Weekly market insights

Machine Learning Intelligence

发布日期: 2023年10月29日

Institutional opinions:

class="font-[700]">Stock Market Correction: The stock market has entered correction territory, with a decline of about 10% from its peak in late July. This correction is attributed to factors such as rising long-term government bond yields and mixed earnings reports from major tech companies.

: There is some confidence that the current market pullback will not escalate into a bear market. Several key fundamental drivers and economic factors support the idea that this is a run-of-the-mill correction.

: The U.S. economy has shown resilience, with strong growth driven by consumer spending and government spending. While the pace of growth may slow, a strong labor market and solid consumer finances are expected to support consumer spending.

: Inflation is on a downward path despite strong economic growth. The Federal Reserve's preferred measure of inflation, the core PCE price index, is expected to continue to moderate. This is seen as a positive factor for the market.

: The Federal Reserve is expected to end its rate hikes, which historically has been positive for markets. A Fed pause can lead to stock market gains and bond market stability.

: The surge in the 10-year Treasury yield is expected to approach a cyclical peak as economic growth slows and inflation gets closer to the Fed's target. This could relieve pressure on equity valuations and bond prices.

: The recent pullback in stocks has improved valuations, making some segments of the equity market more attractive. Yields in fixed income are also considered attractive.

: Corporate profits are expected to return to growth, supporting rising stock prices. This is in contrast to the previous year when profits declined.

: There are signs that the worst in manufacturing activity is over, which can be a positive signal for the broader economy.

: Despite brief spikes in oil prices due to geopolitical uncertainty, they have subsided, indicating a neutral to slightly negative influence on inflation.

: Investor sentiment has shifted from positive to more skeptical. This contrarian indicator suggests that market corrections may be less likely as complacency decreases.

: Historically, November and December tend to be good months for stocks, with above-average gains and a higher likelihood of positive returns.

: Historical data shows that corrections within bull markets have been good times to add equities, with stocks recovering in a relatively short time frame.

: While short-term volatility is expected to persist, the data suggests that the worst-case scenarios have moved further away. Valuations in many parts of the equity market are below historical averages.

: The recommendation is to remain opportunistic and consider adding quality investments at lower prices, while maintaining realistic expectations for returns and volatility. Diversification and balance are emphasized as strategies to weather short-term market fluctuations.

: U.S. corporate earnings have stalled, and they have remained stagnant along with the overall economy. This stagnation in earnings is expected to continue, and it may not align with the narrative of a resilient economy.

: While markets expect a pickup in earnings growth starting with the Q3 reporting season, this expectation may not reflect the reality of relatively slow earnings growth. Modest earnings growth is expected to continue, and it might not meet the more optimistic market expectations.

: A significant portion of expected earnings growth is tied to mega-cap companies, particularly those involved in artificial intelligence (AI). Excluding these mega-cap companies, expectations for broad equities are more muted and may be overly optimistic.

: The macroeconomic backdrop is not favorable for broad equity exposure. Factors such as higher interest rates and stagnant growth have weighed on markets. The economy has experienced "stealth stagnation" in the past 18 months, and this has gone somewhat unnoticed.

: The risk of resurgent inflationary pressures is a concern, and it is expected that the Federal Reserve will maintain a tight monetary policy. Higher interest rates may increase the interest expense for companies, impacting profit margins.

: U.S. stock valuations remain elevated despite stagnant earnings. When considering higher bond yields, the relative risk of bonds versus stocks is shifting in favor of bonds.

: The recommendation is to remain selective in stock investments and to harness mega forces such as AI. Opportunities are seen in sectors like healthcare.

: The 10-year U.S. Treasury yield has reached 16-year highs, and this suggests that interest rates may remain higher for an extended period. The Federal Reserve is expected to continue its tightening policy.

: The economy is navigating a shift in consumer spending and a worker shortage. This is expected to lead to "full-employment stagnation" with inflation going through a rollercoaster ride. Central banks are likely to keep policy tight to combat inflationary pressures.

: Greater market volatility and dispersion are expected, creating opportunities for granularity in investment strategies. Security selection, expertise, and relative value opportunities are emphasized.

: Structural changes, referred to as "mega forces," are expected to have a significant impact on profitability across various sectors. These forces include digital disruption like AI, geopolitical changes in globalization, the transition to a low-carbon economy, aging populations, and financial system evolution. Markets are still assessing the potential effects of these mega forces.

The data reveals a significant increase in inflation uncertainty, with levels not seen since the 1960s, eroding confidence in the 2% inflation anchor. This uncertainty has led to a rise in bond term premia and is attributed to the Federal Reserve's policy shift in August 2020, which tolerates higher inflation. Concerns about fiscal dominance over the Fed's focus on low inflation add to the uncertainty, making inflation hedging more crucial in the current environment.

While a U.S. recession is not the base case, expectations for a recession in the next 12 months are widespread, driven by higher interest rates, elevated oil prices, reduced savings, and geopolitical uncertainties. The diverse and dynamic nature of the U.S. economy leads to "rolling recessions," and these downturns typically have relatively short durations. Recessions are seen as periods of reset and revitalization that leave the economy stronger at the other end. Importantly, recessions can be favorable entry points for Equity investors as they often peak before the start of a recession and bottom before recessions officially end.

Investor sentiment is currently subdued and defensive, influenced by economic and market uncertainties. Subdued sentiment and high cash balances are considered contrarian indicators for potential Equity upside, especially as we move deeper into Q4, historically a strong quarter for Equities. While the data suggests these contrarian indicators, the overall outlook remains uncertain, and the base case anticipates a choppy market environment with a slight upward trend heading into year-end.

Europe has made significant progress in filling the natural gas supply void left by Russia, with natural gas storage levels surpassing their five-year average. Factors contributing to this turnaround include milder weather, policy changes favoring wind and solar capacity, and most notably, high natural gas prices that spurred record conservation. While uncertainties like weather and Middle East turmoil persist, the well-above-normal natural gas storage levels should keep heating prices relatively affordable, reducing the risk of an energy crisis during the 2023-2024 winter.

Third-quarter earnings season is expected to show a fourth consecutive quarter of declining S&P 500 profits, with a projected 1% drop. However, if beat rates remain consistent with prior quarters, overall earnings could potentially end up positive. While revenue growth is anticipated at around 1%, margins are expected to decline relative to the third quarter of 2022. Six of the S&P 500 sectors are expected to show negative earnings, primarily driven by a more than 30% plunge in the Energy sector. Companies are contending with a tight labor market, an uncertain economic environment, and headwinds like a weakening consumer, a rising dollar, geopolitical tensions, and a higher cost of capital. Despite earnings estimates moving higher recently, the looming possibility of a U.S. recession challenges earnings in the coming quarters.

The recent rise in bond yields is causing bonds to underperform year-to-date, raising concerns that bond losses will continue to mount. Fixed income investors should remember that bond total returns comprise two factors: price movement and coupon income. Starting yields at the time of purchase significantly affect expected returns over the bond's life, assuming it's held until maturity. The current opportunities in fixed income, characterized by higher available yields, may provide a cushion against further pricing deterioration and allow for price appreciation if yields decline, especially in a recession or a risk-off period.

