The Factory Daily Letter

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Talking points

Last week, financial headlines were dominated by the ECB meeting and then Friday's US CPI prints that showed how US inflation continued to gain in traction in May (+8.6% YoY vs 8.3% expected, up from prior’s 8.3%, and up 1% m-o-m). The core CPI gauge reached 6% from a year ago and was up 0.6% on the month. For the headline figure, the rise was mainly driven by rising food and energy prices, as well as ongoing bottlenecks and higher prices in reopening services such as travel, transportation and rents. The data surprised (the narrative having been one of peaking inflation) and the ongoing evidence of more persistent higher inflation has raised discussion of more aggressive rate policy from the Fed over the months to come. Markets sold off on the news, the S&P500 closing Friday down 5% on the week (and the Nasdaq down 5.7%) and bond yields rose (the US 10-year Treasury yield is now at 3.17% as we write).It will be all eyes on the Fed this week - markets are as we write still pricing a little more than two 25 basis point hikes at Wednesday's meeting.

Turning to Europe, at Thursday's meeting ECB President Lagarde announced the end of net asset purchases under the APP on 1 July and a first 25 basis point rate hike in July. Inflation figures across the 19-member euro area hit a fresh record high of 8.1% in May, adding further pressure to the central bank to fight inflation. The statement published after the meeting reported that the ECB expects another hike in September but the amplitude (25 or 50 bps) will depend on the evolution of inflation. In terms of fragmentation risk, the ECB said it will remain as flexible as possible and may resume net asset purchases if needed. Officials now anticipate annual inflation of 6.8% in 2022, 3.5% in 2023 and 2.1% in 2024. GDP growth is expected at 2.8% in 2022, 2.1% in 2023, and 2.1% in 2024.

On the geopolitical front, battles continued in Ukraine with Russia trying to capture the cities of Sievierodoniest and Slovyansk. French President Macron is said to be planning a trip to Ukraine, yet date needs to be determined while UK’s defense chief met President Zelensky to discuss the needs of the Ukrainian military. In an interview on Bloomberg radio, Ukraine's Finance Minister said his country will need support from the IMF. Meanwhile, Russia cut rates to pre-war levels as the ruble remained under pressure.

On the commodities side, Brent has been trading above USD120/bbl and households continue to feel the pinch. Data regarding fuel and gas prices were released in UK, and families are now paying £100 to fill up an average-sized family car after petrol prices soared.

On the macro front in the US, the University of Michigan consumer index fell to 50.2 from 58.4, well short of estimates of 58.2. The average contract rate on a 30-year fixed-rate mortgage edged up to 5.4% in the week ended 3 June 2022 from 5.33% in the previous week, holding at levels not seen since 2009. The trade deficit in the US narrowed to a four-month low of $87.1 billion in April of 2022 from a record of $107.7 billion in March and below market forecasts for a $89.5 billion gap. Initial jobless claims for the week ending on June 4th hit 229K (vs 205k expected), an increase of 27k from the previous week level. The big news of course was (and as mentioned above) the higher-than-expected US CPI for May (1.1% vs 0.7% expected MoM) sending the YoY print to 8.6% (the highest for over 40 years). Airfare and used car continued to fuel price pressure. Nonetheless, core inflation remains also very strong at 6% YoY (slightly lower than last month at 6.1%).

In Europe, Eurozone GDP expanded by 0.6% QoQ in Q1 2022 (final print, vs 0.3% expected). The June Sentix Economic Index hit -15.8, up from -22.6 but still at weak levels. Exports accelerated 0.4% in Q1 2022, versus 0.9% expected. In Germany, manufacturing orders for April fell 2.7% (vs 0.8% expected), down from prior’s -4.2% while the industrial production rose 0.7% MoM, missing estimates for 1.3.%, but rising from prior’s -3.7%.

In Japan, the economy contracted 0.5% on an annualized basis in Q1 2022, compared with the preliminary data reflecting a 1.0% decline. Japan’s April household spending figure showed a decrease of 1.70% MoM.

In China, the Markit/Caixin China Services PMI gauge rose to 41.4 in May from April's 26-month low of 36.2, in the third straight month of contraction amid further COVID-19 lockdown measures. China's trade surplus jumped to USD 78.8 billion in May 2022 from USD 43.28 billion in the same month a year earlier, exceeding market forecast of a surplus of USD 58.0 billion. This was the largest figure since the start of the year, as authorities relaxed COVID-19 control measures in Shanghai and Beijing. Exports grew 16.9% YoY.

What’s coming up this week?

  • Monday: UK industrial production;
  • Tuesday: Germany CPI, ZEW Current situation and economic sentiment. US NFIB Small business index, PPI;
  • Wednesday: FOMC meeting, US retail sales, Empire State index, business inventories. Eurozone Industrial production;
  • Thursday: US housing starts, Initial claims, Philadelphia Fed Index
  • Friday: Japan policy rate, Eurozone CPI (final), US capacity utilization, industrial production, leading indicator;

What themes and topics have we been following?

