Weaker USD and ECB next week to extend risk-on in equities
Head of Equity Strategy
Summary: News that US and China to hold trade negotiations in early October combined with weaker USD and positive anticipation of central bank moves the next couple of weeks are driving equities higher. S&P 500 is breakout out today and looks to strengthen further if the USD weakness persists. In today's equity update we also take a look at Slack and Starbucks both disappointing on their fiscal year outlook.
The current risk-on sentiment seems to have three drivers. US and China are to hold trade talks early October in Washington which has lifted general sentiment and the outlook for tariffs not being hiked again in October. USD weakness which especially accelerated yesterday partly due to flow reversion in GBP extending into other pairs is easing financial conditions and lifting emerging markets.
There also seems to be a green shoot element in the DAX futures momentum as traders are betting on Germany to increase government spending, as South Korea has recently done, and lately a rebound in some key manufacturing indices in Sweden which like Germany is a high beta country to global economic activity.
One asset class not supporting our current view of a short-term rally here in equities is gold with spot only inches away from the recent highs. Gold spot is down today but not by the magnitude if this was a one-way street in equities. Also, some credit spreads are also higher the last couple of weeks.
First the DAX and now the S&P 500
The initial breakouts from tight trading ranges happened in FTSE 100 and DAX futures driven initially by weaker GBP and EUR. In the last couple of trading sessions, the momentum has continued without the help from weaker local currencies reinforcing real price action for all the reasons mentioned above.
S&P 500 futures have the breakout crowd today pushing through the 2,945 resistance level that have been the blocker for weeks. With current events that have unfolded over the past week we see momentum extending from here in US equities. Weaker USD is key to fuel the move. A surprise tiering system announced at next week’s ECB meeting could be a massive catalyst for markets as it would elevate European equities across the board.
Fundamentally S&P 500 is around 0.7 standard deviations expensive across nine valuation metrics. However, using data since 1991 the 10-year forward real return annualized is estimated 2.8% which is still higher than offered in many bond segments of the market.
S&P 500 profit growth
EBITDA growth y/y in S&P 500 remains high at 7.7% but given the strong USD, slower growth in the world and many key macro indices are we expect EBITDA growth to come down meaningfully over the coming quarters. Depending on central bank outcomes the next weeks and US-China trade negotiations it might not be a problem for the overall index but beneath the surface a sharp slowdown in EBITDA growth is typically a bloodbath in some key segments of the market. We expect technology hardware, semiconductors, materials and industrials to be the negative surprise here.
Stocks to watch
Slack Technologies (WORK:xnys) shares were down 13% in extended trading despite a Q2 beat on revenue and EPS, and an upward revision to its FY revenue guidance. It was the company lower FY EPS guidance that disappointed as investors clearly want to see a faster path to profitability as the valuation is extremely stretched with a trailing EV/Sales ratio of 29.x. Slack has generated negative free cash flow of $117mn in the last 12 months a significant worsening from a year ago.
Starbucks (SBUX:xnas) shares were initially down yesterday as the US coffee chain adjusted its FY20 outlook seeing EPS growth below the long-term growth target of 10%. Compared to the outlook presented by Starbucks in previous investor presentations their growth is significantly diverging from expectations. The key risk for Starbucks long-term growth plans is the relationship between China and the US. If the relationship worsens it will also have a negative impact on US companies’ ability to do business in China. Technically the 92.50 level is crucial for support here as it’s the gateway to a major gap. For now, there are many technical buyers of Starbucks shares as minimum volatility and momentum ETFs are long Starbucks.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.