WEEKLY: Goldilocks CPI report spurs risk rally
Week ended Jan 13th, 2023
Two weeks into the new year and things could not be better as risk markets continue to rally across the board. Equities everywhere have ripping higher, US Treasury yields have decreased, and Bitcoin has put all assets to shame, up an astonishing 17.4% in the first two weeks of the year. Even gold is higher, although inflation appears to be on the way down, confirmed by the most recent US CPI read (December) released on Thursday. Things in Old Blighty are better than expected, too – the GDP read for November came in unexpectedly positive (+0.1% MoM, don’t get too excited) although the U.K. is meant to be mired in recession. The IMF also seems to be sticking to its growth targets – Managing Director Kristalina Georgieva reported this week that the IMF is sticking with its October forecast of 2.7% global economic growth in 2023, following a series of downgrades several times during 2022.
As I feared (and tweeted about, here), the real barometer of where we stand would be the earnings of large banks, and more specifically, what they would do as far as loan loss reserves. Friday poured cold water on investors in the morning session as all four banks increased their loan loss reserves from 3Q22, signalling economic headwinds ahead.
JP Morgan Chase (JPM): $2.3 bln added to reserves (4Q22 consensus $1.96 bln, 3Q22 $1.5 bln)
Citibank (C): $1.85 bln added to reserves (4Q22 consensus $1.14 bln, 3Q22 actual $1.37bln)
Bank of America (BAC): $1.1 bln added to reserves (4Q22 consensus N/A, 3Q22 actual $945 mln)
Wells Fargo (WFC): $957 mln added to reserves (4Q22 consensus N/A, 3Q22 actual $784 mln)
The collective loan loss reserves of the four banks, of which JPM was the most conservative (i.e., largest increase), was $1.6 billion, a 35% increase vis-à-vis the prior quarter.
In spite of the warning signals that were sent by higher loan loss reserves, investors seemed to bury these concerns by mid-day Friday as US stocks recovered and then resumed their climb. The strong start to the year is not what I was expecting. Investors more focused on trading might have easily been caught wrong footed so far this year even as investors that are long risk assets (like me) are certainly thrilled. I have to issue a “health warning” though – the rapid and unexpected shift in sentiment is certainly welcome although it will likely prove short-lived. Clearly, momentum investors – and there are still plenty of those out there – and retail investors suffering from FOMO have added fuel to the fire. It begs the question: “were things as bad as they seemed a few weeks ago, or are investors getting ahead of themselves?” As history has shown, markets will act ahead of the economy, looking out several quarters from now. I accept this, but at the risk of raining on the “feel-good parade”, my gut tells me that this is too much, too fast. Earnings might ultimately prove to be the culprit. Rest assured that we are facing some choppy waters ahead as global economies continue to acclimate to the normalisation of monetary policy. Why are we suddenly looking so much more positive than expected during the first two weeks of 2023? Here are three reasons:
The US Dollar has continued to slowly ease off the highs experienced a few months ago, benefitting emerging market countries (many US Dollar linked or heavily dependent) and US multinational companies, although the operating benefit of earnings from these companies will not be visible until 1Q23 forward.
Inflation is continuing to slowly decline, raising hopes that central banks will back off of their tightening regime and move sooner to a neutral stance
Technical factors are in play. Momentum is contagious as investors jump in with both feet after waiting for signs signalling an inflection point. “Up” feels like it is starting to be the new narrative, ignoring economic headwinds.
I suppose I remain cautious, even dubious. The first two weeks of 2022 were flat for the S&P 500, but we started to go downhill afterwards. My expectations for this year were for a better second half of 2023, not for a flying first two weeks of this year. I think we are far from being out of the woods on inflation, although we seem to be trending in the right direction. Global economic growth and corporate earnings remain the key drivers. Let’s see how things unfold during the current earnings season.
