The Factory Daily Letter
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A central bank bonanza
It was a monster week for central banks across the globe who, in a Fed-led global policy shift, unleashed a series of inflation-busting rate hikes
As the week began, markets were still reeling from the disappointment around May’s CPI reading that showed consumer inflation reaccelerating to 1.0% MoM (pushing the YoY print to 8.6%) which drove a coach and horses through the peak inflation narrative. Wrongfooted by both this hotter inflation print and the alarming inflation expectations survey data from the University of Michigan, the Fed chose to announce a 75 basis points hike rate hike at its June meeting Wednesday – in a more aggressive policy move than guided and putting the new target range at 1.5-1.75%. Powell, using stronger terms to reiterate the Fed’s commitment to combating inflation (while insinuating that growth was still strong enough to withstand policy – market scepticism notwithstanding), hinted at another hike of a similar magnitude or +50bps in July (then possibly more flexible after the summer), and said the FOMC currently sees rates at 3.0-3.5% by the end of the year (the so-called dot-plot median is now at 3.4%). The hawkish policy risk is additional geopolitical tension and commodity volatility, while a more dovish tone could result from recession conditions emerging sooner than anticipated. You can see the Fed’s official statement here (and the statement of economic projections here).
Not to be outshone, earlier that day the ECB (having the previous week telegraphed a more aggressive pace of rate hikes) called an emergency meeting to discuss the heightened concerns associated with the impaired monetary policy transmission mechanism and the threat posed by rising yields on the eurozone’s more indebted nations (as was flagged by the reaction in peripheral spreads to the ECB meeting), and afterwards issued a statement saying that it would continue to apply its pandemic “PEPP” purchase programme flexibly and come up with a new “anti-fragmentation tool”. See the statement here.
But it was not over…Thursday dawned with a surprise 50 basis point policy rate hike from the SNB in a move designed to counter increased inflation pressure and prevent transmission of the same to goods and services more broadly. It also said that it would be active in currency markets (you can see the policy statement here). The UK followed later that morning, the BoE’s Monetary Policy Committee voted to raise rates 25 basis points for a fifth meeting in a row (with three voting for a 50 basis point move) saying “the Committee will be particularly alert to indications of more persistent inflationary pressures, and will if necessary act forcefully in response”. See the statement here.
On Friday it was the turn of the persistently-accommodative BoJ continuing to diverge from others as it chose once again to stick to its easy policy stance and yield-curve control (YCC) as the rest of the world turns hawkish. Japan’s central bank left its key short-term interest rate unchanged at -0.1% and that for 10-year yields at around 0% at its June meeting and resisted calls to tweak YCC. But it did say would be watching the currency impact.On Monday, China's PBoC paused its policy easing holding its one-year prime rate steady at 3.7% and the five-year LPR at 4.45% as was expected.
How did markets react? The risk-off move that followed the CPI print was enough to send the S&P500 into a bear market (-20% from its top) in what proved a bumpy week for markets, the S&P500 and the Nasdaq 100 both managed to close Friday higher, but the S&P500 still fell 5.8% over the week - in its biggest weekly drop since 2020 (the Nasdaq down 4.8%) while the 10-year US Treasury yield closed at around 3.23%.
In other news war in Ukraine continued with focus now on key territory of Severodonetsk. Macron, Draghi and Scholz visited Kiev, while in an opinion issued Friday the European Commission recommended Ukraine and Moldova be granted candidate status - a symbolic step in their application for EU membership. UK prime minister Boris Johnson also made a visit, pledging military training expertise and the US announced a new defence package, all as concerns built around the escalating food crisis illustrated by the rising price of wheat on Ukraine shortages, soaring energy and food prices caused by the war manifesting in strikes in Tunisia. Elsewhere, French president Macron’s has lost his majority in parliament; the UK’s policy to send asylum-seekers to Rwanda was thwarted by a last minute injunction from the European Court of Human Rights; and in the US the congressional committee hearings over the 6 January Capitol riot continued, and a compromise was reached on gun legislation.
