Weekly market insights

Institutional opinions:

1. Consumer Spending Outlook: There are indications pointing towards a potential slowdown in consumer spending. Factors such as decreasing savings rates, rising credit card debt, and an increase in delinquencies suggest that consumers might be facing financial challenges, potentially leading to a moderation in spending.
2. Economic Growth Expectations: The recent data suggests that there might be a moderation in economic growth. Despite the economy's resilience, the mentioned factors could contribute to a slowdown in overall economic activity.
3. Inflation Trends: If consumer demand softens, companies may adjust to a slower demand environment, potentially resulting in lower inflation. This could have broader implications for the economy and impact the Federal Reserve's decisions on interest rates.
4. Market Dynamics and Opportunities: Anticipating a potential economic slowdown, there is a suggestion that markets could experience volatility. However, markets are viewed as forward-looking, and this volatility might present opportunities to diversify and add quality investments at potentially more favorable prices.
5. Federal Reserve's Stance: The recent data indicates that bank lending standards remain tight, and the Federal Reserve has been cautious in its approach. If the consumer slowdown persists, there is a suggestion that the Fed may not need to raise rates further during this cycle, which could influence interest rates and monetary policy.
6. Investment Landscape in Stocks and Bonds: The recent data sees potential opportunities in both stocks and bonds in the coming year. The anticipation is based on a combination of factors, including moderating inflation, the possibility of the Fed pausing or pivoting to rate cuts, and a potential re-acceleration of economic and earnings growth. These factors are seen as potential drivers for a rebound in consumption and present opportunities for investors.
7. Central Bank Policy and Market Volatility: Developed market central banks have signaled a commitment to high-for-longer policy rates. The recent bounce in U.S. stocks, driven by a Fed pause and slowing wage growth, underscores the volatility in the new macro regime. The preference for international stocks is emphasized, and there's a cautious stance on U.S. stocks, with a particular focus on the tech sector through an overweight to the artificial intelligence (AI) theme in DM stocks.
8. Regional Disparities in Excess Compensation: There is a recognition of diverse policy, inflation, and growth prospects across regional stock markets, impacting corporate earnings. Excess compensation, measured by the earnings yield minus bond yield, varies widely among DMs. The article highlights opportunities to be selective based on these disparities, with an underweight on U.S. stocks due to compressed excess yield and a neutral stance on UK stocks, while being overweight on Japanese stocks.
9. Bond Market and Interest Rates Outlook: Recent drops in ten-year Treasury yields, the largest in a year, are noted. The decision to go neutral on long-term Treasuries reflects expectations of two-way volatility. Caution is expressed regarding higher valuations in U.S. equities, and potential earnings and profit margin crunch due to higher interest rates and financing costs. Overweight positions in euro area government bonds and UK gilts are explained by locking in higher yields.
10. Global Central Bank Actions and Inflation Expectations: The recent actions of central banks, including the Bank of England and the Federal Reserve, maintaining policy rates unchanged, are highlighted. Expectations are for central banks to hold tight on policy rates despite falling inflation, particularly in the euro area. The investment implications include staying cautious on DM stocks, with a focus on selective exposure based on valuations and earnings prospects.
11. Investment Themes and Macro View: recent data introduces three investment themes: navigating "full-employment stagnation," pivoting to new opportunities in a more volatile market, and harnessing mega forces such as digital disruption, geopolitical shifts, the low-carbon transition, aging populations, and changes in the financial system. The investment implications include an overweight on short-dated U.S. Treasuries, a preference for quality in both equities and fixed income, and an overweight on AI as a multi-country, multi-sector investment cycle unfolds.
12. Growing Debt Concerns: The increasing levels of corporate, consumer, and government debt, adding $5 trillion to the U.S. debt pile in a year, raise concerns about sustainability. The mainstream acceptance of "higher-for-longer" rates applies not only to interest rates but also to borrowing costs for various entities. There is a focus on monitoring signs of deterioration in the ability of the U.S. consumer and corporate America to manage debt.
13. Shift in Fixed Income Dynamics: Fixed Income total returns have been disappointing in recent years, attributed to excessively low interest rates. However, the conditions have changed, and interest rate risk is now more reasonably priced. The risk-reward for bond investors is considered more favorable, with higher nominal and real yields providing a cushion against potential price drops.
14. Diversification and Quality Emphasis: The strategy involves maintaining a high level of diversification and utilizing excess cash to add to higher-quality areas that have deviated below strategic asset allocation targets in both equities and fixed income. The emphasis is on a balanced and diversified allocation, with a focus on high quality in both asset classes.
15. Fed's Support for Equities: The Fed's views supporting equity markets include the belief that further tightening is in the pipeline, the consideration of private sector interest rates as a guide to financial conditions, and the willingness to look past inflation expectations. The "no rush" approach by the Fed is seen as keeping inflation higher for longer, supporting profits and risk-assets. Tight financial conditions reinforce a quality bias, and interest rate volatility is expected to remain elevated.
16. Debt Levels and Risks: recent data suggests that there are concerns about the scalability of the growing debt wall, covering corporate debt maturity, consumer debt levels, and the impact on the U.S. government. The risks associated with high debt levels could weigh on sentiment, impact economic and earnings outlooks, and contribute to market volatility. The recommended investment approach is to maintain a balanced and diversified allocation.
17. Shift in Fixed Income Landscape: The discussion revolves around the recent disappointing performance of Fixed Income and the changing landscape. The shift in initial conditions, with higher nominal and real yields, is highlighted as a positive factor for bond investors. The current risk-reward trade-off is deemed more favorable, and the recommendation is to include an appropriate amount of Fixed Income in a diversified portfolio.
18. Challenges of Traditional Diversification: Recent market drawdowns have challenged the effectiveness of traditional 60/40 portfolios, as stocks and bonds sometimes move in tandem during market fluctuations. The 60/40 blend experienced one of its worst performance periods in 2022, falling over 20% through Q3. This prompts a reconsideration of diversification strategies.