The private equity market has seen a decrease in average exit volumes, impacting investors who rely on distributions from prior investments to fund new private capital commitments. As a result, the secondary market has gained importance, allowing investors to trade interests in private companies before a natural exit occurs. The weak performance of public markets in 2022 has caused many investors to remain overallocated to private markets. This may lead to an attractive opportunity for qualified investors in the secondary market, particularly if further financial market stress, such as a recession, occurs, as discounts on secondary purchases historically widen during times of market turbulence.

Equity markets are currently in corrective trends, with rising interest rates and a strengthening US dollar acting as headwinds. Despite challenging technical levels, the base case remains unchanged, with the expectation of a rebound in the coming weeks. The correction is seen as consistent with seasonal weakness, and weekly momentum indicators are considered oversold. However, for a meaningful low in equities, the uptrend in interest rates needs to reverse. If interest rates continue to rise, particularly exceeding 5% by the US 10-year yield, it could lead to further selling in equity markets. The upcoming FOMC Federal Reserve meeting on November 1 is expected to provide clarity on the path of interest rates.

The S&P and Nasdaq are experiencing corrective trends, facing trading resistance near their 50-day moving averages and testing trading support near recent lows. Daily momentum indicators remain negative but are expected to become oversold around the time of the upcoming FOMC meeting on 11/1. If they fall below last week's lows, the next support levels are at 4049-4113 for the S&P and 12,714 followed by 12,305 for the Nasdaq.

While it is too early to conclude that a reversal in the interest rate uptrend is occurring, intermediate-term/weekly momentum indicators are showing signs of being overbought and peaking. This suggests that interest rates may begin stalling in the coming weeks. The upcoming FOMC meeting is expected to be a likely catalyst for this potential shift in the interest rate trend.

The uptrends in the US 10-year yield and the US dollar index pose major headwinds for equities. Both have rallied to key resistance levels with early signs of stalling, particularly 5% for the US 10-year yield and 107 for the US dollar. Notably, the US dollar has diverged from the new highs in rates, peaking in early October. A reversal in these trends would require a decline below 4.5% for the 10-year yield and 105.3 for the US dollar index.

Both the Utilities and Staples sectors have experienced steep corrections as interest rates trended higher. However, there are early signs of bottoming near important technical support levels. Weekly momentum indicators are oversold for both sectors. The utility sector is beginning to stabilize at its 62% retracement level, while the staples sector is bottoming near its 2022 lows. While new bull cycles are not expected in these sectors, they appear to be in the early stages of bottoming.

China recently hosted the Third Belt and Road Forum for International Cooperation, coinciding with the 10th anniversary of the BRI. Over the past decade, the BRI has evolved significantly from its modest beginnings as an idea for economic development in the Eurasian region. It has expanded into a comprehensive representation of China's foreign policy, with 154 member countries representing 80% of UN member states. The initiative has also shifted its focus from regional to global projects. Notably, the completion of the China-Europe Railway Express (CRE) has established a substantial freight rail network connecting Europe and Asia, fostering trade. The BRI's scope continues to evolve, emphasizing renewables, green projects, information and technology infrastructure, and scientific and technological innovation. The initiative aims to support smaller, smart modernization projects in developing countries to enhance local living conditions and promote green development. Concerns about "debt trap" diplomacy have been debunked, with studies suggesting China has shown flexibility in debt negotiations, often offering favorable terms to borrowers.

U.S. equities have experienced moderate losses for the week as quarterly earnings are reported. While most major indexes are lower, the Dow Jones Industrial Average has been the best relative performer, down by -0.96%. The S&P 500, down 2.07%, has outperformed the Nasdaq Composite, which has seen a -3.15% return. The earnings season has revealed that 46% of companies have reported sales exceeding analyst expectations, and 78% have beaten earnings expectations. The U.S. GDP grew at an impressive 4.9% annual rate in Q3, highlighting the strength of the U.S. economy. Economic activity in the private sector has also expanded, with the Purchasing Managers' Index increasing to 51.0.

The Bank of Canada (BoC) has maintained its overnight policy rate at 5%, while acknowledging increased inflationary risks. Past interest rate increases have led to reduced consumer and business activity, particularly in housing and business investments. Rising immigration has alleviated labor market pressures. Overall, rates are expected to stay higher for longer. The Real Estate sector has been impacted by higher financing costs, but it has generally fixed-rate debt, making income distributions sustainable. The sector can be viewed as a bond proxy, making it less attractive in the current environment. The performance of the Real Estate sector has been challenged.

The European Central Bank (ECB) left interest rates unchanged at 4%, the first pause after 10 consecutive hikes. The ECB hinted at a "higher for longer" narrative, as rates are expected to remain at the current level for an extended period. The euro area faces increased risk of a recession, with economic stagnation and a slowdown in economic activity across manufacturing and services sectors. The Q3 euro area bank lending survey indicates that higher interest rates are affecting the economy, leading to tighter lending standards and lower demand for loans from households and businesses.

China plans to issue an additional RMB 1 trillion (US$137 billion) in government bonds to support flood-control projects and improve disaster prevention and relief capabilities. This action reflects a commitment to stimulate economic growth and ease the fiscal burden on local governments. South Korea's export data shows early signs of stabilization, with headline exports up 4.6% and daily average value exports up 8.6% year-on-year for the first 20 days of October, potentially marking the first year of export growth in a year if the trend continues. This data offers insights into the direction of global trade and supply chains.

Momentum in the equity market is waning due to a recent breakdown in the uptrend, driven by rising bond yields, which have become a market headwind. The S&P 500 has broken below its 200-day moving average (DMA), making it vulnerable to a move to the range of 3900-4200 in the near term. Equities are expected to remain challenged until bond yields stabilize. A quick reversal in bond yields could relieve selling pressure and allow equities to resume their uptrend. However, if the 10-year yield continues to rise, equities may remain volatile.

Some rotation has been observed into more defensive sectors of the market, away from areas with relative strength, like the semiconductor index. This shift suggests caution in the near term. However, a longer-term view remains constructive on equities due to positive intermediate-to-long-term signals favoring the bulls.

Rising bond yields are the most influential factor for equities in the near term. If bond yields break above 5%, it could pressure equities and increase volatility. Conversely, if bond yields are peaking, equities may stabilize following the recent sell-off.

The YTD returns for the S&P 500 paint a more positive picture than the reality of individual stocks. The average stock (S&P 500 equal-weight index) is down 3.1% YTD, and nearly half of S&P 500 constituents are in a bear market, despite the S&P 500 being only about 9% off its high. This one-dimensional market leaves the S&P 500 vulnerable to increased volatility.

Over 30% of S&P 500 market cap has reported earnings for Q3. While 74% of companies have beaten expectations by an average surprise of 6.5%, it represents a deceleration from previous quarters. The price reaction to earnings has been muted, with the average stock down 0.7% the day after reporting earnings. Earnings estimates are under scrutiny, and revisions will be closely monitored.

Macro data continues to show mixed data points. Strong retail sales and expansionary Markit PMI data point to a resilient U.S. consumer and economy. However, leading economic indicators have been weakening, which can be a recessionary signal. Economic momentum is viewed as relatively resilient, but the possibility of a period of economic softness in 2024 remains the base case.

The major U.S. stock benchmarks have finished lower for two consecutive weeks due to mixed corporate earnings reports and concerns about higher interest rates. Market sentiment may continue to be influenced by quarterly earnings reports and their impact on share prices. Investors will closely watch the performance of major tech giants, such as Amazon, Alphabet, Facebook, and Microsoft, as they have played a significant role in market results.