On tap this coming week is plenty of economic data from the US, the UK, the Eurozone and China (4Q22 GDP), including price data and retail sales that will be carefully watched. S&P 500 earnings continue, too. The Bank of Japan also has a monetary policy meeting this week, and it will be interesting to see if they continue to take baby-steps to carefully fall in line with its G7 brethren. The political drama of the US debt ceiling will also play out this week as the US is expected to hit the ceiling on Jan 19th according to the Treasury Dept. This Congressional gridlock will waste time and energy, and it could unsettle markets. The World Economic Forum also begins in Davos, so be on the lookout for sound bytes from some of the world’s most respected investors, economists and politicians. You can read more about the coming week below in the section “What’s Coming that Matters.”
MARKETS THIS WEEK
It was an in-line CPI report for December (released Thursday morning pre) that kept things going this week in US markets, along with encouraging news in Europe in terms of energy prices being at levels that are lower than were expected. China is continuing to reopen slowly, with the COVID casualties of course being wildly understated but the leadership under President Xi obviously willing to accept the trade-off of lost lives for getting the Chinese economy back into a higher growth mode. Bond prices have also been rallying globally, with optimism for better-than-expected growth (which would push yields higher) being offset by hopes that central banks will ease faster than had been anticipated. Bitcoin joined the rally in risk assets, climbing back above $19,000 on Friday as the benchmark crypto shakes off the FTX debacle and related infrastructure concerns. Oil is also moving higher, at odds with demand destruction, and gold is moving higher, too. I will remind my readers that although US equities have performed well in the first two weeks of 2023, the performance trails that of the U.K. and broader European equity markets, as well as the star performer YtD – emerging markets. It pays to be diversified if you are not a “quick buck” sort of investor.
DRIVERS OF MARKETS THIS WEEK (LINKS)
December CPI report in the US (here). Headline inflation declined 0.1% in December MoM (vs November), and core inflation (less food and energy) increased 0.3% MoM. Both were more or less in line with expectations. Year-over-year, headline inflation increased 6.5% in December, and core inflation increased 5.7%. Wage inflation moderated, too. The graph below depicts the path of inflation over the last year.
GDP increased 0.1% in the U.K. in November, better than expected, although the U.K. economy still was smaller in the three months ended November. The GDP report from the ONS is here.
The IMF is sticking with its global growth for 2023 of 2.7%. The last official update is from October, and you can find the report here.
WHAT'S COMING THAT MATTERS
There is plenty of economic data to digest this week globally, including:
4Q22 GDP and industrial production for China (Tues)
Dec CPI for the UK and Eurozone (Tues), and Japan (Thurs)
Dec unemployment for the UK (Tues)
Retail sales for Dec for the US (Weds) and UK (Fri), and retail prices for Dec for the UK (Tues)
Housing data in the US and various consumer confidence reads
Earnings for S&P 500 companies for the most recent quarter will start on Friday.
Goldman and Morgan Stanley on Tues, Jan 17th to round out top six US banks
The onslaught of tech earnings begin Jan 19th with NFLX, followed by MSFT (Jan 24th), TSLA (Jan 25th), META (Feb 1st), AMZN and AAPL (Feb 2nd), and GOOG (Feb 7th).
The easiest-to-view website I have found for tracking the earnings calendar is here (Interactive Investors)
The World Economic Forum Annual Meeting is Jan 16th-20th so its begins on Monday in Davos (website here)
US debt ceiling: if this sort of political drama excites you, you can find the letter from Treasury Secretary Janet Yellen to the Speaker of the House on Jan 13th (here), notifying the House that the debt ceiling will be reached on Jan 19th, and the Treasury will take extraordinary steps to ensure the US does not default.
Upcoming central bank meetings:
Bank of Japan – Jan 17th-18th (this week) and Mar 9th-10th
Federal Reserve – Jan 31st/Feb 1st and Mar 21st-22nd
Bank of England – Feb 2nd and Mar 23rd
ECB – Feb 2nd and Mar 23rd
Corporate bonds (credit)
Safe haven and other assets