19. Diversification Through Alternatives: The suggestion is to consider adding alternative investments to traditional portfolios, as they may provide additional diversification and complement existing strategies. Hedge fund and private capital strategies are highlighted as potential alternatives, offering unique return, risk, and income attributes. The benefits include exposure to a broader range of opportunities, improved risk-adjusted returns, and access to strategies that may perform well regardless of market direction.
20. Underperformance of Health Care Sector: Despite solid fundamentals and pent-up demand, the Health Care sector, particularly medical device stocks, has underperformed in 2023. Concerns about the impact of GLP-1 drugs for obesity on the medical device industry, including markets for diabetes, orthopedic, and cardiovascular devices, have contributed to this underperformance.
21. Pressure on Preferred Security Prices: Preferred security prices have been pressured by increasing interest rates and credit spreads over the past few years due to their long duration. Limited new issuance is expected due to higher rates, and investors are reminded of the company-specific credit events that can impact these securities.
22. Consolidation in the Energy Sector: October 2023 witnessed significant consolidation in the Energy sector, with the two largest integrated oil majors acquiring two of the largest independent oil and gas exploration and production companies (E&Ps). This is seen as a sign of the maturation of the U.S. oil and gas industry, with E&Ps prioritizing value over growth. The acquisitions are viewed as meaningful for the sector, increasing overall quality.
23. Pressure on Preferred Security Prices: Preferred security prices have been pressured by increasing interest rates and credit spreads over the past few years due to their long duration. Limited new issuance is expected due to higher rates, and investors are reminded of the company-specific credit events that can impact these securities.
24. Bottoming Process: The S&P 500 is seen bottoming in the 4049-4195 support band after a pullback in Q3-Q4. The proprietary indicator tracking the percentage of stocks with positive weekly momentum fell below 10% in late October, historically indicating higher S&P values over the next 20 weeks 70-75% of the time.
25. Expectation of Upside: Indicators suggest a recent meaningful equity market low with further upside expected through year-end into early Q1. The focus is now on the quality and breadth of participation during the recovery. Broad participation across industry groups is viewed as encouraging and supportive of further upside.
26. Rebound and Resistance: S&P, Nasdaq, and Dow Industrials have rebounded strongly to short-term resistance levels coinciding with a 50-62% retracement of the Q3-Q4 decline. The retracement bands are often points of pause, and a temporary pullback is anticipated. However, the positive weekly backdrop suggests any pullbacks are likely to be short-lived.
27. Yield Pullback: The weekly chart for the US 10-year yield highlights an intermediate-term pullback after testing the critical upside level at 5%. Weekly momentum indicators suggest the likelihood of a pullback, and this downturn in rates is seen as a significant macro technical development.
28. Key Levels: Key short-term levels for the US 10-year yield are around 4.5%, with a crucial support band between 4.24-4.3%. Short-term momentum becoming oversold suggests yields are expected to bottom between 4.3-4.5%, likely coinciding with a pullback in equities. Upside resistance levels are between 4.7-4.8%.
29. Oil Correction: WTI Oil is in a corrective trend from late-September highs, breaking below 77 support. Daily momentum indicators becoming oversold suggest oil is likely to start bottoming short-term near the next support band between 71-74.
30. Global Equity Markets and Earnings: S&P 500 Q3 earnings are on pace to break into growth after three quarters of declines, with a year-over-year growth rate of 4.1%. This marks the end of the "earnings recession." The recent equity rally, up 6.5% in the past eight trading sessions, is attributed to the bond market and the Fed. The decline in the 10-year Treasury yield to 4.5% contributed to the S&P 500's rebound. 80% of companies beat consensus earnings forecasts, exceeding the long-term average. However, the magnitude of earnings beats has lagged. 62% beat consensus revenue forecasts, in line with the long-term average.
31. Cautious Forward Guidance: Management teams have been cautious about providing specific guidance for future quarters. More executives have lowered Q4 earnings estimates than raised them. Concerns about uncertainty, challenging macro conditions, inflation, and rising rates are prevalent. The consensus earnings forecast for Q4 has declined more than usual, down 3.9% in October, raising skepticism about the 2024 consensus earnings forecast of $246 per share.
32. Economic Outlook and Recession Concerns: RBC Global Asset Management's Chief Economist, Eric Lascelles, sees a 70% likelihood of the U.S. entering a recession in the next 12 months, up from the previous estimate of 65%. The current data leaves skepticism about the 2024 consensus earnings forecast of $246 per share, which implies year-over-year growth 11.4% above the 2023 consensus forecast.
33. Global Fixed Income Markets: The yield on the 30-year Treasury bond breached its key technical 50-day moving average, indicating potential further decline. Strong demand is attributed to Jerome Powell's comments and a smaller-than-expected boost in bond issuance. High-yield corporate credit is performing well, with the U.S. High Yield Corporate Index up 7.1% year-to-date. Spreads are at +3.9%, about 30 basis points below the year-to-date average. U.S. mortgage rates tumbled, leading to the strongest advance in home purchase applications since early June. Rates remain high, impacting supply and keeping housing prices elevated.
34. Canadian Economic Trends: Canada's trade surplus more than doubled in September, reaching CA$2.0 billion, primarily due to higher crude oil prices boosting energy exports. Higher interest rates are seen as weighing on domestic economic growth. The Canadian bond market is now pricing in rate cuts as early as Q2 2024.
35. European and UK Earnings: The European and UK earnings season has been broadly in line with expectations. Overall EPS for the STOXX Europe 600 Index in Q3 declined by 13% year-over-year, but excluding the Energy sector, it grew 3% year-over-year. Sales growth has been disappointing, with fewer companies beating consensus sales estimates in Q3. Profit warnings have been above average, and the market reaction to negative surprises has been sharp.
36. UK Bond Market and Interest Rates: The UK bond market reacted positively to the Bank of England's decision to hold rates at 5.25%, with Gilts rallying across all maturities. Market sentiment shifted based on mixed messages from BoE officials, with some suggesting possible rate cuts.
