Last week US equity markets managed to call a halt to a 7-week decline, and while we acknowledge the role played by month-end rebalancing and the associated cutting of short bets, we have also been seeing some interest return to the more oversold, riskier corners of the market. Much still hinges on Fed messaging (and whether it will continue to hike through the rest of the year in its quest to quell inflation, or pause in September to take stock of how the tighter conditions brought about by tapering and rate rises are weighing on the economy). Recent high inflation prints out of Europe are also heaping more pressure on the ECB to lift off as well. After such a sharp post-Covid recovery a degree of ‘normalisation’ across markets was arguably always on the cards; but the ongoing war in Ukraine (and the impact of related sanctions not just on Russia but globally), as well as the Covid lockdowns in China that continue to stifle global supply, continue to muddy the outlook. Tactical traders may be being lured back to markets in the short term (and it is our view that there are opportunities to be had), it could be a little longer before lower volatility and greater visibility (as well as a strong catalyst) appear and medium-term investors return.
Outlook as at 1.6.2022
What have our equity quant indicators been telling us?
As war in Ukraine continues, reports out of the EU summit this week are of agreement to pursue a ban on most Russian oil imports, paving the way for a sixth sanctions package. Markets are also digesting preliminary Eurostat flash inflation data that remains “hotter” than expected headline inflation rising 8.1% YoY in May from 7.5% in April (core to 3.8% from 3.5%) piling pressure on the ECB to act and keeping talk of a 50 basis point hike to the deposit rate in July very much alive (a 25 basis point hike is now baked in as a certainty).
In our equity regional matrix (the top-down quantitative indicator we have built to give us a regional view), Europe’s regional grade has recovered very slightly since our last update, to -11% from -15% (still far from 40% at the beginning of the year) with an improved but still poor trend score (-75%) and ongoing weakness in sentiment (-14%) keeping the region in ‘bearish’ territory. The market continues to be headline-driven, with inflation risk and global central-bank policy in sharp focus, however a recent uptick in EPS revisions suggests that analysts are now feeling more buoyant (see our recent screening of sell-side favourites in Europe again here). Our economists’ central scenario is that the euro area as a whole will avoid a technical recession (two consecutive quarters of negative growth) in 2022, but that some countries will fare better than others. They maintain their forecasts for annual euro area GDP growth of 2.8% in 2022 and 2.0% in 2023 (with risks tilted to the downside). Medium-term energy plays we still like, and themes such as green / alternative energy remain relevant given the prevailing geopolitical tailwinds. See the latest iteration of our European long-only selection here.
The US has now fallen into ‘very bearish’ territory in our equity regional matrix, the trend score still very poor at -74% and sentiment having deteriorated (from -2% to -26%). On the macro front recent data reflects still-solid consumption (0.9% MoM in April after +1.4% in March) but this is increasingly down to consumer credit (the consumer already eating through Covid savings and the savings rate dipping to 4.4% in April – its lowest since September 2008) while the Michigan confidence index was revised down to 58.4 in May as consumers continue to worry about inflation. The health of the housing sector, business investment and inventories are also clearly key going forward and will inform Fed policy more particularly (and whether it takes a ‘pause’ after the summer or continues on its rate hiking trajectory through the autumn). Given the current level of pessimism and light positioning, there could be more room for this rally to continue in the short term, and our recent technical analysis supports this view (we have seen some life return to the more speculative corners of the market and the more tactical might look among US biotech and Chinese tech for some short-term opportunity), however further out the outlook remains challenging. See our post-earnings screening of ‘triple winners’ again here; better-quality short-term reversal candidates here; and the most recent iteration of our US long-only selection again here.
Japan has rebounded back into bullish territory in our regional matrix, now scoring 19% thanks to a recovering trend score (-41% from -98%); valuation at an ‘attractive’ 43%; and liquidity and economics both at 100%. Even if sentiment has fallen slightly (to 36% from 65%): the region continues to attract attention on account of its easy policy, muted inflation and attractive valuations with the BoJ’s yield curve control continuing to weigh on the yen (which should in turn continue to benefit exporters). While clearly not immune from the prevailing global dynamics, the risk environment nonetheless continues to be perceived as healthier here than elsewhere.
EM’s regional score (which is heavily weighted in China) has returned to a ‘neutral’ 10% from ‘bearish’ -12%, it having been fluctuating between the two over the past several weeks. Trend remains weak but has nonetheless recovered a little to -70% from -92%. Chinese equities continue to appear attractively valued but the growth outlook remains challenging and official PMIs in May remained in contraction territory suggesting a continued weakening of growth momentum as Covid containment measures are lifted only very slowly. More easing and policy support notwithstanding and given the current geopolitical headwinds, we would continue to approach with caution (and we keep an eye on ongoing regulation and also sanctions risk).
Outlook as at 1.06.2022
The US 10-year Treasury yield continued its rise in April due to the more hawkish Fed rhetoric (and we saw the 10y-2y US sovereign curve briefly invert). The upward momentum supported a rise towards (and through) the technical hurdle at 2.60% (a level at which the 76.4% Fibonacci retracement and the falling long-term resistance line linking the highs since 1994 meet) and on towards the next resistance at 3.25% (the target of the bullish "cup and handle" and the prior high made in 2018). The recent rise may have been “too high too soon” suggesting that a pullback to around 2.7% may occur. On the other hand, a confirmed move above 3% would put the 10-year yield into a new bullish paradigm.
Key views and targets
A sum-up of our core views and targets is presented in our core views table below (click to enlarge). All of our selection lists are also of course available on request.
Find out more
For the most recent updates on our FX convictions, see our latest technical views on equity indices and sectors, and currencies, commodities and bonds, and a short introduction to our quantitative process is available here.
The Trading Strategy Team
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