The U.S. economy showed strong growth in the third quarter, with GDP expanding at an annualized rate of 4.9%, driven by robust consumer spending. A sustained economic recovery may support overall market stability. However, the Federal Reserve will be monitoring inflation, as core PCE remains above its 2% long-term target, and decisions made during the October 31-November 1 policy meeting may impact market dynamics.

The 10-year U.S. Treasury yield briefly crossed the 5% level but retreated to around 4.8%. The direction of bond yields remains a key factor for market performance, and the ability of yields to stay below or above certain thresholds will continue to influence investment decisions and asset allocation.

European markets experienced uncertainty related to interest rates, economic conditions, and geopolitical conflicts. The European Central Bank (ECB) decided to leave interest rates unchanged, indicating a cautious approach toward inflation and economic challenges. Eurozone business activity continued to contract, particularly in the manufacturing sector, which may contribute to market instability.

Japanese stock markets experienced fluctuations due to rising bond yields and geopolitical tensions. Speculation about potential interventions and adjustments to yield curve control policies by the Bank of Japan (BOJ) remains a market focus. The authorities are closely monitoring currency markets and inflation.

Improving industrial profits in China suggested economic stabilization. The government's measures to issue additional sovereign debt and raise the fiscal deficit ratio indicate efforts to support financial markets and the economy. However, challenges persist in the property market, with defaults by large property developers impacting market sentiment.

In Turkey, the central bank raised its key policy rate to curb inflation. The impact of such measures on inflation and economic stability will be closely monitored. In Hungary, the National Bank reduced its policy rate due to declining inflation, which could stimulate economic activity.

Previous update:

Institutional opinions:

Yield Movement in the Near Term: The data suggests that in the near term, 10-year Treasury bond yields may continue their upward trajectory, possibly surpassing the 5% mark. Factors contributing to this trend include the robust U.S. economy, which has defied recession expectations and driven above-trend growth. This growth has exerted upward pressure on yields, reflecting the economy's prospects. However, this pressure could potentially ease as economic growth moderates in the coming quarters. Additionally, the increase in Treasury supply due to the fiscal deficit, coupled with decreased demand from entities like the Federal Reserve and certain foreign buyers, has resulted in a supply/demand imbalance that is pushing yields higher. The rise in global interest rates, particularly in major economies like Japan, is another factor affecting U.S. Treasury yields.
Factors Driving Yields Higher: Several key drivers have led to the recent surge in 10-year bond yields. First and foremost, the resilience of the U.S. economy, marked by above-trend growth, has been a significant force behind the rising yields. The expectation of a strong third-quarter GDP growth rate, driven by a robust labor market and consumer spending, has contributed to this pressure. Supply and demand dynamics also play a crucial role, with the U.S. Treasury increasing the issuance of bonds to address the growing fiscal deficit, while natural demand from institutions like the Federal Reserve and certain foreign buyers has weakened. Furthermore, the trend of global central banks raising interest rates, as exemplified by Japan, is crowding out demand for U.S. government bonds, amplifying the yield increase.
Future Yield Range: The notion of a "new normal" for 10-year Treasury yields is a key consideration. This new normal, expected to be in the range of 3.5% to 4.5%, signifies a shift from the historically low levels witnessed in the post-2008 era. It is based on the premise that the U.S. economy may experience more moderate growth rates around 1.5% to 2% and core inflation around 2% to 2.5%. While short-term fluctuations can lead yields to overshoot this range, the belief is that, over time, yields will consolidate and eventually reach their peak. This may coincide with the Federal Reserve and global central banks pausing their rate hikes, which would exert downward pressure on 10-year yields, aligning with historical patterns.
Portfolio Implications: The implications of these shifting yield dynamics are significant for portfolio management. With higher yields, the equity market is expected to undergo a transformation, leading to a more balanced performance between growth and value stocks. Investors may increasingly favor the better-valuation and higher-dividend segments of the market. Bonds, as a result of higher yields, are likely to become more prominent within portfolios. The expectation of better income and total return from bond portfolios will make diversification across and within asset classes a critical strategy for investors seeking to adapt to the "new normal" in long-term interest rates. Ultimately, the evolution of yields will influence investment strategies and asset allocation, and well-diversified portfolios are positioned to capture opportunities in both equities and bonds.
U.S. Yields: Two-Way Volatility Ahead: The tactical outlook for long-term Treasuries is shifting to neutrality as markets have already priced in the expectation of high policy rates. The next phase is not expected to be an overweight position on long-term Treasuries, as investors are likely to demand more compensation for holding bonds in a higher-yield environment. This outlook reinforces a strategic underweight position in the long run. The downgrade of high-grade credit is also suggested.
Higher Interest Rates as Part of the New Regime: The focus on higher interest rates as part of a new economic regime is underlined. Factors contributing to the shift to underweight long-term Treasuries are supply constraints making inflation persistent, the expansion of bond supply due to high deficits, and increased macro and geopolitical volatility. The repricing of Federal Reserve policy rates is considered a significant driver of the yield increase. Expected policy rates nearing a peak are driving the yield surge, and rising term premium is predicted to be the next driver of higher yields. It's suggested that 10-year yields could reach 5% or higher in the longer term, while the gap between investment-grade credit and 10-year bond yields has not widened as expected, resulting in further downgrades in credit.
Two-Way Volatility and Near-Term Uncertainties: The near-term outlook suggests two-way volatility for Treasury yields. The Federal Reserve is likely approaching the end of its fast-paced rate-hiking cycle, and policymakers are shifting their focus to assessing financial conditions. The potential damage from further rate hikes may become clearer over time, possibly leading to a shift from the "politics of inflation" to pressure on the Fed to ease monetary policy and support economic activity. Despite expectations of rising yields, uncertainties about the drivers of further yield increases and tightening financial conditions are expected to create more volatility in the near term.
Investment Themes: The investment themes identified are driven by the assessment of the current economic environment. The anticipation is that we are entering a period of "full-employment stagnation," marked by shifts in consumer spending, labor shortages, and persistent inflation. Central banks are expected to keep policy tight to combat inflationary pressures, which may not be conducive to broad asset class returns. Income-focused investments, particularly short-dated U.S. Treasuries, are highlighted. Greater volatility and dispersion in asset performance may lead to a focus on granularity in portfolio construction. Quality in both equities and fixed income is favored. Finally, structural changes in the global economy, referred to as "mega forces," are identified as transformative factors influencing profitability across economies and sectors. These include digital disruption, geopolitical shifts, the transition to a low-carbon economy, demographic changes, and financial system evolution.
Resilience of the S&P 500: The S&P 500 has shown resilience in the face of various challenges, including monetary tightening, housing and profits recession, shifts in the commercial real estate sector, weak global growth, and geopolitical shocks. It is suggested that the market's resilience is due to factors like the Federal Reserve's approach, fiscal stimulus, the housing market's pent-up demand, and the evolution of the global energy system. The S&P 500 may continue to exhibit resilience in the near term as long as the Federal Reserve maintains a cautious approach and fiscal stimulus remains supportive. However, future resilience may depend on how these factors evolve.
Inflation Transition: The data indicates that the macroeconomic environment is transitioning away from low inflation, low growth, and low rates. There is uncertainty about whether the recent spike in inflation is transitory or a more structural shift. Depending on how the Federal Reserve responds to inflation, it may lead to a structurally higher inflationary environment compared to the last decade. Investors should watch for the Fed's actions and inflation trends for insights into market performance.
Israel-Hamas War and Global Markets: The conflict between Israel and Hamas is expected to have a limited immediate impact on the global economy and markets, with most economic fallout confined to Israel and the Palestinian territories. The biggest market impact has been felt by local Israeli equities and some regional markets. Unless the conflict escalates significantly, it is unlikely to have a major global economic impact. The local defense industry may benefit from increased spending. Investors should monitor energy prices, as any major geopolitical disruptions could lead to significant effects on global markets, particularly on oil-importing countries.
Asset Positioning for Inflation: The data suggests that different asset classes perform differently during inflationary periods. Historically, equities tend to outperform fixed income during periods of accelerating inflation, while international developed and emerging market equities have fared well. Gold and commodities can be volatile but may perform well. Investors should consider asset allocation strategies based on their views on inflation. A well-diversified portfolio is recommended, as inflation's impact on asset classes can be influenced by various factors beyond inflation itself.
Impact of Inflation on Asset Classes: The data points out that performance dynamics can shift after the peak in inflation, with small-cap and value stocks potentially outperforming large-cap and growth stocks. Fixed income may perform better post-peak than during accelerating inflation. Post-peak inflation, investors may want to adjust their portfolio to favor small-cap and value stocks. Understanding these shifts can be valuable in making investment decisions.
Global Impact of Geopolitical Conflicts: While the Israel-Hamas conflict has primarily affected local markets, the possible implications for energy prices should be closely monitored. Geopolitical events can influence oil production, which can have a significant impact on global markets. A larger geopolitical impact on oil prices could potentially disrupt global equity markets, especially for major net oil-importing regions. Investors should keep an eye on geopolitical developments that may affect energy prices.
Correlation Between Equities and Fixed Income: The correlation between equities and fixed-income asset classes has increased significantly in the past two years, raising concerns about the effectiveness of holding bonds in a diversified portfolio. This shift has been influenced by the Federal Reserve's tightening campaign and higher interest rates. If correlations remain elevated and interest rates continue to rise, it may be challenging to rely on fixed income as a counterbalance to equity market volatility in the short term. Investors should closely monitor these correlations and adapt their portfolio strategies accordingly.
Stocks vs. Bonds: There are questions about the value proposition of stocks versus bonds, especially with long-term Treasury yields nearing 5%. While Treasury rates exceed visible stock yields (dividends and buybacks), the data suggests that stocks offer more than just yield and that earnings play a crucial role in stock price gains. Despite the attractiveness of bonds, stocks may continue to provide a compelling investment opportunity due to their potential for earnings growth. Investors should consider the overall investment environment and their risk tolerance when deciding between stocks and bonds.
Benefits of Holding Bonds: The data highlights five reasons to continue holding bonds, including performance, diversification, lower volatility compared to equities, yield potential, and liquidity. These factors emphasize the importance of bonds in a well-diversified portfolio. Bonds can still serve as a valuable asset class, providing stability, income, and diversification to investors. The choice between bonds and equities should be guided by individual financial goals and risk tolerance.
Gold Market: Gold prices have faced headwinds, including rising global real interest rates, high U.S. Treasury yields, and a stronger U.S. dollar. These factors have affected the demand for gold, which is often traded in U.S. Dollars. Gold prices may remain under pressure in the short term, particularly if the U.S. dollar continues to strengthen. However, long-term fundamentals for gold, such as tight supply, may support its value, and a potential weakening of the U.S. dollar could benefit gold prices in the future.
