The Factory Daily Letter
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A quick recap on what was, what’s coming up, and what we are watching
After the previous Friday’s tick higher, last week the volatility continued as the market digested the tightening monetary conditions, stoking the debate about how tight the Fed will ultimately tolerate and/or at what level it would be prepared to settle on inflation. Caution now extends beyond just non-profitable tech with markets now attempting to price not only inflation but now also a higher degree of (more broad-based) recession risk. Wednesday’s selloff once again stoked conversation around capitulation and thus buying opportunity and the S&P500 managed to close the week just shy of bear market territory. US yields closed the week lower (the 10-year US Treasury yield trading around 2.80% this morning) weighing on the US dollar. This week we have EU and US PMIs for May, Fed minutes, revised US Q1 GDP and core PCE.
In geopolitics the news flow on negotiations between Russia and Ukraine continued to be piecemeal and contradictory, with much talk of how an emboldened Ukraine is unlikely to accept Russian control of Donbas (or even Crimea) as part of any deal. The US Senate voted overwhelmingly in favour of a 40bn aid bill for Ukraine and the Biden administration was reported ready to block Russia’s ability to pay US bondholders by way of letting a temporary exemption expire on May 25. Turkey and Hungary voiced their objections to Sweden and Finland joining NATO.
Elsewhere Brexit tensions started flaring again over the implementation and workability of the already controversial Northern Ireland Protocol - the transitional arrangement that currently covers the post-Brexit border relationship between Northern Ireland (UK) and the Republic of Ireland, the UK’s threat of making unilateral changes to the agreement in the absence of joint efforts to find a solution raising once again the threat of a trade war/tariffs with Europe.
On the monetary policy front at the beginning of the week the PBoC kept its MLF rate steady despite the clear evidence of economic slowing (with industrial production and retail sales falling way below expectations at the hands of zero-Covid policy), yet it did announce a 20bps cut to the first-time mortgage rate over the weekend, and then Friday cut its five-year LPR lending rate by a larger-than-expected 15 basis points to 4.45% to support housing demand. In the UK Bank of England Governor Andrew Bailey came under fire for failing to tackle inflation sooner, adding fuel to the debate over whether the aggressive fiscal tightening expected from Chancellor Rishi Sunak and the rising energy costs will ultimately prove deflationary, while BoE chief economist Pill flagged more tightening in light of the upside risk to the medium-term inflation outlook. Speaking on Dutch TV Christine Lagarde signalled that liftoff could come as soon as July for rates – “weeks” after bond-buying ends – in line with ECB guidance.
Turning to the Fed, in what was considered his most hawkish comments to date at a live Wall Street Journal event Tuesday Fed Chair Powell said the Fed would keep raising interest rates until there is “clear and convincing” evidence of abating price pressures. He acknowledged that there could be ‘some pain’ involved in maintaining price stability but also said that a strong labour market can be maintained, reiterating the view that the US economy is strong and well-positioned to withstand less accommodative, tighter monetary policy. This while Kansas City Fed’s George said Thursday that turbulent markets would not alter the Fed’s rate hiking plan, saying in a CNBC interview that the Fed is looking for ‘the transmission of our policy through markets understanding that tightening should be expected’.
On the data front, the week began with the disappointing economic data out of China, the economy evidently continuing to suffer from the hard lockdowns; with industrial production (-2.9% YoY in April) and retail sales (-11.1% YoY) falling way below expectations and surveyed urban unemployment rising to 6.1% in April from 5.8% previous (breaching the government’s target of 5.5%). Also on Monday the US New York Empire State Manufacturing index surprised to the downside, falling to -11.6% in May (from 24.6 in April), missing forecasts of 17.
The European Commission’s spring forecasts revealed downward revisions: real GDP growth in both the EU and the euro area is now expected at 2.7% in 2022 and 2.3% in 2023 (down from 4.0% and 2.8% respectively in the Winter 2022 interim forecast) and made reference to the war in Ukraine as exacerbating pre-existing headwinds, acknowledging that the main hit to the global and EU economies comes through energy commodity prices. Inflation in the euro area is projected at 6.1% in 2022 (before falling to 2.7% in 2023) in a considerable upward revision from the Winter forecast (3.5%): inflation is expected to peak at 6.9% in the second quarter of this year and decline gradually thereafter. Reference was made to the “Strong and still improving labour market” and falling government deficits (although war-related costs rising).
US retail sales data Tuesday showed an in-line rise of 0.9% MoM in April: down on March’s 1.4% but nonetheless an indication that consumers continue to spend high, inflation notwithstanding. Second reading growth data for Q1 showed the euro area economy expanded 0.3% QoQ, level with previous and slightly higher than estimates while employment rose 0.5% (up from a downwardly-revised 0.4%).
Growth data out Wednesday showed that Japan’s economy shrank 0.2% QoQ in Q1 of this year (albeit beating consensus of a 0.4% fall) while in the US April housing starts fell 0.2% to 1,724,000 rate; building permits to a 1,819,000 rate. UK unemployment edged down to 3.7% in Q1, while UK CPI rose to 9% YoY in April (2.5% MoM) up from 7% in March and marking the fastest rise since 1982 in a surge driven by the unprecedented spike in energy prices.
On Thursday, Japan reported a trade deficit of JPY8.39.2bn in April in the ninth consecutive monthly trade shortfall. Construction output in the Euro Area rose 3.3% YoY in March, easing from February's 8.9%. US data releases included initial jobless claims rising 21K to 218K in the week ending 14 May, beyond estimates of 200K, and the Philly Fed manufacturing index suffering a sharp fall to 2.6 in May (well below forecasts of 16).
