- Major US indices logged strong weekly gains after a notable Monday, Tuesday and Friday rally.
Semi-conductors and cloud names helped buoy the technology sector, with both gaining more than 8% after an abysmal performance the week prior.
- Semiconductors have come under significant pressure this year falling 45% year to date last week.
- Sentiment and positioning remained overly bearish with BofA’s bear & bull indicator staying at 0.0 for the 5th straight week.
- BofA’s global fund survey also showed cash levels rising 0.6% to 6.3%, a level only ever reached after September 11th 2001.
- Earnings continue to be better than feared, a theme-investors also saw in the 2Q – See Big bank earnings as well as AXP, IPG, OMC to paint the picture that ad spend and the consumer have remained resilient.
- Despite a potential recession on the horizon, looking back at the last 7 bear markets:
- The average downturn has been 40%, lasting about 13-months.
- During this same time frame 1-year and 2-year returns from the bottom in the S&P 500 have averaged 47% and 74%, respectively.
- In the United Kingdom, Rishi Sunak, former Chancellor of the Exchequer from 2020 to 2022 became the next Prime Minister after leader of House of Commons, Penny Mordaunt, dropped out of the race to become the leader of the Conservative party.
- In Italy, Georgia Meloni was officially sworn in as the new Prime Minister of Italy on Sunday. Meloni’s coalition includes Berlusconi’s Forza Italia, Matteo Salvini’s league and her party, Brothers of Italy.
- In China, the delayed third quarter GDP data shows a mixed recovery with the economy advancing at 3.9% year-on-year according to China National Bureau of Statistics.
Major US indices logged strong weekly gains last week, posting their best weekly performance since June. Yields ended near their highest levels of the week with the 10- year closing under 4.22%, while the 2-year ended at 4.47%, pulling back after touching its highest level (4.61%) since the summer of 2007.
Value underperformed growth by 1.4%, but both were broadly higher on the week. All 11 sectors finished higher, with standout performances from Energy, Technology, Materials and Consumer Discretionary.
Semi-conductors and cloud names helped buoy the technology sector, with both gaining more than 8% after an abysmal performance the week prior. Semiconductors have come under significant pressure this year as market participants continue to evaluate:
• New China export restrictions that have been imposed out of Washington
• A string of warnings in regards to demand from giants like Micron and Samsung, which have caused analysts to slash their forecasts at the fastest pace since 2008.
• Ramping up of tensions between the US and China after the US unsealed charges claiming two Chinese intelligence officers tried to obstruct a criminal investigation of Huawei Technologies
Prior to the rally last week, the Philadelphia Semiconductor Index was down more than 23% since the start of August, bringing its year-to date losses to 45%, and on track for its worst annual performance in 14 years.
Underperformers included homebuilders, regional banks, logistics- trucking and rails, hospital operators, and broadcasting/multimedia names.
Ultimately, stocks rallied on a few themes, including technical and mechanical factors, as well as deeply depressed sentiment and positioning, all of which remained key to the upside narrative this week. BofA’s latest flow show report outlined that its “Bear & Bull indicator” remained at 0.0 for a 5th straight week, while their global fund manager survey showed cash levels rising 0.6% to 6.3%, a level only ever reached after September 11th 2001.
There were also some articles highlighting the shift to cash by retail investors in recent weeks. In an article published by the Financial Times, nearly $140B has poured into retail money market funds in 2022, with $36B of inflows over the last 3-weeks, taking the size of these investment vehicles to $1.55T.
For a while now, many investors have heard the phrase “there is no alternative” (TINA), in regards to finding returns outside of equities. And while that may have been true in previous years during a low interest rate environment, there now appears to be multiple alternatives; all of which are tied to the Fed’s policies. These alternatives in many ways do not offer the same risk/reward as equities, but with higher-than normal yielding money market funds now available, investors do indeed have an alternative.
RECESSION OR NO RECESSION
Recession fears continued to pickup with the Fed largely maintaining their hawkish monetary policy stance. However, it is worth noting that some dovish signals started to emerge this week, with WSJ Nick Timiraos, SF President Daly and Chicago’s Evans all warning about the risk of overtightening.
With additional outsized rate hikes on the horizon (75bps is anticipated following next weeks Fed meeting), the worry for investors becomes the increasing probability of a hard landing, with a possible recession looking more and more likely.
Per Cornerstone Macro, every recession has been preceded by a Fed tightening cycle, but not every Fed tightening cycle has led to a recession (1966, 1984, 1994, 2018). In periods where the Fed is hiking and food and energy inflation rose above 5%, the economy has always gone into a recession, 100% of the time. This year food and energy inflation hit 22%, leading Cornerstone Macro to believe a recession is on the horizon, even as inflation continues to decline. Furthermore, we’ve heard from a number of corporations regarding slowing hiring, reducing corporate staff and scaling back expenses; all precautionary measures when you expect business to slow.
However, while conventional wisdom and previous indicators continue to lead many to believe a recession is more probable than not, the latest earnings show scant signs of a recession. The economy and consumer continue to display resiliency as the Fed continues to fight inflation, which has driven the volatility and market performance this year.
So far, earnings this quarter have once again been “better than feared”, a theme we also saw in the 2Q of 2022. Looking at results from American Express (AXP), one would not expect a recession on the horizon. Earnings topped expectations as the firm added a record number of Platinum customers (Annual fee of $695), pushing revenue up 24% to an-time high.
