HIGHLIGHTS
Stocks are still in free fall and bearish sentiment is far from getting exhausted. US equity closed its third quarter at the lowest level since 2020. There was a late selloff into the month-end in US Treasury, and the 10Y benchmark yield hovered around 3.82%. Job data next week would be critical as it will affect the rate hike trajectory of the Fed. The spiraling losses are snowballing into forced asset liquidation, which potentially amplifies the selloff. Volatility has been exacerbated in the quarter end, partly driven by the balance sheets adjustment.
Great British “Peso”: GBP crashed to all-time low early this week mainly driven by the enormous tax cuts. The pound dropped 3% right after the announcement and the decline extended further to 5% after he mentioned there would be more to come. While the UK government aims to boost the economy which eventually creates more tax revenue, the Bank of England (BoE) is having a hard time fighting the 40-year high inflation. BoE may need to calm the market down by introducing an emergency rate hike. Market is pricing in a larger chance of a 200bps rate hike in the coming meeting in November.
ECB: More wagers are putting at a 75bps rate hike in the next ECB meeting after the announcement of the policymaker on Thursday. Inflation data in German, the biggest economy in the eurozone, hit a 70-year high at 10.9%. From the interview of the ECB policymaker, we can conclude that 50bps is the minimum, 75bps is likely to happen, and 100bps is not impossible but with low odds as ECB is suggested to avoid doing too much in one go given that there were two sizeable moves already in the last few months.
Recession Odds: A 98% likelihood of a global recession is forecasted by the model of Ned Davis Research. While many investors are resisting the idea of a profits recession this year, it seems unavoidable by the day. The selling pressure will continue as the outlook is not showing we are in a recession now, while we are likely to be in one soon. The risk of severe recession globally is increasing in 2023, creating more downside risks for global stock markets.
MARKETS
10,575.62 | -2.96% | |
S&P 500 | 3,585.62 | -2.91% |
Dow | 28,725.51 | -2.92% |
10-Year | 3.80% | +10bps |
Brent | 87.96 | +2.10% |
DXY | 112.12 | -0.95% |
*Data as of market close. 5-day change ending on Friday.
VIEW FROM THE STREET
Equity
Bank of America: Various assets have broken important technical support levels. The accumulated losses will force the fund to sell more assets for liquidity and cash, thus the selloff will be accelerated. A decline of 20% below the 200-day moving average has been a good entry point historically.
J.P. Morgan: Our year-end target for S&P500 is above-consensus high at 4,800, equivalent to a 34% gain from this Friday. However, the escalating geopolitical and monetary policy risks are likely to make the target harder to meet. Unless the abovementioned risks are alleviated, the target may not be realized until next year.
UBS: Equity risk premium is making equities less attractive than bonds. Also, earning estimates are under pressure. However, a further upward squeeze is expected due to the over-depressed sentiment and the prospect of peak inflation. Investors are recommended to selectively long cyclicality via commodity-linked stocks.
Morgan Stanley: Investors are confused about the conflicting signals from leading and lagging indicators. Many of them are hoping there are still positive prospects for 3rd quarter earnings growth. Lagging indicators like a strong labor market suggest the resilience in earnings and pickup in GDP growth. On the other hand, leading indicators like yield curves suggest the likelihood of a recession in the coming 12-18 months is rising.
Fixed Income
Morgan Stanley: The 10Y Treasury yield has rebounded from all-time low with a swing of around 230bps over the last 10 months. Although the forward P/E ratio has corrected some with the rate spike, we expect the correction would be amplified when earnings fall. Standard Chartered: The 10Y yield is expected to hover around 4%, which is seen as technical resistance. Rates are not likely to jump sharply from here in the coming year. IG-rated corporate bonds are recommended as it offers better credit quality with good yields. IG-rated government bonds in the developed market are not recommended due to high-interest rate volatility and hence, a lower risk-reward profile.
Economy
Morgan Stanley: Market participants are good at translating economic data into forecast half a year ahead, leading to a false sense of security in the current earnings. However, policies may operate with longer lags sometimes, which could be as long as two years. Investors are suggested to expect more negative surprises and not underestimate the effect of rapid rate hikes.
UBS: Fed is not alone. Global central banks announced more than 700bps of rate hikes in a week, including 75bps from SNB (Swiss National Bank), 100bps from Riksbank (Sweden’s Central Bank), 50bps from BoE (Bank of England), and many others. BoJ (Bank of Japan) is sticking with its policy stance but the Japanese government has intervened in the currency market surprisingly. Sterling was under pressure due to concerns about major tax cuts and other spending measures.
Citi: Looking at the hard landing period historically at 1973, 1980, and 1981, when inflation fell significantly over the next two years, the unemployment rate rose 3.4% on average, which is much higher than the Fed’s forecast of 0.6%. It is not surprising that unemployment increase substantially in 2023.
Commodity
Standard Chartered: Remain bullish on oil prices in short term as sanctions of the EU are expected to take effect in winter and the proposed oil cap price could tighten supply and increase volatility. Gold remains a core holding and is a key diversifier in the portfolio as it has proven to be a superior hedge against recession historically.
HSBC: Oil prices ended a choppy session later this week. Investors are eyeing a worsening economy against the potential output cuts by OPEC+.
Currency
Bank of America: Exchange rates of economies other than the US are facing headwinds for common currency returns in the international stock market due to the aggressive Fed rate hikes. The unfolding economy slowdown and energy crisis will further extend the weakness in foreign currencies.
Standard Chartered: The dollar strength is mainly driven by the faster pace of rate hikes, leading to a larger interest rate differential between the US and other countries. Amid the concerns of slow economic growth and geopolitical risks in Europe and the Middle East, the demand for safe-haven USD is increasing. However, USD is expected to peak in 6 to 12 months. Fed is likely to pause hikes, narrowing the interest rate differentials. Capital outflow from the US to other regions like Asia because of the lagging growth. Geopolitical tensions would be eased thus reducing the demand for safe-haven currency.
KNOWLEDGE TRANSFER
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DISCLOSURE
This newsletter is meant for informational purposes only and is not investment advice. Always consult a licensed investment professional before making important investment decisions. Advertising and sponsorship do not influence editorial content or decisions. Market Hedwig is not responsible for the promises made or the quality or reliability of the products or services offered in any advertisement.