37. Asia-Pacific Equity Markets and China's Economic Situation: Asia-Pacific equity markets saw mixed trading, with ASEAN countries leading and more developed markets lagging. China slid into deflation in October, with weak Consumer Price and Producer Price Index readings. RBC Global Asset Management believes further policy action in China is likely to address economic challenges. An unconfirmed report on Ping An Insurance being asked to take over distressed developer Country Garden led to market volatility, highlighting sensitivity to corporate events
38. Market Sentiment and Technical Analysis: The S&P 500 experienced a notable climb of 6.5% from its October 27th lows. Powell's slightly dovish tone at the 11/1 FOMC meeting, supportive economic data, and lower bond yields contributed to this upward movement. October economic surveys indicate a softening macro-environment, with ISM manufacturing declining to 46.7 and ISM services to 51.8. The highlight was the Friday jobs report, showing softer employment and inflation moderation. The Fed may adopt a "wait and see" approach, given softer employment and inflation moderation. The implied odds of another rate hike this cycle have declined to just 15%. Incoming data, including October CPI, PPI, and retail sales, will be crucial.
39. Fundamental Analysis and Earnings: 85% of Q3 earnings season is complete, with 80% of companies beating earnings estimates by 7.4%, above long-term averages. However, price reactions have not been as impressive, and EPS upside is getting slightly less than the average of 0.9% two-day gain. Forward earnings estimates are declining as corporations and analysts brace for economic uncertainties and rising interest rates. Q4 estimates reflect a sequential earnings decline, and 2024 estimates have also declined. While the stock market is up, the market of stocks has been weak. Year-to-date index returns are attributed to just 10 Tech-oriented stocks. The equal-weighted S&P 500 P/E is 14x, inline with valuations seen during the 2014-2016 US manufacturing recession.
40. Technical Analysis and Support/Resistance Levels: The upper end of the downtrend channel is a critical resistance level. After this, horizontal support is observed at 4500 and 4600. Key support levels to watch include the 20 DMA (4282), 200 DMA (4253), and recent lows (4100). Maintaining these support levels is crucial for signaling the potential end of the drawdown.
41. Breadth Thrust and Bond Market Positioning: The market's response from oversold conditions has been positive. Thursday's 2% S&P 500 gain and Friday's 1% gain came with strong breadth, indicating potential strength near market lows. Follow-through is needed for sustained upward momentum. Powell's dovish tone shifted the tighter Fed policy narrative, resulting in a drop in the US 10-year yield to 4.5%. High short interest in the bond market suggests potential for further declines, relieving pressure on equities.
42. Sector Analysis: The utilities sector has been Upgraded to Equal-Weight from Underweight due to the potential for lower rates over time. The degree of decline in the sector is considered overdone. While rates and financing costs remain high, the valuation has shifted from the high end to the low end of its 10-year range. Also, despite increased volatility, mega-cap Tech maintains its leadership, pushing to new relative strength highs. Earnings strength supports the sector's relative performance trends.
43. Overall Market Outlook: Despite acknowledging that the market has work to do for sustainable upside, there is a bias that equities are ready to recover some of their decline, potentially having seen the low of this drawdown. In addition, economic uncertainties and challenges persist, but the market has likely discounted a significant amount of negativity. Inexpensive valuations provide some comfort for accumulating favored stocks within a long-term perspective.
44. U.S. Market Analysis: In the U.S. market, the S&P 500 and Nasdaq Composite experienced mixed performance after a notable winning streak, with the S&P 500 nearly achieving its longest in two decades. The market's strength was concentrated, as indicated by the lagging equally weighted S&P 500, and upside surprises in technology-oriented firms, such as Datadog, supported growth indexes. U.S. Treasury auctions played an influential role in market sentiment, with weaker demand for the 30-year Treasury bond raising concerns about the government's borrowing needs. Limited economic data releases and the unexpected fall in the University of Michigan's consumer sentiment gauge added to market uncertainties, impacting both equity and bond markets.
45. Europe Market Highlights: In Europe, the pan-European STOXX Europe 600 Index ended slightly lower, with mixed performances in major stock indexes. European government bond yields rose amid concerns about "higher for longer" interest rates following hawkish comments from ECB President Christine Lagarde. In the UK, Bank of England Governor Bailey dismissed early talks of cutting interest rates despite Chief Economist Huw Pill's statement, and economic growth remained flat in Q3, matching the BoE's forecast. Eurozone economic indicators pointed to a weak economy, with retail sales falling and German industrial production shrinking. Political developments in Portugal announced a snap election in March 2024 after Prime Minister Antonio Costa's resignation amid a corruption probe.
46. Japan Market Insights: In Japan, stock markets rose supported by strong corporate earnings, government commitment to economic stimulus, and a weakened yen against the U.S. dollar. Bank of Japan Governor Kazuo Ueda warned about the challenges of normalizing short-term interest rates due to potential impacts on financial institutions and borrowers. Japan's cabinet approved an extra budget for Prime Minister Kishida's economic stimulus package worth over USD 110 billion.
47. China Market Overview: In China, equities rose as investors remained relatively unmoved by data showing a slip into contraction in consumer prices and the 13th consecutive month of decline in producer prices. Trade data offered a mixed snapshot of China's economy, with a decline in exports but unexpected growth in imports. Concerns about China's economic growth persisted, leading to expectations of potential further stimulus measures to counter deflationary pressures.
48. Mexico Monetary Policy: In Mexico, the central bank decided to keep the overnight interbank interest rate unchanged at 11.25%, with policymakers acknowledging the advancing disinflation process. The post-meeting statement was slightly less hawkish, noting that the balance of risks for inflation is still to the upside. Analysts do not expect a rate cut in 2023 but possibly in the first quarter of 2024, depending on the trajectory of inflation and economic conditions.
49. Potential moderation in wage growth: There has been a decline in average hourly earnings (AHE) growth to 4.1% y/y, down from a peak of 5.9%. The analysis implies that there might be further moderation in wage growth, especially if the labor market remains tight.