On the data front…
In the US, producer prices rose 0.8% MoM in May, in line with forecasts and following a 0.4% MoM rise in April (and 10.8% YoY, slightly below the 10.9% April YoY figure). Small business confidence also out Tuesday edged lower to 93.1 in May. Producer prices rose 0.8% MoM in May in line with forecasts, while retail sales data out Wednesday showed an unexpected fall in May down 0.3% MoM, missing expectations of a 0.2% rise. With the Fed rate decision (see above) came the economic staff projections with policymakers seeing rates rising to 3.4% this year (well above the 1.9% they forecast back in March), and the economy expanding 1.7% (down from 2.8% in March); the growth outlook also lowered for 2023 and 2024. PCE inflation projections rose to 5.2% this year but were revised lower for 2023 and 2024.
The New York Empire State Manufacturing index rose to -1.2% in June from -11.6 in May missing forecasts of 3; new orders edging slightly higher, delivery times lengthening and inventories growing, while optimism on the 6-month outlook remained muted. Mortgage applications rose 6.6% in the week ending 10 June but were still 52.7% lower than a year earlier, while the NHAB housing market index fell for the sixth month in a row to 67 in June (its lowest level since 2020) from 69 in May. On Thursday Housing starts were down 17.4% MoM and building permits fell 7% to their lowest level since last September and well short of forecasts. The Philly Fed Manufacturing index fell to -3.3 in June, well below forecast of 5.5, while weekly initial jobless claims fell 3k to 229k in the week ending 11 June. Into the end of the week we had industrial production which rose 5.8% YoY in May (following a 6.3% rise in April) at 0.2% MoM (half of the expected 0.4%) while the CB leading index was at -0.4%, in line with expectations.
In Europe, the ZEW economic sentiment indicator for Germany rose slightly to -28 in June (up from -34.3 in May) – in line with market forecasts of -27.5. Euro Area Industrial production rose 0.4% in April rebounding off a 1.4% drop in but still less than expected. Friday saw the record-high Euro Area inflation figure confirmed at 8.1%.
Also last week, the UK economy shrank 0.3% MoM in April, more than the 0.1% contraction in March, while the jobless rate edged higher to 3.8% in the three moths to April 2022 (higher than consensus). In Japan the Reuters Tankan sentiment index for manufacturers rose to 9 in June coming off 5 in the previous month reflecting a sentiment that is expected to improve in the coming months despite cost concerns aggravated by the weaker Yen. The trade deficit jumped to JPY 2,384.7 billion in May from JPY 212.9 billion. Data out of China included industrial production unexpectedly growing 0.7% YoY in May in a rebound supported by manufacturing output. Retail sales also fell less than expected, falling 6.7% YoY in May.
What’s coming up this week?
Powell's testimony, Flash PMIs and the latest revisions to the University of Michigan numbers.
- Monday: US markets closed for the Juneteenth holiday; Germany PPI (May); EA construction output;
- Tuesday: Existing home sales; EA current account; Powell testimony;
- Wednesday: BoJ meeting minutes; UK inflation; US mortgage data; EA consumer confidence (flash, June); European Council Meeting; Powell testimony;
- Thursday: Jibun Bank flash PMIs; EA and UK S&P500 Global flash PMIs; Fed bank stress test results;
- Friday: UK Gfk consumer confidence; UK retail sales; Germany Ifo Business Climate; US new home sales; U. of Michigan sentiment (June, final); European council meeting;
What themes and topics have we been following?
- The Technical View: Stagflation concerns killed the relief rally (and sent US equities into a bear market);
- 75 basis points: The Fed shifted up a gear in its fight against inflation;
- The anatomy of a bear market: After a fall of more than 20%, what comes next?
- Signs from the insiders: Insiders are buying again – we catch the signals and screen the favourites;
We summarise each of these below, and, as ever, wish all of our readers a good week ahead.
The technical view
Stagflation fears killed the relief rally
The hotter-than-expected CPI print for May put recession fears squarely back on the table (and a pin in any notions that the Fed might not have to be as aggressive as was priced). The S&P500 index closed that week down over 5% with 90% of stocks in negative territory in a broad-based decline that reflected the great level of uncertainty in the market and the lack of risk appetite ahead of the Fed meeting and indeed the selling continued into last week.
