continued large rate increases and the early November FOMC meeting is nearly fully priced to deliver a 75 basis point hike, with December’s meeting priced at 50-50 odds of 50 vs. 75 basis points.
… showing how the energy crisis in Europe and the weak krona continue to drive higher inflation. The headline CPI released this morning hit 10.8%, above the 10.5% expected and up from 9.8% in August, while the core inflation level rose to 7.4%, slightly below the 7.5% expected and up from 6.8% in August.
If investors were looking for a negative surprise and evidence of margin compression PepsiCo was not the answer. The beverage and snacks business delivered better than expected revenue and earnings in Q3 and lifted fiscal year organic revenue growth to 12% from previously 10%. PepsiCo experienced a bit of margin compression during the quarter but enough to offset the higher revenue growth. It looks like PepsiCo is a very robust business during inflation.
The uranium miner Cameco and the renewable energy business Brookfield Renewable Partners are teaming up to buy the nuclear services business Westinghouse as the outlook for nuclear power is improving. Cameco’s CEO said yesterday that he sees a ‘wave’ of demand coming for nuclear power and that Russia’s invasion in Ukraine is a game changer for the industry.
... although earning season is likely to begin generating more headlines and sentiment shifts in coming days. As noted above, it is questionable how much information value the market can extract from any downside surprise in the CPI print today, given Fed forecasts that it will continue its tightening regime even as the inflation and the economy (presumably) decelerate. Therefore, upside surprises may generate more significant market volatility. Elsewhere, core Retail Sales growth has been anaemic in recent months, but the ISM Services has remained strong, suggesting a still strong services sector. Bank of America’s CEO Brian Moynihan was out yesterday claiming that the US consumer is “in good shape” and spending more than a year ago despite the ominous backdrop. “The consumers basically have more money in their accounts by multiples than they did pre-pandemic.”
Kwarteng commented that any turmoil “is a matter for the governor”. Could Bailey be made a scapegoat and fired over the recent debacle in the gilt market, which was also in part due to the launch of the government’s “mini-budget”, in which abandoning planned tax rises and introducing new cuts suggested the government was set abandoning any sense of caution on the longer term trajectory of fiscal imbalances. The FT cites “people briefed on the discussion” that the BoE may be forced to continue to support the market after tomorrow. The 30-year gilt yield returned above the 5.00% level it touched before the BoE intervened yesterday before dropping toward 4.8% by the close. The BoE is priced to hike more than 100 basis points at its November 3 meeting and another 100 basis points in December.
The speech will be closely watched for the Chinese leader’s response to the current global backdrop, including the recent moves by the US to limit Chinese access to semiconductors, as well as for hints on the domestic agenda, especially the future of the Zero Covid policy.
Today’s earnings focus is Walgreens Boots Alliance due to its large footprint with the US consumer selling everything from pharmacy prescription drugs to shampoo and other hygiene products. Given PepsiCo’s stronger than expected result yesterday Walgreens may also surprise in its Q3 results. Delta Air Lines is another important earnings release to watch as travel and leisure are consumer discretionary activities that could see weakness given the cost-of-living crisis.
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