50. Impact of pandemic-related distortions: Pandemic-related distortions in the labor market had initially led to a rapid shift in the composition of the labor market, contributing to higher wages. The easing of this distortion and a return to pre-pandemic labor market composition could potentially take around 50 basis points (bps) out of wage growth.
51. Fed's perspective on inflation and rate hikes: The Federal Reserve (Fed) is monitoring the relationship between economic and labor market conditions to bring inflation back to the 2% target. The acknowledgment of a welcomed decline in average hourly earnings and the potential for further moderation in wage growth could be seen as aligning with the Fed's goal of managing inflationary pressures.
52. Possible impact on Fed's policy decisions: recent data suggests that if wage growth continues to cool and there is evidence of a slowing economy, it becomes more likely that the Fed may not pursue further rate hikes. The combination of moderated wage growth, a resetting of labor market composition, and signs of a slowing economy could influence the Fed's decisions on monetary policy.

Institutional opinions:

1. Interest Rates: The recent pullback in yields and a decline in interest rates have been favorable for the stock market. It's predicted that maintaining stability in bond yields, without another significant surge or a sharp fall in interest rates, will be important for the equity market's performance.
2. Positive Momentum in the Stock Market: The recent rally in the stock market is attributed to factors such as a more balanced outlook for future interest rate decisions by the Federal Reserve (Fed), cooling labor-market conditions that can help control inflation, and better-than-expected earnings announcements. This suggests that the stock market may continue to experience positive momentum as we close out 2023 and enter 2024.
3. Monetary Policy: The Federal Reserve's decision to hold interest rates steady and their willingness to keep rates on pause is seen as a key driver of the recent stock and bond market gains. The continuation of this equity bull market will likely depend on the Fed's willingness to remain on pause for further rate hikes.
4. Labor Market Conditions: The Goldilocks scenario in the labor market, where there are ongoing job gains while wage growth remains moderate, is considered positive for the economy. A balance between strong job growth and moderate wage growth is seen as conducive to economic growth and controlling inflation.
5. Historical Trends: Historical data is referenced to suggest that the final two months of the year, November and December, have been favorable for stock-market returns. This historical trend may provide some optimism for investors.
6. Market Corrections: The recent market correction is viewed as a buying opportunity. Previous corrections have typically been followed by significant rebounds in the stock market. This suggests that, despite the potential for future interest rate worries, the recent market correction may have presented an attractive opportunity for investors.
7. Changing Financial Landscape in the U.S.: The data suggests that there are significant shifts occurring in the U.S. financial sector, particularly in the markets for deposits and credit. These changes are expected to have a lasting impact on investment returns in the future.
8. Market Volatility and Interest Rates: The recent data highlights that U.S. stocks hit five-month lows while 10-year Treasury yields have risen above 5%. This indicates that there is increased market volatility and that higher interest rates are a key feature of the current financial landscape. The end of zero interest rates has led to greater competition for bank deposits.
9. Federal Reserve Policy: The Federal Reserve is expected to play a crucial role in shaping the financial landscape. The data suggests that the Fed is likely to hold policy tight, primarily due to an aging population that constrains the workforce and fuels wage pressure. The Fed's role in monetary policy will continue to impact financial markets.
10. Banking Sector and Borrowing: As competition for deposits increases, banks may need to pay higher interest rates to savers, which could, in turn, lead to higher interest rates on bank loans. This might potentially reduce demand for loans and lead to a consolidation of banks to reduce the need to support loans on their balance sheets. U.S. regulatory proposals are expected to reinforce this process.
11. Diversification in Funding: The data suggests that the higher interest rate environment is catalyzing longer-term changes in the U.S. financial landscape, including the expanding role of non-bank credit providers. This diversification in funding sources is seen as a positive development for borrowers.
12. Economic Growth and Consumer Spending: The data highlights that strong consumer spending drove a stronger-than-expected rise in Q3 GDP. However, it is suggested that this level of growth may not be sustainable, as consumers are drawing down their savings and signs of a slowdown in spending are emerging.
13. Investment Themes: The data points towards several investment themes, including the expectation of "full-employment stagnation," where inflation is set to fall further, but long-term inflation expectations are uncertain. It is suggested that central banks will need to keep policy tight to combat inflationary pressures, which may impact asset class returns. The data also emphasizes the importance of income as an investment focus.
14. Portfolio Strategy: The data advises investors to pivot to new opportunities, considering greater volatility and the potential for higher dispersion within and across asset classes. Security selection, expertise, and skill in achieving above-benchmark returns are highlighted.
15. Mega Forces: The data identifies several "mega forces" that are expected to shape the financial landscape, including digital disruption, geopolitical changes, the low-carbon transition, aging populations, and the evolving financial system. These mega forces are seen as drivers of significant shifts in profitability across economies and sectors.
16. An evolving U.S. financial landscape: The Q3 GDP growth exceeded expectations, driven by strong consumer spending. However, this is not expected to be sustainable as consumers may exhaust their savings. The ongoing shifts in the financial landscape, such as surging borrowing costs, geopolitical tensions, and elevated oil prices, point to downside risks for personal income, retail sales, corporate revenues, and profits growth. There is a noticeable increase in risk aversion among investors, which could lead to heightened volatility in the markets.
17. Market backdrop: The S&P 500 has experienced significant fluctuations in recent years due to various global events, including the COVID-19 pandemic, inflation spikes, wars, and fiscal policies. Despite the market's volatility, the S&P 500 has historically outperformed other asset classes, with an annualized return of 11.2% between 1945 and 2022.
18. Thought of the Week - Foreign Financing Matters: Foreign holdings of U.S. Treasuries are at a near all-time record of $7.7 trillion, indicating a significant level of confidence in the U.S. Economy. While China has reduced its holdings of U.S. Treasuries, other countries like Japan and the United Kingdom have increased their holdings. The composition of U.S. Treasury buyers has shifted, with hedge funds, pensions, mutual funds, and insurers becoming more significant players.
