CIO View

Choppy markets going into an important week

Gone is the euphoria. The MSCI World lost 2.8% last week, the S&P 500 was down 3%, and the Japanese TOPIX index even down by 6.2%. Once a directional change in markets seems to become lasting, explanations and justifications hit the email inbox in abundance. The Wall Street Journal reported that pension funds are withdrawing money from the stock market(1): “Stock portfolios at large pension funds had a blockbuster run. Now, managers are cashing out.” In another article titled “Bloated Wall Street Bulls Are Cashing Out of Markets En Masse” one could read(2): “money has just been pulled out of equities and junk bonds at the fastest rate in more than a year.” There are probably several reasons behind the swing in sentiment.

One cause is certainly the increase in bond yields due to some surprisingly firm U.S. inflation numbers over the last three months. 10-year Treasury yields added 10 basis points over the week. Not that the inflation figures were a disaster, but ongoing progress in disinflation had become a necessary condition given the optimistic valuations. The next chance for the market to be either relieved or disappointed will be the release of the U.S. personal consumption expenditure (PCE) data this Friday.

We’d argue that poor U.S. inflation figures were not the only factor to blame for the yield increase. Last week, the IMF published its new “World Economic Outlook”, along with the whole extensive dataset. Immediately, we checked the data on public finances, especially regards the usual suspects. Italy certainly comes to mind, and the Fund’s updated estimates do not look promising, indeed: for 2023, the IMF lists a public sector balance of -7.2% as its new estimate, while the autumn projection was -5%. In the case of the United States, the Fund lists a 2023 budget balance of -8.8% and a structural deficit, corrected for cyclical influences, of -8.6%. Not that this is of big concern for markets, or is it?

Well, a comparison of credit default insurance costs reveals that markets might be somewhat ahead of rating agencies. Let's take a look at 5-year CDS: Germany trades at 12 basis points, other AAA countries like Australia at 17 bps, or Canada at 26bps. Formerly a crisis country, Portugal, now rated “A” again, trades at 38 bps, a BBB-country like Spain at 39 bps. Insuring United States sovereign bonds against a default nowadays costs 42 bps, while Italy stands at 68 bps. The latter’s “BBB” credit rating was confirmed by Standard & Poor’s on Friday.(3) Early in 2022, U.S. CDS were at 13 bps, hence in addition to inflation fears, credit considerations have contributed to the yield increase, too. It looks like markets might be a bit more attentive than some analysts. Washington should take note!

But back to markets. In addition to rising yields, geopolitical tensions also weigh on the markets, especially the situation in the Middle East. Regarding the counterattack on Iran, our friend Frank Kelly notes that “It appears the attacks were calibrated and limited.” Even if we have been spared an immediate escalation, one should not underestimate how dangerous the situation remains.

Another important factor is the current reporting season. On paper, the earnings season had a strong start, as according to Bloomberg calculations the 70 S&P 500 companies that released their numbers so far have exceeded earnings expectations by 9.6% in aggregate, which is about twice the historical average. That didn’t help much however as markets have become merciless, punishing even for slight disappointments. One semiconductor machinery provider’s shares lost more than 9% over the course of the week on missed order intake figures for the first quarter.(4) A big chip producer’s shares lost 6.7% on Friday after the company lowered its outlook for semiconductor demand.(5) On Friday as well, a server manufacturer was hit when its stock shed a full 23% after the company announced the date for the quarterly figures, but did not yet preannounce the results yet.(6) Markets have become a bit demanding, haven’t they? Put differently: after rising by 25% since October 2023, it should have been obvious that markets were priced for perfection!

Talking about tech, “Progress in LLMs will continue, similar to the computer era where we will look back and say how weak they were” was one quote that our Tech sector analyst brought home from his visit to Silicon Valley. Well, even weak technology can stay around for quite a long time, as we’ve learned the other day: Zilog has announced that it will halt production of its Z80 CPU models.(7) The company, co-founded by Federico Faggin, one of the fathers of Intel’s 8080 chip, introduced the Z80 in 1976! Not that we would want to draw any conclusions from this anecdote.

This week will see the release of the first preliminary April purchasing manager indices (PMIs) tomorrow, Germany’s IFO index on Wednesday, and U.S. Q1 GDP figures on Thursday. U.S. March personal consumption expenditure data will round it off, with the PCE deflator most in focus. Market consensus expectations go for a slight decrease in the core rate from 2.8% year-on-year to 2.7%. Besides economic data, Q1 reports by Microsoft, Meta, Alphabet and Tesla will have a say where markets are going to trade by the end of the week.

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1. Source: The Wall Street Journal, April 18, 2024.

2. Source: Bloomberg, April 20,2024.

3. Source: Bloomberg, April 20, 2024.

4. Source: Seeking Alpha, April 18, 2024.?

5. Source: Bloomberg, April 18, 2024.

6. Source: Bloomberg, April 20, 2024.

7. Source: huckster.io, April 18, 2024.

Forecasts are based on assumptions, estimates, views and hypothetical models or analyses, which might prove inaccurate or incorrect. Past performance is not a reliable indicator of future returns. Source: DWS Investment GmbH as of 4/22/24.