Additionally, results from several advertisers like Interpublic and Omnicom were also surprisingly strong; showing little slowdown in the ad space; the ad market can serve as an early recession signal. As we look forward, additional gains will depend on the mega-cap earnings due this week, including Alphabet, Microsoft and Apple.
BEAR CASE VS BULL CASE – WHICH DO YOU BELIEVE?
With the S&P 500 touching a new low of 3,491 less than 2-weeks ago, and then subsequently rallying to its best weekly gain in more than 3-months, investors, managers, traders and economists all remain at odds as to what the next move may be. Below we outline both the bear and bull cases:
• Broad concerns about headwinds from excess inventories & Dollar strength
• Uncertainty about China’s continued zero-Covid approach
• Ongoing geopolitical tensions in Ukraine
• Firming crude prices
• Fiscal-policy chaos in the UK
• Underpinned by weak sentiment/positioning
• Hopes for a better-than-feared earnings season (As we saw last quarter)
• Peak inflation
• Supply chain easing
• Resilient economic indicators
• An easing in UK financial stresses
• Positive seasonality
• Weak earnings expectations
Rather than speculate if the bottom is actually in, or if we still have another pullback on the horizon, we can use historical markers to draw some comparisons. We recognize that no two bear markets are the same, but believe a historical framing can be helpful to maintain an objective long-term viewpoint.
THE CHARTS BELOW OUTLINE THE FOLLOWING:
• The last seven bear markets have averaged downturns of 40%, and have lasted 13 months.
• During this time frame the average 1-year return from the bottom is 47% and 2-year return is 74%.
• During a market recovery, equities have the strongest historical return.
The Bloomberg World index closed the week up 3.13%, with growth up 4.12% and value up 3.13%. Fundamentals seem to be back into play as investors digest earnings releases. Central Banks tightening remains in the background as every word from policy makers appears to be scrutinized. The IMF updated its global economic outlook to account for rising inflation, rising interest rates and the war in Ukraine. The IMF now sees global growth at 3.2% this year and 2.7% in 2023. Its new global inflation forecast is 8.8% in 2022 and 6.5% in 2023. This new outlook is in line with global Central Banks tightening policy.
In the United Kingdom, Rishi Sunak, former Chancellor of the Exchequer from 2020 to 2022 is set to become the next Prime Minister after leader of House of Commons, Penny Mordaunt, dropped out of the race to become the leader of the Conservative party. Over the weekend, Boris Johnson said he would not campaign for the leadership position despite having the support of 100 MPs. Last week, Liz Truss stepped down as a Prime Minister after losing the confidence of her cabinet and Tory MPs as market turmoil pushed her to do a U-turn on her mini budget proposal. The British pound rallied to 1.13 dollar per pound and the 10-year Gilts yield dropped to 4.05% from 4.33% a week earlier. British stocks gained 1.62% last week, led by technology, up 6.14%.
In Italy, Georgia Meloni was officially sworn in as the new Prime Minister of Italy on Sunday. Meloni’s coalition includes Berlusconi’s Forza Italia, Matteo Salvini’s league and her party, Brothers of Italy. Last week, Silvio Berlusconi blamed Zelenskiy for Russian invasion of Ukraine, attracting unwanted media attention on the coalition. One of the first pressing issues will be allocating emergency funds to help companies and households deal with the energy crisis. This year, Italy has already spent $66.3 billion to protect consumers from energy price hikes. Matteo Salvini, the new infrastructures minister, is pushing Meloni to increase spending, but the recent UK Gilt crisis could serve as a cautionary tale. Italian stocks gained 3.04% last week.
In China, the delayed third quarter GDP data shows a mixed recovery with the economy advancing at 3.9% year-on-year according to China National Bureau of Statistics. In September, home prices fell the 13th consecutive month despite government incentives programs and lower rates. President Xi Jinping officially started his third term after the 20th Communist Party Congress and promoted close allies to top leadership positions. He also hinted at a potential tax shakeup to foster common prosperity and more regulations on big tech to ensure technological independence. The Nasdaq Golden Dragon China index plunged as much as 23% on Monday and the offshore Yuan surged.
In Japan, Bank of Japan’s balance of payment suggests record $37 billion currency intervention on Friday as the yen nearly touched 152 per dollar. This amount is double what policy makers spent last month on currency support. The yen rallied to 147 per dollar on Friday, but as of Monday, it is back to 148.91 per dollar. Top currency official warned reporters present at the last G-20 meeting that Japan would respond to excessive moves in the currency market. However, the alleged FX intervention on Friday has not been confirmed by officials as they declined to comment on the matter. The total amount of currency intervention for October will be disclosed by the ministry at the end of the month. The NIKKEI 225 index dropped 0.74% last week.
In South Korea, the Central Bank raised interest rates by 50bps, in line with market expectations. Bank of Korea Governor Rhee Chang-yong told reporters at a news conference that this tightening of financial conditions will help reduce the gap with the Federal Reserve and defend the Korean won. He added that volatility in the foreign exchange market can be greatly attributed to expectations for a strong dollar. Two policy makers voted against the decision over growth concerns as manufacturing PMI was below 50.0 for the third consecutive month in September. The IMF projects 2.6% real GDP growth for South Korea in 2022 and 5.5% inflation. The KOSPI index gained 0.03% last week, with construction down 5.12%.
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