Week ended Oct 14, 2022
ANOTHER INSANE WEEK
“Global growth is forecast to slow from 6.0 percent in 2021 to 3.2 percent in 2022 and 2.7 percent in 2023. This is the weakest growth profile since 2001 except for the global financial crisis and the acute phase of the COVID-19 pandemic.” – extracted from World Economic Outlook from the IMF, dated October 11, 2022
Politics can be so cruel. Not surprisingly, Prime Minister Liz Truss did just as I expected to save herself. She summoned Chancellor of the Exchequer Kwasi Kwarteng – who was attending the annual IMF meetings in Washington DC – back to London and promptly threw him under the bus. Gilts and Sterling had already gotten a boost the day before after leaks suggested that Ms Truss and team might do a U-turn on her package of debt-financed fiscal stimulus. On Friday afternoon, Ms Truss promptly held an awkward news conference at Downing Street (on YouTube here) in which she announced a further walk-back of her tax cuts, and that Mr Mr Kwarteng would be replaced with Jeremy Hunt. Temporarily at least, things might look a bit brighter, but I suspect this is nothing more than a short reprieve from significant economic pain to come in the U.K. As the dust settled, investors seemed indifferent at best although Thursday’s improvement in Gilts and Sterling seemed to have held for now. As an aside (although I could find nothing official), I presume that the Bank of England ended its support of long-dated Gilts as planned on Friday. So at this point, I would say:
Bank of England, 1; Ms Truss’ Conservative government, 0
The Labour Party must be licking its chops, and that’s slightly scary given I’ve not seen much to impress me from that party either. Yikes!
If political events in the U.K. weren’t enough to keep you on the edge of your seat, then volatility in U.S. equity markets certainly should had. On Thursday, we witnessed the craziest swing in equity prices I can recall without an obvious (significant) event as a driver. It all started with the release of September CPI in the US pre-open, which came in higher than consensus, almost guaranteeing that the Fed Funds rate will be jacked up another 75bps at the next FOMC meeting in early November. Bonds and stocks dropped immediately in the pre-market, which carried through to the open. The S&P 500 index was down 2.4% (to 3,491.58) within minutes of the open, and the yield on the 10y UST soared 22bps to 4.07%. I suppose this reaction made sense, but what followed is difficult to rationalise. When I looked at the screens an hour and a half later, the S&P 500 had clawed back all of its losses and then continued to rise – in fact to gain momentum – the entire day, ending up 2.6%. Using the prior day’s closing level for the S&P 500, that is a 5.4% swing low-to-high in a single day! US Treasuries also settled, with the 10y falling back to 3.95% by the end of the session. And what was the catalyst behind this wild day, you might ask? I can only guess that this crazy trading session might be attributed to short covering or some technical driver like that, because there was no other news I could find that would cause such an “on-the-dime” reversal in sentiment so suddenly. The explanation of technical drivers is also be supported by the fact that the VIX – the fear index for equities – traded in a narrow range throughout the day, never even reaching the high of Wednesday (i.e. the day before) in spite of the wild fluctuations in equity indices. At this point, I guess you could say:
Inflation, 1; Federal Reserve, 0
Below is a quick summary of markets this week, followed by more news (and links) and importantly, what lies ahead.
MARKETS THIS WEEK
As you can see in the market data summary table below, there was again no place to hide this week as far as equities, with the exception of Chinese equities (coming off the week-long national holiday the week before) and the DJIA, reflecting its more defensive tilt. The NASAQ was hammered, bringing its YtD loss to 34%, a stunning reversal from 2021 but not surprising given the increase in interest rates and the over-valuation of many of the names in the index. US Treasuries also took it on the chin, with perhaps the more bothersome sign being further steepening in the 2y-10y yield curve, now screaming recession. The decline in oil prices that occurred after the boost from OPEC+ announcing that it would reduce supply is another sign that investors might be bracing for a decline in demand due to the slowing of the global economy, expected by IMF following their recent update (see section below). Corporate credit weakened too, signalling economic weakness ahead but also potentially (as I heard at the #BloombergInvest New York conference this week) the liquidation of credit assets – especially investment grade bonds and high-rated CLO tranches – to create liquidity in troubled portfolios, like U.K. pensions. One more thing to note is that the 30y fixed-rate mortgage rate (Freddie Mac data) rose to 6.92% this week. Digest this in the context of the last read of 2021 being 3.11%. Residential real estate is going to get slammed, too.
