The Factory Daily Letter
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A quick recap on what was, what’s coming up, and what we are watching
It was another volatile week for US equities; coming off post-the Fed-meeting of the previous week attentions turned to the US CPI print for April that released Wednesday: it fell on a YoY basis in a highly-anticipated sign of ‘peaking’ - but not to the extent expected (hoped) by surveyed economists. Some more reassurance came from Jerome Powell later in the week - by which he reiterated his support for 50 basis point rate hikes (not higher) – which allowed some temporary respite, however slowing growth, higher inflation and tightening financial conditions continue to weigh on sentiment and the debate continues as to whether markets have seen sufficient capitulation to sustain any meaningful bounce – the path of least resistance still evidently to the downside in Friday trading stretched/extreme technical and sentiment indicators across the board notwithstanding (see last Friday’s letter “Capitulation contagion: dissecting the market malaise” again here and also summarized in the section below). A better day Friday notwithstanding, the S&P500 closed down 2.4% on the week (in its sixth consecutive week of losses) the Nasdaq down about 2.6% and the 10-year US Treasury yield closed the week at 2.92%.
War in Urkaine continues on: Vladimir Putin stopped short of declaring ‘war’ at Moscow’s Victory Day Parade but continued to refer to Russia’s invasion of Ukraine as part of a pre-emptive special military operation against the perceived threat posed by neo-Nazis (and Ukrainian Nazi-sympathisers) backed by the US and partners. In an attempt to get all members on board with a proposed embargo on oil imports, Europe dialled-back some of its proposed sanctions and Ursula Von der Leyen flew to Hungary to discuss the proposed oil embargo with holdout Viktor Orban (and foreign ministers meet again this week to discuss delaying the oil ban following Hungary's refusal). Otherwise western countries managed to introduce new coordinated sanctions (with some local adjustments) against Russia and Belarus. Finland declared its intention to launch a formal NATO membership bid, with Sweden likely to follow suit this week.
Elsewhere there was some welcome evidence of falling daily Covid infection rates in Shanghai and Beijing (albeit so far insufficient to allay Chinese growth concerns and there has been a swathe of disappointing economic data out this morning). In Europe tensions could build again over the Northern Ireland trade protocol as UK PM says unilateral changes to the Brexit agreement could be made if the EU does not engage in dialogue. Biden was reported to be considering reducing tariffs on China imports to reduce inflation pressure. On the policy front, Fed officials (including Powell as mentioned above) continued to push back against a 75bp rate hike, while in Europe ECB officials continued to talk up the prospect of rate lift off as early as July.
On the data front, wholesale inventories in the US rose 2.3% MoM to USD840bn in line with estimates following an upwardly-revised 2.8% rise in February; on Wednesday CPI came in at 8.3% YoY following 8.5 and vs 8.1% estimated, with core 0.6% MoM following 0.3% MoM and vs 0.4 MoM estimated, while PPI Thursday reflected an 0.5% MoM rise in producer prices in April. The preliminary release of the University of Michigan’s consumer sentiment survey Friday fell to 59.1 in May (from 65.2 in April and disappointing vs consensus 64). In its bi-annual Financial Stability Report the Fed however warned of deteriorating liquidity conditions in key financial markets due to surprising inflation, rising rates and the war in Ukraine;
In Europe the ZEW indicator of economic sentiment on the economic situation for Germany rose to -34.3 in May , coming off a 2-year low of -41 in April; in Europe the indicator rose sharply to -29.5 from -43 in April. The preliminary print for Q1 UK GDP disappointed, the economy expanding 0.8% on the quarter and slowing from 1.3% expansion in Q4.
In China, data released last Monday showed the country’s trade surplus surged to USD 51.12 billion in April (up from 40.89 bn in April 2021) with exports rising and imports unchanged. Data released Wednesday showed China’s inflation rate accelerated to 2.1% in April from 1.5% in March (above forecasts of 1.8%) in the highest reading since last November. A slew of disappointing data this morning included industrial output falling 2.9% YoY and retail sales down 11.1% YoY.
What’s coming up this week?
Following the CPI data last week, market participants will be looking to Housing Starts for clues on inflation and the viability of Fed policy; as well as US retail sales for further indication on the extent to which the US consumer continues to support the growth outlook:
- Monday: China industrial production; spring forecasts from the European Commission;
- Tuesday: UK unemployment (Mar.); US retail sales (Apr.); EU Q1 GDP
- Wednesday: Japan Q1 GDP growth (prel.); US Housing Starts and Building Permits (Apr.); UK inflation (CPI & RPI); EU trade figures and HICP inflation;
- Thursday: Japan Trade Balance (Apr.); US Existing Home Sales (Apr.); ECB Minutes; UK trade figures;
- Friday: UK Gfk Consumer Confidence (May); Japan Inflation (Arp.); UK Retail Sales;
The Q1 earnings season continues with retailers in focus: US, Walmart, Cisco, Applied material in the US, Ryanair, EasyJet, Vodafone, Generali, Richemont in Europe are among the names reporting. For a fuller list of those reporting screened with our quant grades click here.
What themes and topics have we been following?