Rise in Interest Rates and Distressed Opportunities: The data suggests that the past decade of low interest rates has ended, with the Federal Reserve raising rates multiple times. This may lead to opportunities in distressed credit, particularly for hedge funds that specialize in restructuring debt obligations for companies facing financial stress. As interest rates continue to rise, distressed credit hedge funds could perform well by helping companies navigate financial challenges. Opportunities in distressed debt may expand in the coming years as higher rates impact overleveraged businesses.
Recession Indicators: The data highlights three indicators that can provide context for predicting a potential recession: the steepening of the U.S. Treasury yield curve, job losses over a three-month period, and deteriorating consumer confidence. While none of these indicators currently signal an imminent U.S. recession, they should be closely monitored. If one or more of them are triggered soon, it could indicate an increased risk of recession, prompting more defensive portfolio positioning.
Yield Curve Steepening: The data mentions the yield curve's recent shift from an inverted position to re-steepening, suggesting resilience in the labor market and the wider economy. The bond market's belief that the Federal Reserve will maintain higher interest rates for an extended period may lead to margin squeezes and impact corporate profit margins. If the yield curve continues to re-steepen, it could be a second warning signal of a possible recession, particularly if interest rates remain elevated. This may lead to potential economic pressures and employment challenges.
Job Market: The data indicates that job losses would be a signal of an imminent recession. However, the U.S. labor market is currently robust, with a significant number of job openings and positive job creation. While the labor market remains strong for now, the rapid turnaround in previous cycles suggests that job losses could materialize quickly. Monitoring job market trends is crucial to assess recession risks.
Consumer Confidence: Deteriorating consumer confidence can also signal the onset of a recession. The data shows a survey-based indicator where consumers' perceptions of the current economy versus future prospects play a significant role. The indicator has declined in the current cycle, but a sustained increase could indicate a recession is underway. Monitoring this indicator, alongside other economic data, is essential for assessing the overall health of the economy.
Inflation and Interest Rates: In Canada, the data indicates that inflation decelerated in September due to prior rate hikes. The Bank of Canada may consider extending its rate-hiking pause as it watches for incoming data, even though inflation has recently cooled off. The central bank's stance may depend on factors such as job creation, gasoline prices, and mortgage interest costs, which could influence inflation. The BoC's decisions will be based on incoming economic data and their impact on inflation.
Political Landscape in Poland: The data highlights a change in the political landscape in Poland following recent elections. The centrist shift could have implications for the country's relationship with the EU and the rule of law. The political changes may lead to a more pro-European stance in Poland, but the governing process may be complicated due to key state institutions still being led by previous loyalists.
China's Economic Data: China's GDP growth in Q3 exceeded expectations, driven by government stimulus efforts. Despite concerns about the real estate sector, the data puts Beijing's 5% GDP growth target for 2023 within reach. The positive economic data could impact market confidence, particularly in the real estate sector. Continued attention to real estate-related issues and credit concerns among developers is warranted.
Taiwan Semiconductor Manufacturing Co. (TSMC): TSMC reported better-than-expected Q3 earnings due to strong demand for AI chips. The data indicates that demand for AI chips is robust despite a sluggish global economy. The data suggests that the demand for AI-related technology and chips remains strong, and this trend may continue into 2024. It indicates ongoing technological growth and innovation.
Equity Market Trends: The equity market has undergone a pullback and is now experiencing a bounce from oversold conditions. Bond yields and Federal Reserve (Fed) expectations have been the primary drivers of market movements. The recent dovish comments from the Fed and the shift in market expectations for rate hikes suggest that the central bank might be on pause for now. This could provide support for equities, but near-term price momentum has been lost. Whether the market can regain momentum and break through resistance levels or if it remains constrained will be key to watch.
Upcoming Data and Earnings Seasons: The upcoming September Consumer Price Index (CPI) report and the Q3 earnings season are highlighted as crucial factors for stock performance. Earnings estimates have been steady, with strong results in Q1 and Q2 buoying expectations. The market will closely watch earnings season to gauge how companies are responding to current business trends and their outlooks. Earnings performance in sectors under pressure, such as Utilities, Staples, and REITs, will be closely scrutinized. Additionally, Consumer Discretionary, which has been facing challenges, will be of interest. If earnings hold up in the face of market pressures, they may present opportunities.
Technical Analysis: Technical analysis suggests that the S&P 500 has found support, but near-term price momentum needs to be rebuilt. The levels to watch include ~4410-4450 as important resistance and the 200-day moving average and recent lows (~4215) as crucial support. The technical analysis indicates that the market is at a critical juncture. Rebuilding momentum and breaking through resistance levels will be essential for a sustained market recovery. Conversely, if the market fails at resistance and breaks to new lows, it could increase the odds of further downside.
Bond Yields: The Fed's recent policy outlook led to a surge in the 10-year bond yield from 4.37% to a recent peak of 4.89%. Recent Fed comments have leaned dovish, and odds of another rate hike have dropped. The direction of bond yields remains critical for equities. While the recent technical price target was nearly reached, the upward trend in bond yields continues. How yields evolve will significantly influence the equity market. If bond yields stabilize, it could provide relief to the equity market.
Interest-Sensitive Stocks: Interest-sensitive sectors have experienced intense pressure due to rising bond yields. These areas may be deeply oversold in the short term. A stabilization in bond yields may provide some relief, but the sustainability of performance trends in these sectors will be a key focus. Opportunity may emerge in these sectors as market dynamics evolve.
U.S.: The Nasdaq Composite Index has faced significant headwinds, almost returning to bear market territory, mainly due to geopolitical concerns, Federal Reserve comments, and rising long-term bond yields. The Fed appears unconvinced that inflation is under control, which has implications for future monetary policy decisions. The direction of the Nasdaq Composite Index and growth stocks will likely remain sensitive to geopolitical events, particularly in the Middle East. The market may continue to experience increased volatility as a result. The Federal Reserve's stance on inflation and interest rates will be closely monitored. Any shift in policy expectations could impact market sentiment and direction.
Europe: European stock markets, including STOXX Europe 600, experienced declines due to concerns about interest rates and the potential escalation of conflicts in the Middle East. Disappointing earnings reports also weighed on the mood. European government bond yields increased as investors considered the possibility of higher interest rates driven by persistent inflation. European markets may remain sensitive to interest rate developments and geopolitical events, particularly the situation in the Middle East. European Central Bank policymakers are monitoring oil prices, and if inflation remains a concern, interest rates may stay on hold for some time. This suggests a cautious approach to monetary policy in Europe.
Japan: Japan's stock markets faced declines amid expectations of prolonged higher interest rates. The Bank of Japan (BoJ) has been adjusting its yield curve control policy to allow yields to rise more freely but cap them at 1% to achieve gradual increases. The BoJ's approach to controlling yields and supporting gradual increases will continue to be a focus in Japan. Wage growth is essential to meeting inflation targets, so any signs of changing wage-setting behavior will be closely monitored.
China: Chinese stocks saw significant declines as issues in the property sector overshadowed better-than-expected gross domestic product (GDP) data. Concerns about property market troubles and falling home prices persisted despite robust economic growth in China. The property market situation in China is a significant concern, and its resolution will likely impact investor sentiment and market performance. While GDP growth was strong, it may not be sufficient to offset concerns in the property sector, and markets will closely follow these developments.
Poland and Hungary: Political developments in Poland, including the election results, and the potential impact on relationships with the European Union are in focus. Hungary's central bank is aiming to combat inflation and maintain positive real interest rates. Political developments in Poland, especially related to its relationships with the EU, could impact market sentiment, and resolving EU fund issues will be essential for economic stability. In Hungary, a tight monetary policy will be maintained, and interest rate reductions may be considered in the coming years if inflation trends toward the central bank's target. Fiscal targets in Hungary might be challenging to meet.
Inflation Expectations: The data indicates that headline inflation rose 0.4% month-on-month (m/m) and 3.7% year-on-year (y/y) in September. Energy prices, particularly gasoline prices, have contributed to this rise in inflation. However, the data suggests that the recent increase in gasoline prices might be temporary and that gasoline prices may decline in October and November. If gasoline prices indeed decline as suggested, it may lead to a decrease in the overall Consumer Price Index (CPI) inflation. The downward trend in gasoline prices could potentially offset some of the inflationary pressures, leading to reduced headline inflation in the coming months. This reduction in CPI inflation might discourage the Federal Reserve from imposing further interest rate hikes.
Impact on Monetary Policy: The expectation of reduced inflationary pressures and a potential decrease in interest rates in 2024 suggests that the central bank (in this case, the Federal Reserve) might adopt a more accommodative monetary policy stance. A more accommodative monetary policy could support economic growth by making borrowing cheaper and encouraging spending. Lower interest rates could also influence investment decisions and boost asset prices.
Oil Prices and Refining Margins: The data highlights the relationship between crude oil prices, gasoline prices, and refining margins. Refining margins can impact the final cost of gasoline. Monitoring refining margins is crucial for understanding the potential effects on consumer prices, such as gasoline prices. Variations in refining margins may impact the extent to which changes in crude oil prices affect the prices at the gas pump.