Friday saw Japan’s consumer prices figure rise 2.5% YoY in April, marking the 8th straight month of annual inflation. Friday’s UK consumer confidence print was disappointing, it falling to a record low of -40 in May due to growing concerns over the cost-of-living crisis; yet UK retail sales surprised to the upside by unexpectedly rising 1.4% MoM in April.
What’s coming up this week?
- Monday: Germany Ifo Business Climate (May); Eurogroup meeting;
- Tuesday: Flash PMI data for May for Europe, the US. UK and Japan; US new home sales; EU EcoFin meeting;
- Wednesday: Germany GfK consumer confidence (Jun); US durable goods orders; Fed minutes; ECB Financial Stability Review;
- Thursday: Ascension day holiday in Europe; second estimate US GDP Growth (Q1); US initial jobless claims and pending home sales (Apr);
- Friday: US personal income and spending data (Apr); retail and wholesale inventories and goods trade balance (Apr); PCE price index (Apr) and Michigan consumer sentiment (May; final);
The Q1 earnings season is starting to wind up with Nvidia, Costco and United Utilities among those reporting. For a fuller list screened with our quant grades click here:
What themes and topics have we been following?
- The technical view: Dissecting the tactical bounce of Friday 13th;
- Q1 earnings review: Screening for the season’s ‘Triple Winners’;
- Focus on Europe: We think European cyclicals are ripe for a (tactical) rebound;
- What was hot and what was not? Qarterly13F clues on US hedge fund positioning;
We revisit each of these in summary below and as ever wish all our readers a good week ahead.
Friday 13’th tactical turnaround
Not so auspicious after all
We are looking at one of the worst starts to the year the S&P500 has ever recorded. A ‘dovish hike’ from the Fed and another strong earnings season are among the more positive drivers that have nonetheless so far proven unable to prop up sentiment while the current high volatility continues to put off longer-term investors now wholly preoccupied with inflation and recession risk. But on Friday 13th May equity markets did manage to enjoy a welcome rally after what had been (another) dismal week.
A strong Friday following a bad weekly start has historically been consistent with local bottoms, so in last week’s technical view we dug into the technicals to find that on the short-term chart S&P500 had formed a bullish “morning star” pattern (a bullish candlestick pattern that can signal potential recovery or the start of a new uptrend) while the index was also testing the 50% Fibonacci retracement of the wave (3):
The rally was short-lived and it was another down week in equity markets last week. It remains our view that we are yet to see a catalyst strong enough to support the market: lower levels of volatility and greater liquidity, coupled with a stronger catalyst, are clearly needed to attract flows and encourage medium-to-long-term investors back to the stock market. That said, we continue to look for tactical long opportunities when and where conditions look extremely oversold and key technical support levels are tested (the caveat being of course that such opportunities are likely to remain very tactical in nature and strategies designed to exploit what may turn out to be a series of very short-lived relief rallies).
In any event you can still see last week’s Technical View again here in which we screened Friday 13th ‘big reversal’ names for remaining short-term tactical opportunity across those still not looking short-term overbought screened for growth and quality.
We screen for the season’s ‘Triple Winners’
On the surface, the Q1 corporate reporting season has been another strong one, companies again beating expectations with a healthy degree of surprise. Moreover, Europe has been outshining the US in terms of earnings momentum, it being behind in the economic recovery cycle and benefitting from a series of favourable tailwinds. But in both regions the trend has been normalising while the overall picture belies the weaknesses becoming evident beneath the surface. EPS and sales growth is now peaking as base effects pass through and the environment becomes more challenging with energy and materials increasingly taking the strain as price pressures also slowly start to bite.
That beats have gone unrewarded and misses heavily punished illustrates just how the prevailing market pessimism has been weighing on the post-earnings price action (as was starkly illustrated by Wednesday’s retail rout).
Given this backdrop, we expect investors to continue to prefer companies that deliver both on sales and EPS, and that are sufficiently confident in their business to raise guidance. See Friday’s earnings review again here for our favourite post-earnings screening (which we think is as valid today as ever) for the season’s “Triple Winners”.
European equities have been pricing a worst-case scenario
And cyclicals look ready for a rebound
Having underperformed immediately following Russia’s invasion of Ukraine, the European equity market has been outperforming the US peer recently. Moreover, by several measures it also appears to have priced the deteriorating economic outlook to a greater degree than its US peer:
The central bank policy differential favours Europe, and the weaker euro supports its exporters. When we carried out our study last week Europe was trading at a 27% valuation discount to the US: one of the most attractive levels it has been over the past 20 years. Sentiment indicators had also reached such extreme levels to suggest a rebound (albeit tactical) might be supported by any better news or data points – and European cyclicals could be well-positioned to benefit.
See last Wednesday’s letter again here in we presented the case for European cyclicals on the basis that recent underperformance has made them more attractive.
13F Hedge fund reports : from beta to alpha
What do the fillings tell us?
2022 has been a difficult year for investors so far, and the big hedge funds are not unscathed. The HFRX Global Hedge Fund index (representative of the overall composition of the hedge fund universe) is down 4% year-to-date, yet this disguises some big differences between the different strategies: commodity hedge funds and CTAs lead the field with outperformance, but there are several single asset class funds and directional strategies that have suffered some deep losses.
They may be backward-looking, but the quarterly “13F” forms filed by the big US institutional investment managers can still give us some occasional insight into prevailing trends by telling us which sectors and stocks have fallen in and out of favour among the professional investment community over the past quarter. The main takeaways from the Q1 filings? Managers have been reducing passive (ETF) long exposure, trimming tech, and becoming more active:
For more details and screenings of those names that have fallen in and out of favour over the quarter, see last Thursday’s letter again here.
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