19. Investment Implications: Heightened risk aversion is influencing investors to seek high-quality companies with low-cyclicality cash flows. The current era of "higher-for-longer" applies not only to interest rates but also to other key metrics like global oil prices, budget deficits, and political discord. Geopolitical events typically lead to initial market selloffs, followed by recoveries as the worst-case scenarios don't materialize.
20. Yield Curve Inversion and Economic Implications: The current configuration of the U.S. Treasury yield curve, which displays short-term interest rates trading above longer-term rates, has witnessed a substantial inversion. This inversion, characterized by a negative difference between the 10-year and 2-year U.S. Treasury yields, has been a historically reliable indicator of impending recessions, provided it surpasses the threshold of significance (exceeding 25 basis points) and duration (persisting for more than four weeks). While yield curve inversion doesn't directly cause a recession, it acts as a warning signal. Historical data demonstrates that such inversions preceded eight of the past recessions, but there have been exceptions like the mid-1960s, where an inversion was followed by an economic slowdown rather than an official recession. Notably, the 2020 recession, triggered by the pandemic, also saw a yield curve inversion, although it may not apply to unforeseen shocks like pandemics.
21. The Full Picture of Yield Curve Dynamics: It's important to consider that in six out of the past eight recessions, the yield curve transitioned from negative to positive, either slightly before or around the time the recession commenced. Historically, recessions have not both started and ended with an inverted curve; they have always concluded with a positively sloping curve. Currently, there has been a rapid "un-inversion" in the U.S. Treasury yield curve over the past month. Long-term Treasury yields, influenced by the Federal Reserve's policy rate, have surged, narrowing the gap with short-term Treasury yields. Given our outlook that the Fed will maintain higher policy rates for an extended period and be cautious about rate cuts, we anticipate most of the steepening in the yield curve to stem from elevated long-term yields in the near term.
22. Investment Implications: The past three years have posed challenges for fixed-income returns due to the upward movement in yields. However, current long-term U.S. Treasury yields present an attractive opportunity, especially considering our anticipation of an impending U.S. recession. Heightened risk aversion among investors, seeking safe-haven assets like Treasuries, is expected to drive up demand and reduce yields. Additionally, with the Fed's tightening cycle likely nearing its conclusion, expectations of rate cuts in the event of a recession are on the horizon. Under these circumstances, it's reasonable to expect price appreciation in bonds across the yield curve. While there is potential for 10-year U.S. Treasury yields to rise further in the short term, even beyond 5%, we continue to advocate for the implementation of a barbell strategy within bond portfolios. This involves extending duration relative to the portfolio's specific benchmark and prioritizing high-quality investment-grade fixed-income. History suggests that the yield curve is a significant indicator with consistent trends, although the possibility of deviations in the current cycle should be acknowledged.
23. Equities Performance Analysis: Stock returns in 2023 have presented a complex narrative. Despite the double-digit year-to-date return of the S&P 500 Index, it's important to dissect the underlying dynamics. The S&P 500 Index's composition, where individual company performance is weighted according to market capitalization, can mask the performance of a few mega-cap technology-related firms. Seven such companies have seen their year-to-date returns skyrocket by an average of 88%, significantly elevating the S&P 500 Index. However, this obscures the broader weakness evident across various sectors of the stock market. When examining other stock indexes, including those covering large-cap, mid-cap, small-cap, developed market, and emerging market equities, it becomes apparent that most have exhibited minimal gains, with the best among them rising by just 1%. Even the S&P 500 Index, recalculated as an equal-weighted index, has dipped by over 3% this year. These data reflect an overarching theme of tepid stock returns in 2023.
24. Outlook in Light of Impending Recession: With the expectation of a recession looming on the horizon, it's probable that the average stock will continue to face challenges. Investors are advised to emphasize portfolio quality and exhibit preferences for U.S. Large Caps over U.S. Mid Caps and Small Caps. In the international arena, Developed Market ex-U.S. is favored over Emerging Market equities.
25. Crude Oil Supply Dynamics: The recent surge in crude oil prices has been noteworthy, with benchmark prices like West Texas Intermediate (WTI) and Brent registering substantial gains from July through October. Remarkably, this occurred despite slower global gross domestic product growth, highlighting that the primary driver of elevated crude oil prices is not augmented demand but, rather, restricted global supplies. The crux of the supply issue lies in the actions of OPEC+, a consortium of oil-producing countries, which has been diligently reducing oil production for a significant period. OPEC+ has succeeded in driving down global inventories, contributing to the maintenance of elevated oil prices. The reduction has been so effective that OPEC+ has reaffirmed its commitment to prolonging these cuts until the end of 2023. As evidenced in the data, this reduction in supply has resulted in a considerable decrease in global crude oil stocks stored in floating storage units over the past six months.
26. Predictions for Oil Supply and Prices: Given these observations, it's foreseeable that global oil supply will remain constricted, at least until the close of 2023. The year-end 2023 target price ranges for crude oil remain unchanged, with WTI estimated to be between $80 and $90 per barrel, and Brent in the range of $85 to $95 per barrel.
27. Private Equity Activity and Opportunities: Private equity activities have experienced a slowdown in the third quarter of 2023. Exit values were at their second lowest since the 2008-2009 financial crisis, surpassed only by the pandemic-driven downturn in the second quarter of 2020. These circumstances have limited the capital available for distribution to investors. The reduced exit activity, coupled with economic uncertainties, has contributed to a 15% drop in year-to-date fundraising through September.
28. Opportunities in Private Equity: Despite this backdrop, three areas show promise: The secondary market serves as a valuable tool for returning capital to investors under less-than-ideal exit conditions. Also, a notable uptick in interest is observed in the middle market, as its share of private equity fund closings reached the highest level since 2009 in the third quarter. Increased middle market deal activity is attributed to smaller deal sizes and more attractive valuations. In addition, in 2023, growth equity deals are expected to surpass other private equity deals. This segment typically focuses on faster-growing and often profitable companies with lower capital requirements.
29. Equity Market Analysis: Early indicators point towards the development of an oversold intermediate-term equity low. Throughout Q3 and into Q4, equity markets have seen a pullback, approaching oversold conditions near crucial support levels. The catalyst for an equity rebound hinges on a decline in interest rates, which is perceived as a key driver for such a resurgence.