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Oil Supply Stability: Despite concerns over potential disruptions in global oil supply, it appears that so far, there has been no significant impact on oil production. The oil market remains relatively stable, and unless the conflict escalates and spreads, the supply-and-demand dynamics for oil are expected to remain unchanged.
Historical Resilience: Despite the human tragedy and the geopolitical shocks in the Middle East, markets have a well-established history of overcoming such events. While there was an initial flight to safety, with assets like government bonds, the U.S. dollar, and gold rallying, markets are showing signs of resilience.
Short-Term vs. Long-Term: The impact of geopolitical risks and market shocks is typically short-lived. Although there may be a knee-jerk reaction with stocks declining on the day of the event, history shows that equities tend to recover in most cases within six months to a year.
Rates in Focus: While geopolitical uncertainty is a concern, the primary focus in the market remains on interest rates. Over the past two months, stocks have been influenced by the bond market, particularly the surge in long-term yields. The recent rise in Treasury yields has had the potential to reduce the necessity for further rate hikes, with the Fed's tone evolving towards holding policy rates steady.
Bond Market Opportunity: The bear market in bonds is approaching its final stage, and the decline in long-term government bonds may pave the way for substantial gains in the fixed-income market. As economic growth slows, inflation approaches target levels, and the Fed concludes its tightening cycle, an opportunity arises for investors to explore longer-duration fixed-income assets, particularly in mid-2024.
Divergence in Equity Performance: Over the past year, the equity market has shown divergence in performance, with the largest companies enjoying outsized returns, creating a narrow leadership dynamic. Smaller segments of the market, including small-caps, high-quality dividend stocks, defensive sectors, and value-style investments, are now presenting attractive valuations. As market dynamics continue to evolve, there may be opportunities for these lagging segments to catch up.
The Value of Diversification: In an environment where market concentration is on the rise, diversification remains essential. Recency bias, which overemphasizes recent experiences, should not undermine the importance of well-diversified portfolios. While the S&P 500 has become more concentrated, diversification helps manage concentration risk and allows investors to spread their risk across various assets.
Glimmers of Optimism: Despite the ongoing geopolitical concerns, there are reasons to remain optimistic as we approach the end of 2023. Corporate profits are rebounding, inflation is moderating, and interest rates may have peaked. These factors suggest that the recent market pullback is unlikely to transform into another bear market. Investors are advised to focus on diversification and explore opportunities in high-quality investments that have temporarily fallen out of favor.
Structural Forces Shaping Markets: The global markets are currently adapting to a new paradigm characterized by structural mega forces. These forces include higher long-term interest rates and lower growth potential, driven by demographic aging and geopolitical changes in supply chains. This structural shift is not a typical business cycle and will significantly impact markets.
Impact on Developed Market Stocks: Developed market (DM) stocks have already experienced a decline in performance, erasing approximately half of their gains for the year. However, the tech sector has remained resilient, particularly due to the momentum behind artificial intelligence (AI). This sector may continue to thrive in this changing landscape.
Implications of Rising Treasury Yields: The surge in long-term Treasury yields is a result of market adjustments to these structural mega forces. Looser U.S. fiscal policies, the transition to a low-carbon economy, and supply chain shifts are contributing to the rise in yields. This development suggests that DM economies may experience weaker long-term growth, although this change in yields is not yet fully reflected in equity valuations.
Labor Market Challenges: The U.S. economy has stagnated over the past 18 months as it transitions to a lower growth path. The tight labor market, influenced by an aging population, is more indicative of labor supply constraints than a strong economy. Job growth may slow, and the economy will be limited in its ability to add jobs without reigniting inflationary pressures.
Opportunity Identification: In the midst of these structural shifts, identifying catalysts and beneficiaries becomes crucial. AI, in particular, presents opportunities as companies focus on AI-related patents. The broader impact of mega forces can be assessed by examining how they interact with one another and identifying the potential beneficiaries not yet fully priced into the markets.
Mega Forces Driving Shifts: The combination of mega forces, including AI, geopolitical shifts, low-carbon transition, aging populations, and financial system changes, is reshaping economies and sectors. Geopolitical fragmentation will likely rewire global supply chains, and the transition to a low-carbon economy will vary across different regions. Recognizing these shifts and their impact on sectors and companies is essential.
Investing in a New Regime: The new regime shaped by mega forces and geopolitical fragmentation requires a cautious approach. Maintaining an overweight position in short-dated U.S. Treasuries is one strategy in this environment. Additionally, emphasizing quality in both equities and fixed income can help navigate the uncertainties of the evolving macro backdrop.
China's Equity Attractiveness: The attractiveness of China's equity market to investors will remain dependent on diplomatic developments. A diplomatic thaw could significantly enhance China's appeal to equity investors, given its geographic advantages and position as one of the world's largest economies.
"Higher-for-Longer" Investment Landscape: The concept of "higher-for-longer" will extend beyond U.S. interest rates. It will impact several key variables such as world oil prices, the U.S. federal budget deficit, global defense spending, and political discourse as the 2024 presidential election approaches. Investors should anticipate a choppy investment landscape in the medium term.
Tech Sector and Rising Yields: The technology sector may continue to face challenges, particularly as interest rates are expected to remain elevated. Rising yields have already impacted the sector's performance. Tech stocks may continue to be sensitive to interest rate changes and could experience valuation adjustments.
Market Volatility and Risk Factors: Market volatility is expected to persist due to a range of factors, including labor strikes, political uncertainty in Washington, geopolitical tensions, and fluctuations in oil prices. Investors should prepare for a turbulent investment environment with potential sudden market movements.
Portfolio Adjustments: In response to changing economic conditions and market dynamics, investors are advised to maintain diversified portfolios. The use of excess cash to increase allocations to higher-quality assets that have deviated from strategic targets is recommended. Early next year, rebalancing may be necessary as more economic data confirms a lower growth trajectory.
Geopolitical Challenges for China: China's geographic advantages are dampened by diplomatic tensions, particularly concerning its significant coastline and reliance on maritime activities. The geopolitical environment surrounding China poses a headwind for risk assets, making it challenging for investors to upgrade Emerging Market Equity indexes with substantial allocations to China.
Impact of China's Geography: China's extensive coastline facilitates international trade but also exposes it to strategic chokepoints and geopolitical risks, particularly regarding Taiwan and maritime trade routes. These geographical considerations have a significant impact on China's economic security.
Food Security Concerns: China's decreasing arable land poses risks to food supply chains, both domestically and globally. Climate change and other factors have led to a decline in arable land, making China reliant on food imports from countries with which it may have geopolitical tensions.
Vulnerability to Natural Disasters: China's susceptibility to water scarcity, desertification, and natural disasters, including earthquakes and floods, presents economic risks. The financial impact of addressing climate vulnerabilities is a concern for China's future.
Global Defense Spending: Global defense spending is expected to rise due to geopolitical realities, including tensions in Europe and Asia, cybersecurity concerns, and Middle East conflicts. This trend could benefit defense and cybersecurity-related industries.
Political Discourse and Budget Deficits: Political uncertainty and the U.S. budget deficit are contributing to market concerns. Political gridlock in Washington may lead to increased market volatility and affect factors such as the U.S. dollar and fiscal consolidation.
Impact of Higher Interest Rates: The outlook for higher interest rates will continue to affect various sectors, particularly Technology. As rates remain elevated, sectors like Energy may outperform while rate-sensitive sectors like Utilities may face challenges.
Earnings Season and Market Sentiment: The upcoming earnings season could shift market sentiment, but overall, more volatility is expected in the markets. Factors like labor strikes, geopolitical tensions, and rising oil prices could introduce multiple shocks to the investment landscape.
