EQUITIES 7 minutes to read

Are equities ready to rally?

Peter Garnry

Head of Equity Strategy

Summary:  The Fed has stepped in with what the market considers policy support while the key risk event remains the upcoming G20 summit in Buenos Aires this weekend.


Whether it was Fed chair Jerome Powell’s October 3 comments that started the subsequent equities sell-off or not, it took less than two months for Powell to change his assessment of the US economy. In a speech yesterday at the Economic Club of New York, the Fed chair sounded upbeat on the economy while indicating that the Fed Funds Rate was probably just below the neutral rate.

The reaction was immediately up 0.9% in S&P 500 index futures with momentum extending after the cash market closed; S&P 500 Index futures were up 2% in yesterday’s session. In our Equity Update webinar on Tuesday we did indeed argue that the Fed blinked and that rate hikes would likely end by Q1'19.

The economy is clearly late stage and several sectors are showing weakness, including housing. At this point it is probably more by the Fed to observe financial markets more than the economic data which by their very nature is lagging. If not, the Fed risks overshooting on rates.
Enlarge
Source: Bloomberg, Saxo Bank

The below statements are the official wordings by the Fed chair over the two events.

October 3: “We may go past neutral. But we’re a long way from neutral at this point, probably

November 28: “Funds rate is just below the broad range of estimates of the level that would be neutral for the economy

A l
ower interest rate trajectory is short-term positive for equities and based on yesterday’s speech we are revising up equity returns post- the G20 by two percentage points across all three scenarios. The Fed’s new stance will also likely strengthen the US' negotiation hand in case the G20 leads to nothing.

Three rate hikes discounted in financial markets on top of the tariffs hike to 25% from 10% on the latest $200bn would have been toxic to equities. It would have given the Chinese a good hand against Trump in Q1 as their stimulus is working through the economy with likely effect in Q1. We are not changing the probabilities for the G20 outcome and still believe a no deal is the most likely scenario.

Enlarge
Source: Bloomberg, Saxo Bank
While we remain constructive on China’s ability to engineer a rebound in Q1, we must also recognise the things that argue against this view. Our biggest worry is whether the credit transmission has weakened to a point where the banking sector is no longer able to effectively channel stimulus to the real economy. The chart below shows the market value to total assets of the four largest Chinese banks. The ratio has been falling consistently since the Great Financial Crisis. Rising loans have not been able to lift market values one-for-one, which is essentially investors mistrusting the creditworthiness of the last years of credit extension.
Enlarge
While yesterday’s event was significant and important, the real risk to markets is still this weekend’s G20 meeting and the important Trump-Xi meeting. Stay safe out there.

You can access both of our platforms from a single Saxo account.

Disclaimer

The Saxo Bank 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 Bank 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 Bank 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 Bank 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 Bank 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 Bank 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/legal/disclaimer/saxo-disclaimer)