30. Momentum Indicators and Support Bands: Weekly momentum indicators for the S&P and Nasdaq, which track moves over 2-4+ months, have transitioned from overbought levels at the beginning of Q3 to oversold levels through October. This transition suggests that both markets are at the nascent stages of bottoming near support bands, represented in blue. It is anticipated that this trend will likely result in a rebound extending through the year-end.
31. Role of FOMC Meeting and Treasury Auction: Today's FOMC meeting and a closely monitored treasury auction hold significant implications for signaling potential changes in the interest rate uptrend. With weekly momentum indicators indicating overbought conditions and signs of stalling, a drop below 4.7% followed by 4.5% in U.S. 10-year yields is required to suggest that the uptrend in rates may be reversing. On the other hand, a push above 5% in U.S. 10-year yields would signify a continuation of the rate trend, likely leading to further declines in equities, with key support levels at S&P 4049 and Nasdaq 12,269 coming into focus.
32. Equity Rebound and Market Correction: The S&P and Nasdaq markets exhibit a pattern characterized by three downside movements, often defining the final stages of a market correction. Daily momentum indicators, as shown in the top panel, have become oversold and are displaying signs of bottoming, which is indicative of a potential 2-4 week rebound.
33. US 10-Year Yield and Its Trajectory: The direction of the U.S. 10-year yield continues to be a focal point for investors. While the uptrend persists and challenges the critical 5% threshold, early indications suggest that rates may be approaching a peak. Weekly momentum indicators, tracking moves over 2-4+ months, are signaling a potential stall in rates near current levels.
34. Short-Term Pullback and Key Levels: A short-term pullback for the U.S. 10-year yield is currently underway, with a decline under the widely observed 5% level. This pullback is testing a crucial downside range between 4.7% and 4.8%. A move below 4.7% is likely to have a positive impact on equities, with the next significant downside level at the 5-month uptrend at 4.5%.
35. Technical Outlook for Gold: Although gold is not frequently discussed in weekly notes, its technical stance is noteworthy. It has rallied back from substantial support at its rising 4-year moving average in red and is retesting the upper end of a resistance band spanning from 2000 to 2075. In the very short term, gold is overbought, and a pause is anticipated. However, a move above 2075 would represent an essential breakout with the potential to extend towards 2358 and potentially even higher price levels.
36. Fixed Income Market Analysis and Outlook: Following several significant events during the week, it is imperative for fixed income investors to shift their focus beyond yield and towards bond price appreciation and potential high total returns. The average yield on the Bloomberg 5-10Y Gov/Credit Index stands at 5.4%, with an average dollar price below par at $87. When markets price in not only the end of rate hikes but also the timing of the first rate cut, yields may fall, resulting in bond price appreciation and total returns. Reinvestment risk exists for investors who remain in short-dated bonds if they roll over into a lower-yield environment. While it is still early days, there are attractive entry points in the bond market, particularly in the 3- to 10-year part of the yield curve, which offers a favorable risk/reward tradeoff at the moment.
37. Key Market Events: This week marked a momentous period for global fixed income markets and markets in general, even though it appeared that not much occurred in terms of substantial changes. The significance of these events became clear. To start with, there were concerns that the BoJ might abandon its yield curve control program, which caps the 10-year Japanese government bond yield's rise at one percent. While the cap was removed, the BoJ still retains a degree of reference and operational "flexibility" around this level. The potential impact was on the demand for U.S. Treasuries by Japanese investors. In addition, the Treasury Department's decision to address increased financing needs due to rising deficits, primarily attributed to lower tax receipts and reduced remittances from the Federal Reserve, played a role in the ongoing surge in Treasury yields. Also, the Fed recognized tighter financial conditions due to rising yields, declining stock prices, and dollar strength since August. This created headwinds for economic activity, causing a more cautious tone from Fed Chair Jerome Powell.
38. Market Reactions and Indicators: The S&P 500 rose by 4.7% since October 27. The 10-year Treasury note yield decreased by about 32 basis points from its October high to 4.67%. Historically, when the Fed concludes rate hikes, bonds typically perform well, and this trend might continue. As bonds with more duration tend to outperform shorter-dated bonds, it's suggested that investors consider shifting from short-dated securities to intermediate and longer-dated bonds.
39. U.S. Market Analysis: U.S. stocks entered November on a strong note, rebounding after experiencing three consecutive months of declines. The "bad news is good news" perspective emerged, driven by weaker economic data hinting at lower inflation and anticipated lower interest rates. With over two-thirds of S&P 500 companies having reported Q3 2023 earnings, results appear to be satisfactory. However, guidance for the next quarters remains subdued, with concerns about a potential recession in 2024. Weaker economic data includes ISM manufacturing surveys, consumer expectations, and a weak ADP jobs report. However, productivity gains and moderating wage growth could potentially dampen inflation.
40. Canadian Market Analysis: Canada's economy is slowing, with a preliminary September GDP estimate showing no growth for the fourth consecutive month. Higher interest rates have impacted households, leading to declining retail and home sales. The Bank of Canada (BoC) suggests supply and demand are approaching better balance, but wage growth remains strong, and disinflationary momentum is slower than expected. Sluggish growth is expected to persist, but the BoC is unlikely to cut rates until there is clear evidence of slowing core inflation.
41. European Market Analysis: The Bank of England (BoE) voted to keep the bank rate unchanged at 5.25%, indicating a second consecutive pause in the hiking cycle. The BoE's forward guidance suggests policy rates will remain at current levels for an extended period, pushing back on market expectations of rate cuts. The economy may experience a downturn, but the central bank maintains a relatively high bar for further hikes, possibly marking the peak of interest rates.
42. Asia Pacific Market Analysis: South Korea's exports rose for the first time since late last year, indicating global demand resilience. China's factory activity declined in October, highlighting ongoing economic fragility and the need for policy support. HSBC announced a $3 billion share buyback program. Ping An Insurance reported a 5.6% YoY profit decline for the first nine months of the year. Kweichow Moutai became the most traded stock in China's equity market, with record-breaking turnover.