WHAT MATTERED THIS WEEK
US CPI data for September
Ouch – that was a miss. You can dive into the data yourself here, but end result is that headline CPI increased 0.4% (MoM) in September, following nil in July and 0.1% in August. Core CPI (ex-energy, ex-food) increased 0.6% in September (same as August increase). The Fed has a lot of work to do!
IMF cuts global growth forecasts
The IMF not surprisingly cut its global growth forecasts this week, declining from 6.0% in 2021 (actual), to 3.2% for this year and 2.7% in 2023.
Growth in developed markets economies are expected to decrease to 1.1% in 2023. Inflation is also expected to slow. The graphic to the right extracted from the IMF report is interesting in that it compares the IMF more optimistic forecast from April 2022 to the update forecast. You can see that global economic growth has been revised down, and the decrease in inflation is projected to be slower than forecast in April. The full IMF report is long and detailed, but you can also find an executive summary and other data on the website for the report here.
Four US banks reported earnings on Friday (change Friday post-earnings in brackets) – JPM (+1.7%), MS (-5.1%), WFC (+1.9%), and C (+0.1%). The results were generally better than consensus expectations aside from Morgan Stanley, which missed on the top and bottom lines due to slower investment banking revenues. Credit provisions are not surprisingly being increased as banks brace for slower US economic growth, and there is no sign that trading or advisory income will improve in the quarters ahead. All of the banks sound cautious as far as the outlook. The good news is that net interest income will improve as interest rates push higher, and US banks generally remain very well capitalised and should be able to withstand a sharp downturn in economic activity, should it occur. Refinitiv’s weekly earnings update for the S&P 500 is here.
Note also that Refinitiv is projecting S&P 500 earnings of $54.83 for this quarter, growth of only 2.06% compared to 2Q22. The forward P/E ratio of the S&P 500 index is 15.7x, and the trailing P/E index is 16.7x (based on Friday’s close).
Below are some of the key data releases and other financial events that matter for the weeks ahead.
S&P 500 earnings –BoA reports on Oct 17th and GS on Oct 18th, completing earnings for the big six US banks. A number of other banks also report this week. Corporates reporting this week that could weigh one way or the other on sentiment include NFLX (Tues), TSLA (Weds), SNAP (Thurs) and AMX (Fri). In total, 66 S&P 500 companies will report earnings this week.
Mid-term elections are approaching in the US, slated for Nov 8th. According to The Economist, at this point Democrats are expected to keep their majority in the Senate but lose their majority in the House. In total, all 435 seats in the House of Representatives are open, 35 seats (of 100) in the Senate will be contested, and 36 state governorships will be decided.
As far as economic data, the focus on Monday and Tuesday will likely be on China, which will release 3Q22 GDP (consensus +3.4% YoY) and Sept retail sales (consensus +3.3% YoY). Data to be released in the UK on Weds includes CPI for Sept, with consensus 10.0% YoY and core CPI 6.4% YoY. UK retail sales for Sept will also be released (Fri), with the MoM decline expected to be 0.5%. UK (Thurs) and Eurozone (Fri) consumer confidence will also be released next week.
Upcoming central bank meetings (and last one of year):
ECB – Oct 27th (next and Dec 15th)
Federal Reserve – Nov 1-2 (next Dec 13-14)
Bank of England – Nov 3rd (next Dec 15th)
Bank of Japan – Oct 27-28 (next Dec 19-20)
Corporate bonds (credit)
Safe haven and other assets