No One-Way Bet
Gary Dugan, Chadi Farah, Bill O'Neill
The Global CIO Office
It all looked too easy: a US soft landing, lower inflation, and a compliant-with-market-wishes Fed that was seemingly prepared to deliver to the market further 50bps rate cuts. It was easy money for investors, and bonds and equities rallied.
A couple of US data points later, we still have good growth, but nascent inflation worries, and the Fed looks likely to downsize its forthcoming rate cut(s). Bonds sell-off, and interest rate sensitive stocks such as US REITS dip.
The US employment report was remarkably strong. The 254,000 new jobs added in the month of September were much higher than expected, and the unemployment rate fell to just 4.1%. Private sector jobs added were double the previous month’s number. Long gone are the market’s and probably the Fed’s worries that the US labour market was showing any worrying signs of weakness. The great volatility in the employment report should, though, make us somewhat sceptical about taking the data too much on trust.
The Fed will likely have its head turned by the stronger-than-expected employment data; in any case, the market moved quickly to take out the possibility of a 50-bp rate cut at the Fed’s next meeting. The market now anticipates a 25-bp cut per meeting through the next 12 months. The data has becalmed the government bond market with a reset of higher yields across the curve back to where they were at the start of August and the US 2-year bond is roughly 40bps off its lows. Such a rise in yields looks like an uncharacteristic reaction, but it may also reflect the exaggerated trader positioning running into the day of the report.
The employment report changed the leadership of the equity markets and, hence, may take some momentum away from the broader market. Utilities and REITs – the recent sector leaders – both ended Friday’s trading session down on the day. The employment report’s negative impact on the interest rate-sensitive stocks helped redirect investors back to the tech sector. Better-than-expected news from individual tech companies of late has already put the sector on a better footing. We think REIT stocks may struggle given the ongoing disappointing earnings growth.
With the market now expecting the Fed to cut rates by just 25bps per meeting, investors will have to be a great deal more patient in waiting for market returns.
Chart 1: US NASDAQ Index versus US REIT Index
Index
Source: Bloomberg
The pending US presidential election in just a few weeks is likely a countervailing risk event to limit further equity market gains despite the greater confidence about a soft-landing economic scenario. The polls remain so tight that no outcome is a foregone conclusion. Given the polarisation of political views, around half of the population will be hugely disappointed with the result. Post-election debate and challenges could go up to the electoral college vote, which is scheduled on 17 December.
At last week’s close, the S&P500 Index was technically at an extreme deviation from the medium-term averages, but it is getting there. Another 1-2 % rise in the index would be at the higher end of the range for deviation from the 50-day moving average. It is currently at a demanding P/E multiple of 24.7x when earnings forecasts for the current year continue to fall. We still prefer the bet on the tech sector, where earnings forecasts continue to rise. Take a stock like NVIDIA ($124) for instance; while its share price is unchanged over a month, consensus earnings forecasts are up 6%.
Chart 2: US S&P500 Index Price Technical Indicate Need for a Pause
Source: Bloomberg
China’s Golden Week Still to Come?
Chinese equity markets will re-open this week after the Golden Week holiday. We expect the local markets to open with gains of about 5-7%, catching up with the performance of the Hang Seng index, which was open for trading last week. We note the growing debate amongst portfolio strategists on how far China might rally further from here. The government initiatives announced thus far are probably already reflected in the equity market price.
However, there is still a good measure of market expectation that the authorities may announce further stimulus packages worth up to 4% of GDP. Analysts also point to the enormous scale of savings held in bank accounts. In a note last week, market strategist Mark Tinker estimated that there was around $40 trillion of savings in Chinese household cash deposits, more than the US and the EU equity market combined and four times the size of the Chinese stock market. The question you have to ask yourself is what will convince the households to even consider putting their hard-earned savings to work in the risky equity market. The rise in the equity market might be exciting, but the very high levels of volatility could keep investors at bay.
Nevertheless, the Chinese equity market will have two sources of technical support: Firstly, we expect EM portfolio managers to want to cover their underweight positions in the Chinese market. EM managers went into the rally with weightings at a 5-year extreme low; secondly, the support for the equity markets that may come from government sources. Also, within the EM complex at the moment there is a lot of debate whether the Indian equity market is markedly overvalued, which could be another reason why investors might turn to Chinese equities.
Chart 3: Local Chinese Equity Indices to Catch up with the Hang Seng Index
Source: Bloomberg