Economic Cycles: The data highlights similarities and differences between the current economic situation (2023) and the 2007-2009 recession. While economic data show some parallels, the severity of the previous recession was primarily due to household mortgage debt and leverage, factors that are less prominent today. The pivotal difference in this cycle is the influence of the pandemic and its lingering effects on consumer spending patterns. Goods initially gained favor over services, with durable goods manufacturing and the travel and entertainment industry showing unusual strength. An extended United Auto Workers strike could potentially accelerate a slowdown in the manufacturing sector.
Investment Implications: The analysis suggests that goods-focused sectors are likely to underperform services industries in the S&P 500 during the forecasted recession, particularly those sensitive to interest rates. The Consumer Discretionary sector is expected to be most affected by this weakness. In contrast, Materials and Industrials sectors receive favorable ratings, primarily due to factors like the commodity super-cycle and fiscal-policy support. Quality is emphasized in investment decisions, favoring U.S. Large Cap Equities over international stocks, with a balanced approach to fixed income.
Equities: The current data emphasizes the impact of rising long-term yields, which may hit the most economically sensitive asset classes and sectors, especially U.S. Small Caps and Emerging Market Equities. Consumer Discretionary and Real Estate sectors are expected to face considerable headwinds due to a combination of rising borrowing costs and slowing economic growth. In contrast, U.S. Large Cap assets and specific sectors like Industrials, Materials, and Health Care are seen as more resilient.
Fixed Income: Rising long-term yields are a key concern, influenced by factors like Treasury issuance, rising debt levels, and a resilient consumer. Despite the upward trend in yields, the data recommends holding the line on duration and suggests considering dollar-cost averaging as a strategy.
Real Assets: The data highlights the struggles faced by most real estate industries, particularly in the context of rising interest rates. High mortgage rates and soaring home prices have diminished housing affordability, leading potential homebuyers to rent for more extended periods. Select residential REIT sub-sectors, such as single-family homes and apartments, have shown relative outperformance. While the data leans toward an unfavorable view of REITs relative to other sectors, there's a relatively positive outlook for the residential sub-sectors.
Alternatives: The commercial real estate market is experiencing pressure from increasing interest rates, with many property loans approaching maturity. Investors have become more cautious and reduced capital commitments to both public and private real estate investments. Opportunistic strategies, which capitalize on market dislocations, have gained favor, while core and core-plus strategies face fundraising challenges. A notable gap exists between public and private real estate prices, but caution prevails in the private real estate market due to potential distress and defaults.
Market Outlook: Despite geopolitical concerns and the looming recession worries, two key macroeconomic factors, namely interest rates and the U.S. dollar, have taken center stage. The recent surge in interest rates, surpassing Q4 2022 highs, has triggered a bond selloff and lifted rates and the dollar while pressuring various risk assets, notably equities, during Q4. However, the data suggests that a tactical peak in bond yields might be forming, potentially supporting a seasonal low in equities.
Bonds and Yields: The data indicates that the 30-year yield chart is displaying initial signs of reversing near a significant technical level at 5.5%, with a weekly momentum indicator reaching overbought levels. Furthermore, exchange-traded funds tracking bonds have moved down with record high volumes, often signaling major lows. This suggests that bond yields may have reached a tactical peak, supporting a potential upswing in equities.
Key Levels: For the U.S. 10-year yield, short-term tops are observed, with first support at 4.5%. A move below the 4.24-4.3% range is required to indicate a major trend reversal. In the case of the U.S. dollar, it has paused at its 50% level, and a move below the 105.3-105.8 support range would suggest a trend reversal, likely benefiting equities.
S&P 500: The S&P 500 appears to be oversold and is starting to find support around the 4200 level, which aligns with the rising 200-day moving average and the potential development of a seasonal low in Q4. The proprietary weekly quadrant balance indicator, tracking the percentage of stocks with rising weekly momentum, is deeply oversold and beginning to bottom, which could be supportive of further upside for stocks into year-end and Q1.
Equity Markets: Equity markets are rebounding from deeply oversold levels seen in early October, with initial resistance levels near the 50- and 100-day moving averages around S&P 4400 to 4460 and Nasdaq 13,600 to 13,900. While short-term volatility may be influenced by this week's CPI report, the expectation is that a choppy bottoming pattern is forming throughout October, potentially leading to further upside into year-end.
Semiconductor Sector: The semiconductor sector, as an important indicator for the broader equity market, experienced a Q3 pullback and is now demonstrating signs of bottoming, aligning with the anticipation of a seasonal low for the broader market. Although a pause or pullback may occur in the very short term, the overall trend for semiconductors, characterized by higher lows and higher highs, remains intact, and further upside into 2024 is anticipated.
Potential Government Shutdown: The U.S. House of Representatives faces significant challenges in averting a government shutdown when the current stopgap funding deal expires in mid-November. The recent removal of Kevin McCarthy as speaker raises the likelihood of a partial government shutdown, which, unlike previous brief symbolic closures, could extend for a more prolonged period. The complexities arise from the partisan nature of the House speaker role and the slim majority, which makes both taking and maintaining the position challenging. As a result, it is anticipated that the new speaker may adopt an aggressive partisan policy platform, reducing the chances of a pre-shutdown budget deal. The shutdown risk is compounded by the potential for an extended closure due to the profile of the next speaker, potential voter response favoring the Republicans, and opportunities for major policy wins.
Implications of an Extended Shutdown: The data suggests that an extended government shutdown is more likely under the new speaker, with several key factors contributing to this risk. The profile of the next speaker is expected to be more partisan, making compromise less likely. Additionally, polling indicates that Republicans could benefit from a shutdown, even without policy changes. The previous example of Democrats conceding on Ukraine aid for political reasons illustrates that Republicans might leverage similar tactics, pressuring Democrats to compromise or face criticism for a government shutdown. As such, the data suggests that the next speaker could be inclined to pursue a shutdown, and the situation may not end quickly unless polling dynamics change.
Challenges to a Pragmatic Speaker: The possibility of a more pragmatic, deal-focused speaker is considered politically challenging. Such a speaker would likely require Democratic support to be elected, which seems unlikely as Democrats would gain little from supporting a Republican speaker who could renege on commitments. This strategy would also be viewed unfavorably by Republican voters, posing a risk to incumbents who vote in favor of a speaker candidate with Democratic support. The data indicates that a deal-making speaker may need bipartisan pragmatic support, which appears improbable, making it challenging for a pragmatic speaker to emerge.
Shutdown Impacts and Preparation: The historical data on government shutdowns indicates limited immediate market impacts, but the potential for a brief shutdown could lead to a downgrade of the U.S. credit rating by Moody's, which may add to governability concerns. Economically, a shorter shutdown could have a disinflationary effect, potentially prompting a faster shift to less restrictive policy by the U.S. Federal Reserve. This move might be welcomed by bond investors, but it could also increase the odds of a U.S. recession. An extended shutdown, while causing damage to government employees and related businesses, may lead to increased volatility in the run-up to a potential November shutdown, potentially causing an equity selloff. In such a scenario, high-quality fixed income, particularly in the middle part of the yield curve, might be favored.
Global Equity Market: The U.S. equity market has rebounded, with the S&P 500 and Nasdaq showing positive performance since early October. Recent calming comments from some Fed officials, coupled with a pullback in Treasury yields, have supported equities. The upcoming Q3 earnings season and developments in the Middle East are expected to play a significant role in determining the direction of the U.S. equity market. The ongoing conflict between Israel and Hamas has raised concerns, but its impact on equities has been limited so far.
Canada: The yield on the Government of Canada 10-year bond has declined, resulting in a steepening of the yield curve. A strong economy has pushed longer-term maturities higher, and while the Bank of Canada is fighting inflation, it has prevented shorter-term yields from falling. The latest jobs report revealed growth in September, though concentrated in part-time work. The BoC faces the challenge of balancing inflation and wage pressures with signs of a cooling economy.
Europe: LVMH reported Q3 sales below consensus expectations, marking its first quarterly miss in over three years. The European luxury goods sector, which had initially outperformed, has recently underperformed due to a greater-than-expected moderation in growth in the U.S. and Europe. The sector is facing negative earnings revisions and a valuation de-rating. Despite short-term headwinds, the luxury goods industry remains attractive for long-term investors, given its pricing power and the growth of the middle class in China.