  • The Technical View: In last week’s Technical View, we looked at the current technical picture on the S&P 500 and discussed potential opportunity in solar;
  • ECB preview: ahead of last week’s ECB meeting we took a look at macroeconomic conditions within the eurozone and discussed the potential effects of the end of the APP and rate hikes on the outlook for the single currency;
  • A supportive backdrop for Japan: a weak yen due to supportive monetary policy, the reopening of China and attractive valuations lend us to believe that Japanese stocks could continue to outperform.

We revisit each of these in summary below and as ever wish all our readers a good week ahead.

The technical view

Investors experienced a painful selloff as equity indices reached a bottom in May. Since then, stocks have entered a new rebound phase mainly fuelled by a combination of heavily oversold technical indicators and extreme pessimism. As shown on the graph below, the AAII Bull/Bear sentiment survey has recently started to rebound from extreme levels of pessimistic, but remains in negative territory.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022.

Following May’s sell-off, the S&P 500 may have reached a bottom at that time, and current levels could offer a buying opportunity in our view. From a technical perspective, the S&P 500 has moved above ST equilibrium prices according to the ichimoku method. This positive price action may pave the way for a rise towards the Ichimoku cloud at around 4300. On the other hand, the Kijun at 4 058 has become a support.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022. *Criteria are explained in the endnotes. The target price presented in the chart is based upon chart analysis. This is not the product of any Pictet financial research unit.

In this new market phase, it is necessary in our view to be more selective in terms of investment choices as investor have now turned their approach from beta-oriented to alpha-oriented. Among the themes that managed to deliver positive returns over the past weeks, we have noticed a technical breakout on the Invesco solar ETF, a sign of a potential new long term trend.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022. *Criteria are explained in the endnotes. The target price presented in the chart is based upon chart analysis. This is not the product of any Pictet financial research unit.

See last week’s technical view again here for our technical analysis on the S&P 500 and the invesco solar ETF, as well as a screening of solar stocks with upside potential.

ECB preview: ready to tighten

Last Thursday, the ECB announced the end of its net asset purchase programme and a first 25-bp rate hikes in July, in response to soaring inflation. While market participants already anticipated such a decision for July, the likelihood of a 50-bp rate hike in September has been on the rise over the last weeks as inflation reached a new high-record (+8.1% YoY in the Eurozone in May).

The Covid-19 crisis has prompted Europe to implement stimulus packages to boost the economy. However, the global economic slow down and the war in Ukraine have led analysts to revised lower their GDP growth projections and higher their inflationary expectations, as shown on the graphs below.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022.
Source: FactSet; Pictet Trading Strategy; as of 10/6/2022.

Over the last months, early hawkish comments from the Fed, rising US rates and the euro’s dependence on Russian energy have put pressure on the single currency, especially against the USD. As a result, the EURUSD pair has broken multiple supports to return near its March 2020 level. However, from a short-term technical perspective, the RSI has formed a bullish divergence suggesting that the negative momentum may be losing steam and that a rebound from oversold may occur. A daily close above the 50-day SMA (currently holding at around 1.08) would trigger a rise towards the next resistance at around 1.10.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022. *Criteria are explained in the endnotes. The target price presented in the chart is based upon chart analysis. This is not the product of any Pictet financial research unit.

See Wednesday’s letter again here for more details regarding the eurozone. We remain positioned for a potential tactical rebound in equity markets as any small improvement in the news flow or the data could allow equities to take a breath and European companies seem attractive should this scenario materialize.

A supportive backdrop for Japan

While many central banks have already started to normalize their monetary policy amid significant inflationary pressures, one of them remains so far highly accommodative: the Bank of Japan. Indeed, BOJ’s governor Kuroda recently said that the Japanese economy was still in a recovery phase, and that given the weak inflation in the country, there was no need to tighten its policy. This comment further pushed the fall of the yen, that fell to a 20-year low against the dollar, the greenback benefiting from a significant monetary divergence and investors’ preferences for safe-havens.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022.

From a historical perspective, the annual performance of the Nikkei 225 has been strongly correlated to the evolution of the USD/JPY, a depreciation of the Japanese currency tending to boost Japan’s equities. Yet, there remains a significant gap between both times series, as shown on the graph below. This could mean that Japanese equities could further gain in traction in the weeks to come (worth noting that the MSCI Japan is up 12.5% over the last three months, significantly outperforming its developed peers.

From a historical perspective, the annual performance of the Nikkei 225 has been strongly correlated to the evolution of the USD/JPY, a depreciation of the Japanese currency tending to boost Japan’s equities. Yet, there remains a significant gap between b

Moreover, Japan could benefit from the progressive easing of covid-related lockdowns in China, as Japanese companies – mainly cyclical and export-based oriented – have a significant revenue exposure to the China’s economic activity.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022.

Finally, the index remains technical well-oriented and “cheap”, as its valuation is around 0.77x the NTM PE of the MSCI World. Read our daily letter here again for more details and for our quant screening of those cyclical Japanese stocks with upside potential.

Source: FactSet; Pictet Trading Strategy; as of 10/6/2022. *Criteria are explained in the endnotes. The target price presented in the chart is based upon chart analysis. This is not the product of any Pictet financial research unit.

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