43. Market Overview: The S&P 500 has been in a downtrend since the peak on July 31st, and investor optimism for a soft landing is diminishing. The anticipation of the "higher-for-longer" stance from the Federal Reserve and the accompanying rise in bond yields is creating headwinds for equities. Valuation multiples have contracted as higher rates are expected to impact economic activity, and this is causing concerns of a potential economic contraction and weaker corporate earnings.
44. Future Possibilities: Investors may find a silver lining in valuations and a potential shift in Federal Reserve expectations down the road. The Federal Reserve's dual mandate involves maintaining low inflation and promoting maximum employment. As the economic conditions worsen and employment weakens, it is expected that the Federal Reserve will shift its focus from battling inflation to supporting employment. The market is forward-looking, and valuation expansion typically drives market returns ahead of fundamental improvements.
45. Short-Term View: The S&P 500 index has experienced a 10% pullback over the past few months, and many stocks have seen even more significant declines. Cyclically-oriented sectors of the market have weakened, and this suggests a need for technical recovery to rebuild sustainable upside. However, the pullback also appears to be overdone, with various indicators signaling oversold levels. For investors with excess cash, an opportunity to put funds to work may be present, despite potential short-term volatility.
46. Key Data and Factors to Watch: The upcoming week brings a substantial amount of economic data, particularly in terms of employment figures. The October Jobs Report and ISM Services data will be particularly significant. Employment trends have been influential in economic activity, Federal Reserve expectations, bond yields, and equity markets. Additionally, the influence of bond yields on valuation and equity market movements should be monitored closely.
47. US Macro Outlook: The Federal Reserve is currently in a "wait-and-see" mode with its rate hike cycle, assessing the impact of higher rates on the economy. Data and its effect on bond yields are crucial for equity market movements. The Federal Reserve's "higher-for-longer" messaging has recently pushed bond yields upward, affecting valuations negatively.
48. Q3 Earnings Season: Around 60% of the S&P 500's market capitalization has reported Q3 results so far, with 76% of companies beating earnings estimates by 7.8%. However, despite earnings beats, price reactions have been muted. Forward earnings estimates are declining due to uncertainties related to rising interest rates. Q4 estimates have decreased significantly, now reflecting a sequential earnings decline, with expectations for this trend to continue.
49. Interest Rates and Valuations: Expectations suggest the economy is heading for a contraction, which may lead to weaker corporate earnings. The potential silver lining lies in valuation and the prospect of a shift in Federal Reserve expectations. The Federal Reserve's dual mandate could allow it to shift focus from battling high inflation to supporting employment as economic conditions deteriorate. This shift may result in lower bond yields and support valuation multiple expansion.
50. S&P 500 Technical Analysis: The S&P 500 has been in a downtrend with lower highs and lower lows since its peak on July 31st. The index has seen a pullback of approximately 10%, with numerous stocks trading significantly below their recent levels. The market appears oversold, which might indicate a potential bounce. A positive sign would be if the index breaks through resistance and maintains recent lows during weaknesses, accompanied by a robust breadth thrust in advancers vs. decliners. If the index fails at resistance and continues to drop, it could signal more weakness ahead.
51. Weakening Performance of Cyclicals: Sectors such as semiconductors, transports, consumer discretionary, and banks have displayed signs of weakening, which indicates the need for a technical rebound. However, despite the pullback, many quality companies are oversold. Investors are recommended to put a portion of their excess cash to work with a long-term perspective.
52. Intermediate-Term Trends: Intermediate-term trends remain positive. Indicators like High Beta vs. Low Volatility and Equal-Weighted Consumer Discretionary vs. Staples continue to be in uptrends, with higher highs and higher lows since the beginning of the year, indicating positive intermediate-term returns.
53. Seasonality: While investment decisions should not be solely based on the calendar, it's noteworthy that November marks a more favorable season. The August-October period is historically the weakest, while November-January tends to be the strongest.
54. Market Composition: The market's performance is heavily top-heavy and dominated by a few tech-heavyweights. A significant portion of the S&P 500's year-to-date return can be attributed to the top 10 companies. Diversification remains crucial for long-term performance and risk management, and it's anticipated that underlying strength will eventually shift or broaden. For investors looking to increase exposure to tech or areas left behind, it may be an opportune moment as valuations have become more attractive.
55. U.S. Market Overview: The U.S. market had a strong week with the S&P 500 recording its most robust weekly gain in nearly a year. This rally was fueled by a slowing economy and a dovish stance from the Federal Reserve that led to a significant drop in long-term bond yields. While growth stocks and technology-related companies outperformed, the gains were broad-based, with small-cap stocks in the Russell 2000 Index notably strong. A combination of earnings season, end-of-fiscal-year trading strategies, and the Federal Reserve's policy meeting contributed to the market's positive sentiment. The labor market showed signs of cooling, with job additions falling below expectations in October and the unemployment rate rising, albeit still at a historically low level. Despite these challenges, wage growth remains a key focus, and there are encouraging signs of productivity growth in the workforce. Concerns about Treasury funding eased somewhat as the U.S. Treasury reduced its quarterly refunding auctions, alleviating worries about supply exceeding demand in the bond market.
56. European Market Overview: In Europe, the stock market rebounded after a previous week of losses. Major European stock indexes posted solid gains as the perception of central banks concluding their monetary policy tightening cycles led to declining bond yields. The Bank of England (BoE) maintained its high-interest rates but warned that they would remain at a restrictive level for an extended period. Eurozone inflation slowed, and the economy contracted, particularly in Germany. Declining housing market activity remained a significant concern, as new home sales dropped. However, support measures and expectations of 5% GDP growth in 2023 have kept the outlook relatively optimistic.