Hopes were at that time that the selloff was bottoming and tactical entry opportunities could be emerging at prevailing technical levels, however markets had by then already sold off beyond what we would typically consider ‘healthy consolidation’. The momentum indicators crossed lower and the S&P500 index hit another important support at 3,900 (the prior low and the 50% Fibonacci retracement of the post-Covid rally), looking to next support at around 3,680, (the 61.8% Fibonacci retracement) which should theoretically mark the end of the correction phase (but if broken could trigger further deterioration in the technical outlook):
That was Tuesday; on Friday the S&P500 closed the week down 5.8% (at around 3,675) and analysts are now looking to the technical support presented by the 200-week moving average currently holding at around 3,500: see our weekly technical update later today (available on request) and in the meantime you can see Tuesday’s letter again here (which also included a screening of those names that had suffered more than three consecutive down days of more than 1% as possible candidates to buy on weakness should support step in).
The Fed hikes
Investors took fright from the May US CPI print of 8.6% YoY (1% MoM) – as indeed did the Fed – which was also spooked by the U. of Michigan survey flagging concern around inflation expectations. Reiterating the ongoing strength in the economy Powell communicated Wednesday that the Fed was prioritising inflation (sensitivity about growth data and financial expectations notwithstanding) as he announced a 75 bps rate hike and guided the new target range at 1.5-1.75% (see the macro summary again at the beginning of this letter, and the full Fed statement here).
This more reactionary (some might say ‘panicky’) Fed, whose actions now appear to be driven more by headline inflation, has encouraged our economists to change their scenario to one of a 50 basis point hike in the Fed Funds rate at the July meeting and thereafter 25 basis point hikes at each to the year end. Such would put the rate in a range of 0.75-3.0 by the end of the year (which would still be below the 3.4% ‘dot-plot’ median Fed member forecast); the risk being that it is more aggressive. Doubtless markets will continue to pour over CPI, wage growth and inflation expectations data going forward as they reprice policy and recession risk.
The anatomy of a bear market
The S&P 500 has lost more than 20% since the beginning of January, putting it technically into a bear market (following the Nasdaq). So we have been looking at past bear markets for clues on what could follow - and indeed history suggests much could depend on the likelihood of recession – a word that is on everyone’s lips these days. Our own PTS macro momentum model has recently deteriorated and is now heading in the direction of ‘recession warning’ territory, while our bear market probability model is also sending warning signals: with the uncertainty and lack of catalysts currently evident in the global economy – not to mention the headwinds presented by hawkish central banks that have now embarked on policy tightening – we think it is unlikely we will see a rebound across the necessary economic drivers sufficient to support a significant uptick the macro momentum in the short-term.
So what shape does a bear market take? While we are mindful of the distinct nature and characteristic of each bear market, there is a tendency for bear market rallies to occur right at the outset. Moreover, breadth statistics suggest that the current bear market might already showing signs of out-pacing the more protracted, more recent (tech bubble and GFC) bear markets of 2000 and 2007.
The recent price action has taught us that bullish phases remain fragile. However there are several historical indicators emerging that would support calls could call for a bear-market rally over the coming days. See Thursday’s letter again here for a look back at past bear markets and what this could tell us about what might come next:
The insiders are sending signals
On Friday we took a look at the tell-tale-trends in the data officers, directors and significant stakeholders are obliged to file when transacting on related stock. Widely considered a “smart money” indicator, corporate insider activity is frequently referred to by investors to glean some insight into the level of executive confidence in their company’s stock price - and as an indicator on the stock market as a whole (and, unlike the 13F reports of fund manager holdings that are filed only quarterly, insiders have just a few days to report their activity to the SEC making the information much more valuable from a timing perspective).
Why are we looking at it now? Because insider buying has recently started to outpace selling again – both in the US and in Europe: While equity markets are selling off, insiders are buying more than selling their corporate stock in a trend that has been steepening - and moreover at pace that has historically proven a positive sign for stocks (see chart below). Since 2010, the insider buying/selling ratio has climbed so fast only three times: August 2011, August 2015 and March 2020.
The behaviour varies across the sectors: while buying activity has surged globally, it has been mainly driven by insiders in the communication services, discretionary, financials, healthcare, industrials and real estate sectors; while energy (the only sector currently in positive territory in terms of YTD performance - 49%) has suffered a consistent decrease in its insider buying ratio over the past six months. A similar picture is reflected in Europe, the discretionary, industrials and real estate among those sectors with the highest ratios; while staples and energy have the lowest . Also of note is how insider buying has proven robust across tech – on both continents.
For more detail and screenings for those stocks that have been the most bought (and sold) by insiders over the last six months within each market see Friday’s letter again here.
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