- Capitulation contagion: We have been dissecting the equity market malaise, taking stock of the deteriorating technical picture across several sectors, themes and bell-weather stocks;
- A complex setting for gold: Apparently shunning its haven status, gold has recently been selling off along with risk assets. But over the medium-term, a reversing dollar and higher inflation should support gold – and more so its miners;
- Utilities vs financials: The dynamics between these two inflation-sensitive sectors could be an interesting means by which to play this challenging environment;
- Troubled tech: Still holding out for a rebound?
We revisit each of these in summary below and as ever wish all our readers a good week ahead.
Dissecting the market malaise
Over recent weeks we have been commenting on how extreme breadth statistics and signals from other stretched risk and sentiment indicators have been calling for a rebound off some key technical support levels. But what happens as said supports are broken?
Like an insidious disease, the pessimism that crept initially unnoticed into some discreet corners of the equity market has now spread, becoming more apparent first among those more speculative areas of the market (i.e. those that enjoyed a great deal of retail interest through the pandemic) and more recently in the more well-established yet nonetheless ‘growthier’ regions (such as technology): many of these “super-spreaders” have now erased all of their pandemic gains.
The origins of the contagion can be traced back to rising yields, while the rising dollar has a hand in this too; and so far another quarter of solid earnings, a ‘dovish’ rate hike from the Fed, and robust economics have been unable to quell the fever:
Volatility, while not (yet) extreme, remains elevated, as markets await a catalyst: a “shot-in-the-arm” event that can wake them from their stupor. On Friday we took a top-level technical look across several equity market sectors, themes and bell-weather stocks, and discussed why, while we continue to seek out tactical opportunities as they emerge at key technical support levels, we think some more defensive sector exposure might nonetheless now be called for as this bout of malaise plays out. See it again here.
Utilities vs financials
Playing the inflation-sensitive
The US CPI print for April was the macro event of the week: market participants and policymakers alike scrutinising the report for more visibility on the nature and direction of inflation and, in turn, what is most likely next for markets. As it happened, US CPI for April came in at 8.3% YoY, coming off March’s 5.5% print but higher than consensus 8.1%.
On the approach to the CPI print, on Wednesday morning we took a look at the relative resilience of utilities over recent weeks, and contrasted that with the poor performance and deteriorating trend across financials. The relationship between the two has a close historical correlation with US financial conditions, and might also be an interesting means by which to protect against rising volatility.
See Wednesday’s letter again here for a dive into the technical and breadth indicators on utilities and financials, a look at how historical correlations suggest the performance relationship between the two might play out in the current environment, and for a selection of (1) utilities names with the best risk reward and (2) financials sporting poor technical profiles, both screened with our quantitative grades.
Still holding out for a tactical rebound?
Technology stocks led the rally during the pandemic, yet since the beginning of the year, against the prospect of a Fed hiking rates more aggressively into a slowing economic outlook, pessimistic investor sentiment and rate moves have been encouraging investors to leave the sector. The Nasdaq has now fallen to break technical support at around 250:
Over the past few weeks, the Nasdaq 100 index and the S&P 500 have experienced a rare lasting weekly downtrend. The selloff has been intense, more than 60% of the tech index’ members falling more than 20% from their 52-week highs.
So in last week’s Technical view we discussed how in the short term the Nasdaq 100 has become so extremely oversold - suggesting that relief rally could occur: as we wrote, recent breaks of some key supports still needed to be validated, and a number of indicators suggested there may yet be opportunity to participate in a rebound.
The technical outlook remains challenging, and as summarised in the section above, the market appears to be awaiting a catalyst of significant might to turn sentiment around and encourage medium and longer-term investors back into the market - solid earnings and strong labour market data (reflecting a robust economic backdrop) having to date proven unable to provide the necessary reassurance. That said, following a selloff such as this there are still several reasons why one might consider opportunities to be emerging across some of the (better quality) beaten-down tech names. See last week’s Technical view again here.
A complex setting for gold
Will it brighten; and if so, will the miners catch up?
During the first equity market decline of the year – that which ran from January to March - gold gained 16%, rising 1,780 to 2,070 dollars per troy ounce as it benefitted from its traditional safe haven status. However, it failed to break through key technical resistance, and moreover in the more recent sell off it has suffered alongside equities (this time apparently losing its safe-haven appeal): the Fed’s hawkish policy and a stronger dollar has jeopardised investor desire to buy gold.
Further out however, one would expect a pullback in the (currently very high) US dollar (see technical chart on the DXY below) to support a recovery in gold, while medium term the higher-inflation regime might also prove a tailwind. The chart below illustrates how the precious metal has historically held a tendency to benefit from periods of higher inflation:
The short-term technical chart below illustrates how the recent consolidation in the gold price reached an important support at 1,836 (defined by the 200-day SMA). Our core longer-term technical scenario is that the positive momentum in gold resumes towards 2,300 (the target of the triangle breakout). Furthermore, both the precious metal and its miners are currently at key technical support levels, suggesting that a rebound may occur. Gold miners (GDX US), which have underperformed the broader market since April, may be set for a technical bounce if the positive momentum in gold resumes:
See Thursday’s letter again here for our view on how the prevailing backdrop might affect gold; our technical outlook on gold and the miners; and for a screened selection of gold-miner stocks currently scoring well according to our in-house quant process and sporting the most attractive risk ratios.
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