57. Japanese Market Overview: Japan's stock markets performed well, gaining around 3% during the week. The Bank of Japan (BoJ) maintained its ultra-loose monetary policy stance but allowed yields to rise more freely within its yield curve control framework. Notably, the BoJ raised its inflation forecasts, indicating a more optimistic view on price growth. The Japanese government announced a fiscal stimulus package to stimulate growth and alleviate the impact of rising inflation, although waning voter support remains a concern. The outlook for Japan's economy and monetary policy remains cautious, but the BoJ's dovish stance has supported sentiment in the market.
58. Chinese Market Overview: Chinese stocks saw gains as speculation arose that U.S. interest rates may have peaked, offsetting concerns about China's slowing growth. Factory activity in China contracted, indicating economic challenges, and the property market's continued decline remains a drag on growth prospects. The housing market's struggles have raised concerns about China's economy, and while the expectation is for 5% GDP growth in 2023, the lack of substantial support for the housing sector has left the economy potentially vulnerable.
59. Other Key Markets (Brazil, Colombia): In Brazil, the central bank reduced interest rates, a widely expected move. Policymakers anticipate further reductions in upcoming meetings, depending on the economy's trajectory. In Colombia, the central bank decided to maintain its interest rate, with a slightly cautious tone due to concerns about sticky inflation and rising inflation expectations. While there's a slight uptick in the growth outlook, the central bank may start cutting rates toward the end of the year, contingent on inflation data.
60. U.S. Economic Strength in 2023: Throughout the first three quarters of 2023, the U.S. economy displayed remarkable resilience, consistently deferring predictions of a mild recession. The first half of the year saw steady growth, despite a setback in the first quarter due to a regional banking crisis. Notably, the third quarter of 2023 saw a substantial acceleration in GDP growth to a real annualized rate of 4.9%, marking the fastest pace in two years. This impressive performance was driven by a surge in private consumption, particularly among affluent households, which contributed more than half of the growth. Other positive contributors included inventory accumulation, housing demand, and national defense spending. However, non-residential investment showed signs of decline, possibly indicating a shift in business sentiment.
61. Challenges and Risks Ahead: While the headline GDP figure is impressive, it may overstate the actual strength of the economy. Several challenges and risks loom on the horizon. The recent increase in long-term yields has put downward pressure on stock markets and poses a risk to the spending spree by wealthier households due to potential negative wealth effects. Positive factors contributing to the growth, such as inventory build-ups and government spending, are likely to be transient in nature. Furthermore, the Federal Reserve, despite acknowledging progress on core-PCE inflation, is expected to keep the possibility of a December rate hike open. This suggests a cautious approach to managing inflation and economic conditions, which could have implications for financial markets and investor portfolios.
62. Investment Strategies and Considerations: In the face of these economic conditions, investors should prepare for a gradual economic slowdown. This may entail maintaining well-balanced portfolios that encompass diversified financial assets to mitigate risks associated with market volatility. Additionally, considering the potential transience of positive economic impulses, exploring alternative investments could be beneficial. Alternative investments, known for providing stable income, enhanced diversification, and potentially robust returns, can serve as a valuable addition to portfolios in this environment. Investors are encouraged to stay informed and adaptable as economic conditions continue to evolve, and new data emerges.

Previous update:

Institutional opinions:

1. 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.
2. Confidence in the Correction: 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.
3. Economic Resilience: 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.
4. Moderating Inflation: 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.
5. Fed's Rate Hikes: 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.
6. Peak in Bond Yields: 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.
7. Improved Valuations: 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.
8. Earnings Rebound: Corporate profits are expected to return to growth, supporting rising stock prices. This is in contrast to the previous year when profits declined.
9. Manufacturing Activity: There are signs that the worst in manufacturing activity is over, which can be a positive signal for the broader economy.
10. Oil Prices: Despite brief spikes in oil prices due to geopolitical uncertainty, they have subsided, indicating a neutral to slightly negative influence on inflation.
11. Investor Sentiment: Investor sentiment has shifted from positive to more skeptical. This contrarian indicator suggests that market corrections may be less likely as complacency decreases.
12. Seasonal Factors: Historically, November and December tend to be good months for stocks, with above-average gains and a higher likelihood of positive returns.
13. Historical Perspective: Historical data shows that corrections within bull markets have been good times to add equities, with stocks recovering in a relatively short time frame.
14. Long-Term Outlook: 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.
15. Recommendation: 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.
16. Stagnating Earnings: 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.
17. Moderate Earnings Growth: 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.
18. Earnings Growth Tied to Mega Caps: 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.
19. Macro Challenges: 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.
20. Inflation Risks: 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.
21. Valuations and Relative Risk: 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.
22. Selective Approach: The recommendation is to remain selective in stock investments and to harness mega forces such as AI. Opportunities are seen in sectors like healthcare.
23. Interest Rate Environment: 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.
24. Full-Employment Stagnation: 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.
25. Granularity and Security Selection: Greater market volatility and dispersion are expected, creating opportunities for granularity in investment strategies. Security selection, expertise, and relative value opportunities are emphasized.
26. Mega Forces: 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.
27. Macro Strategy: 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.
28. Market View: 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.
29. Thought of the Week: 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.
30. Real Assets Spotlight: 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.
31. Equities: 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.
32. Fixed Income: 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.
33. Alternatives: 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.
34. Equity Markets: 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.
35. S&P and Nasdaq: 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.
36. US 10-Year Yield: 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.
37. US 10-Year Yield and US Dollar Index: 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.
38. Utilities and Staples: 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.
39. Belt and Road Initiative (BRI): 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.
40. United States: 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.
41. Canada: 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.
42. Europe: 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.
43. Asia Pacific: 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.
44. Equity Market Momentum: 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.
45. Sector Rotation: 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.
46. Influence of Bond Yields: 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.
47. Bifurcated Market: 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.
48. Earnings Season: 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.
49. Macro Data: 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.
50. U.S. Market Sentiment: 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.
51. Economic Growth: 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.
52. Interest Rates and Bond Yields: 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.
53. European Market Uncertainty: 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.
54. Japan's Market Sensitivity to Yields: 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.
55. China's Economic Stabilization: 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.
56. Central Bank Actions in Emerging Markets: 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.