Asia Pacific: China is considering raising its budget deficit for 2023 as part of a new stimulus package aimed at achieving the official growth target. The government may issue additional debt to fund infrastructure projects, such as water conservation initiatives. HSBC is set to acquire Citigroup's retail wealth management portfolio in mainland China as part of its strategy to become a leader in the rapidly growing wealth market. In Hong Kong, a significant selloff in developers' shares, alongside high borrowing costs and potential home price declines, suggests that the correction in the housing market is far from over.
Equity Market: The current market is characterized by a pullback followed by a bounce from oversold conditions. Bond yields and Federal Reserve expectations have played pivotal roles in recent market dynamics. The Federal Reserve's comments and actions have caused fluctuations in bond yields, which, in turn, have influenced equities. While there has been a recent pullback in bond yields, this week's Fed comments have leaned more dovish, leading to speculation that the central bank is pausing its rate hikes. This shift has increased the odds that the rate hike cycle might be over, at least for the time being.
Technical Analysis: The S&P 500, Russell 2000, and Equal-Weighted S&P 500 have shown an encouraging response to support levels from oversold conditions. However, near-term price momentum has been lost for major indices, and it will need to be rebuilt. Technical analysis indicates that resistance and support levels are essential to watch. A key technical hurdle is expected around the 4410-4450 range on the S&P 500, while the 200 DMA/recent lows at approximately 4215 are seen as crucial support levels. The trend of lower highs and lower lows since July needs to be reversed to rebuild market momentum, but failure to overcome resistance and new lows could signal additional downside.
Macro Analysis (US): The September jobs report showed a moderate increase in non-farm payrolls and a m/m wage growth of 0.2%, which is encouraging for the Federal Reserve, as moderating wage growth can reduce inflationary pressures. However, indicators like the job quits rate suggest that wage pressures may continue to moderate, allowing the Fed to focus on deteriorating employment and economic conditions if they occur. Key economic data, including September CPI, Retail Sales, and Industrial Production, should be closely monitored.
Q3 Earnings Season: The upcoming Q3 earnings season is expected to be influential for stocks in the next month and a half. Earnings estimates have remained steady, partly due to better-than-expected Q1 and Q2 results. The under-pressure interest-sensitive sectors, such as Utilities, Staples, and REITs, may have lower bars to clear on their results. Technology-oriented sectors with strong earnings trends may have higher expectations. The Consumer Discretionary sector, despite facing significant pressure since July, has not seen deterioration in earnings estimates, potentially creating opportunities.
Bond Yields: The Federal Reserve's comments and actions have led to a recent surge in bond yields. The technical target was 4.91%, nearly reached at 4.89%. The trend in bond yields continues to be upward, which could impact equities significantly. Where bond yields go next is expected to influence equities, and it's noted that the current trend in yields is upward, although it may be near a peak.
Stocks Respecting Support: Various indices, including the Equal-Weighted S&P 500 and Small Caps, have held support after recent declines, demonstrating encouraging responses to support from oversold conditions. Despite this, trends remain sideways with resistance near moving averages, signaling relatively weak performance compared to a year ago.
CDS Spreads: Credit spreads are carving out a sideways trend, and high yield CDS spreads did not break out above March levels. This development supported the bounce of the equal-weighted S&P 500 index. The direction of credit spreads may be crucial for the sustainable performance of the average stock.
Interest-Sensitive Names: Interest-sensitive sectors, such as Utilities and REITs, have become deeply oversold during the surge in bond yields. Short-term stability in bond yields could offer some relief, but the focus remains on sustainable performance trends.
U.S. Stock Market Analysis: The U.S. stock market exhibited mixed performance as the third-quarter earnings season commenced. Notably, large-cap value stocks performed well, driven by strong earnings reports from Citigroup, Wells Fargo, and JPMorgan Chase, benefiting from higher interest rates. This indicates a favorable start to the earnings season. Additionally, the possibility of a broader conflict in the Middle East following Hamas attacks on Israel bolstered energy and defense stocks while adversely affecting airlines and cruise operators. DaVita, a dialysis provider, saw a significant drop in its stock value due to reports of Novo Nordisk's successful dialysis drug in treating kidney disease.
Dovish Fed Signals: Federal Reserve officials provided dovish signals that influenced market sentiment. Fed Vice Chair Philip Jefferson expressed concerns about the impact of rising long-term bond yields on the need for future rate hikes. This reflects a shift in the Fed's stance in response to higher yields. Dallas Fed President Lorie Logan, known for her hawkish views, also hinted that there might be less need to raise the fed funds rate due to higher yields, although she emphasized the need for elevated rates. The release of the Fed's September policy meeting minutes further supported this change in thinking. While officials agreed that rates should remain restrictive for some time, they also discussed shifting communications from focusing on how high to raise rates to how long to hold rates. As a result, the probability of a rate hike at the next Fed meeting in November decreased significantly.
Inflation and Bond Market: Inflation data had some surprises, with producer prices showing a slight increase, and core consumer price index (CPI) data in line with expectations, but at its slowest pace in two years. Treasury and municipal bond yields decreased, influenced by the dovish Fed comments and a flight to quality caused by Middle East conflicts. Strong demand and limited supply of favorable bond structures led to favorable conditions in the muni market. In the corporate bond market, high demand was noted, especially for higher-quality secured bonds.
Europe Stock Market Analysis: In the European stock market, the STOXX Europe 600 Index saw a weekly gain, breaking a streak of three weeks of losses. Dovish comments from Fed policymakers and reports of potential economic stimulus measures in China contributed to this gain. However, major stock indexes in Europe showed mixed results, with Italy's FTSE MIB rising, while Germany's DAX and France's CAC 40 fell. The European Central Bank's (ECB) minutes from its September meeting revealed that policymakers voted to raise the deposit rate to a record high. The decision was a close call due to considerable uncertainty. The ECB's concern was that pausing the rate increases might be interpreted as a weakening of the bank's determination, especially when headline and core inflation remained above 5%.
German Economic Outlook: The German government revised its economic outlook, projecting a shrinkage of the economy by 0.4% this year due to higher energy prices and weaker demand from major markets like China. The economy was initially expected to grow by 0.4%. The government anticipates economic growth to pick up at the start of the next year amid a recovery in consumer demand.
UK Economic Data: The UK economy showed signs of stabilization and returned to growth in August, thanks to growth in professional services and education. However, construction and production sectors saw declines.
Japan Stock Market Analysis: Japan's stock markets performed well during the week, with the Nikkei 225 Index and the broader TOPIX Index continuing their strong year-to-date gains. The weakening yen provided ongoing support to stocks. Speculation continued about when the Bank of Japan (BoJ) might further normalize its monetary policy, given its recent adjustments to yield curve control. The International Monetary Fund (IMF) revised up its forecast for Japan's growth in 2023, citing factors like pent-up demand, tourism rebound, accommodative monetary policy, and eased supply chain constraints.
China Financial Markets: In China, financial markets declined due to concerns about softer inflation and trade data, potentially indicating a return to deflation. The impact of trade and lending data is being closely watched. Regulatory news also emerged, including a ban on domestic brokerages and their overseas units from accepting new mainland clients for offshore trading.
Israel: Israeli assets, particularly the shekel currency, came under pressure following Hamas attacks and Israel's declaration of a state of war. The government formed an emergency coalition, emphasizing social and financial stability. The fiscal outlook has become more neutral and may worsen due to increased military spending.
Central Eastern Europe: The Czech Republic reported lower-than-expected inflation, potentially leading to interest rate cuts. Hungary also reported lower-than-expected inflation. Monetary policy changes are expected in both countries.
Economic Outlook: The data suggests that the third quarter of 2023 (3Q23) might represent the high watermark for GDP growth in the near term, with consensus expectations hovering around 3.0% seasonally adjusted annual rate (SAAR). However, the outlook for future growth remains uncertain.
Investment Strategy: Given this economic uncertainty, investors are advised to navigate cautiously and not completely eliminate risk from their portfolios. Maintaining an appropriate exposure to equities and fixed income, both of which tend to outperform cash after peak interest rates, is key to a prudent investment strategy.

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