There is a clear theme at play in markets: Risk -On! The driver? Several:
Central Banks have paused, for longer, on further rate hikes.
Inflation will keep coming down.
So too will yields on bonds, especially the 10y Sovereigns (Risk-Free rate).
Economic activity will remain subdued for longer (see this week’s flash manufacturing and services activity indicators) keeping a lid on input and output prices.
A cease-fire between Israel-Hamas accompanied by hostage exchanges - which has been construed by some as a sign the ground invasion is about to end. If so, this will lessen geopolitical risk in a meaningful way.
Impact on markets?
Equity markets will run higher:
For w/e 22nd November, equities were boosted by the belief the Fed & Co will stop raising rates as inflation continues to ease. Investors bought a net $9.13bn of global equity funds ($10.96bn the week before). European equity funds drew $4.28bn, their highest since 1st Feb. US equity funds drew $6.27bn. Surprisingly, Asia saw outflows of -$2.24bn that ended a 24-week buying streak.
The table below shows the month-to-date performance of the leaders – MSCI World, MSCI EM, S&P 500, Eurostoxx and Nikkei are all up 7% to 8%. These results have also been boosted by FX gains - as the US$ gives back, these currencies gain. Over 1y, the US$ trade-weighted index (TWI) has gone from just under 124 to just over 121. Individually, there have been strong performances by the £ (=1.2607 vs the US$) – especially on the back of better-than-expected activity data which surprised many.
Tech names have rallied again as shown by the Nasdaq which is +0.86% over the last 5 days, +8.46% over 1-month and +36.16% YTD. No doubt the recent press over Sam Altman and OpenAI has fuelled this rally.
Falling yields which have boosted growth and tech names. Bond yields are down overall but not by much! This has helped gold which just remains above $2,000 per Troy ounce.
Oil prices are lower because traders are speculating on whether OPEC+ will come to an agreement on further production cuts. After postponing a ministerial meeting to 30th November (a 4-day delay) because members could not reach a consensus on production cuts, traders are now predicting the most likely outcome will be an extension of existing cuts. Trading was subdued given the Thanksgiving period. Demand has been affected because of poor refining margins resulting in weaker crude oil demand from refineries. Cap it all, US oil inventories have been rising. Chinese demand for oil is expected to weaken in 1H 2024 as its property crunch impacts diesel use. Non-OPEC production is expected to stay strong with companies like Petrobras (Brazil) planning to spend $102bn over 5 years to boost production to 3.2mn boepd (“e” = equivalent) from 2.8mn boepd in 2024.
Outlook?
These markets have legs for now. A few points worth considering from a portfolio perspective:
A rate pause is not the same as rate cuts ahead. It’s a case of wait-and-see. Also, inflation alone is not the only decider here. The decline in headline rates of inflation have been (welcomingly) delivered by a decline in energy price inflation. Core rates remain elevated.
Manufacturing and services data is starting to show clear signs we have hit the low point and that some sort of turn is underway. It’s a momentum game. While manufacturing remains in contraction (under 50) mostly everywhere, the pace of contraction is slowing.
Sentiment is rising – and it’s in Europe where we are seeing this the most. Back in August we started tilting our positioning more towards Europe and Asia EM because of (1) low valuations and (2) cheap FX. This is working and will be a key theme going into 2024 as momentum builds. German business morale has been on the rise for the 3rd consecutive month (Ifo survey) – and this despite all that Germany has been going through (falling output, stagnant economy and budget issues). Worth noting that despite all these issues, overall GDP is flat! In the UK, the GB£ continues to surprise. The GB£ is like a sentiment indicator – GDP has proved better-than-expected, employment remains firm, wages are still rising strongly year-on-year, we have just had a supportive budget for business & consumers and there is strong competition from mortgage providers to offer discounted fixed-rate mortgages over 2y and 5y. Latest FCA data shows some 26% of mortgages are variable. Of these, roughly half are discounted variable/tracker rates and the other half on reversion rates. GfK data showed, not surprisingly, UK consumer confidence was stronger than expected for November.
In summary, consumer demand is gaining traction (aka momentum). Consumer balance sheets are undergoing a restructuring in a stealth-like manner via mortgage restructuring. The loan resets are at higher rates but are still affordable – because wages are rising sufficiently to help offset the higher outgoings. Everything hinges on the employment market. The latter remains tight – the layoffs to date have been modest. The turning point will come when rising consumer demand translates into rising energy consumption which then feeds into higher energy prices. That will be the next round of energy price hikes which in turn will set headline inflation off again. At this point, the cycle repeats all over! I think this will be late Q2 2024.
