The Factory Daily Letter
Please read important disclosure information at the end of the document. It is reserved for the exclusive use of the recipient. This document is intended for distribution to professional clients, accredited investors, expert investors and institutional investors only and not for distribution to retail investors.
The S&P500 closed the week up 6.5% (the Nasdaq up 7.5%) in the US market’s first weekly gain in four and the US 10-year Treasury yield at around 3.13%; while oil and commodities sold off as recession concerns remained front and centre (although the notion that central banks might be forced to be less aggressive as a consequence of slowing economic activity - as has been becoming increasingly evident in the data - also reappeared). With several Fed policymakers, including Bowman and Waller calling for a 75-basis point hike at the July policy meeting, this week’s US inflation reading will be watched very closely. As a new week dawns, we wake to the news that Russia has defaulted following the expiry of the 30-day grace period on two eurobond coupons Sunday, as G7 leaders meet in Bavaria with Ukraine and the possible ban of new Russian gold imports at the top of the agenda. Central bankers also meet in Sintra this week while markets will also be watching the US PCE deflator and personal income and spending data.
Last week it was largely central bank policy testimony that dominated. Powell testified to the House and Senate banking committees, with much being made of the US central bank’s ‘unconditional’ commitment to restoring price stability (as policymakers wrote in the Fed’s semi-annual report to Congress which you can see in full here). Powell said that the Fed was strongly committed to returning inflation to 2% and that ongoing hikes were appropriate, albeit that the bank needs to be ‘nimble’ and that rate hike decisions will be made on a ‘meeting by meeting’ basis. He also reiterated that the economy was strong and able to handle tighter policy (and moreover that inflation must be brought down to sustain a strong job market) – but did however acknowledge that the higher rates could tip the economy into recession.
And across the Atlantic Christine Lagarde testified to the European Parliament, reiterating that the ECB was taking further steps to normalise monetary policy in the face of changing conditions (higher inflation / effect of higher energy costs) repeating that asset purchases under APP would be wound up as of 1 July and that the central bank would raise key interest rates 25 basis points at the July policy meeting (6 July) and again in September with a “gradual but sustained path” of rate rises thereafter. Addressing resurgent fragmentation risk, she also reiterated the bank’s commitment to applying flexibility in reinvesting redemptions coming due in the PEPP portfolio “with a view to preserving the functioning of the monetary policy transmission mechanism, a precondition for the ECB to be able to deliver on its price stability mandate”. (You can read her introductory speech here);
The BoJ released meeting minutes of its 27-28 April monetary policy meeting as approved in the 16-17 June meeting (statement following which can be seen again here), while in other news the European Council met Thursday and Friday to discuss the EU’s relations with its other partners in Europe (Western Balkans); war in Ukraine; the membership applications from Ukraine, the Republic of Moldova and Georgia; economic issues; the Conference on the Future of Europe and foreign policy issues. This morning the PBoC injected a total of CNY 100 Billion into the banking system to ease pressures from rising cash demand via a seven day reverse repurchase at 2.1%.
On the data front…
In the US, Existing home sales data out Tuesday showed a 3.4% decline in May to 5.14 SAAR – lowest since June 202 yet in-line with estimates, while mortgage applications in the US increased 4.2% in the week ending 17 June (but are down 10% compared to a year earlier) while the refinancing index fell 3.1% as the average rate on a 30-year fixed mortgage rose 22 basis points to 5.98%. Initial jobless claims fell in the week ended 18 June but less than expected (by 2K to 229K) while the big news Thursday was the S&P Global PMI data, in the preliminary reading that showed private sector activity eased further in June (the composite measure falling to 51.2 in June from 53.6 in May. The services PMI fell to 51.6 in June, significantly below forecasts of 53.5, while the manufacturing gauge fell to 52.4 – also well below market expectations (56) as output and new orders measures contracted (see last week’s letter “Recession risk: where are we in the cycle” again here). The Fed released results of the annual bank stress tests saying are well capitalised and able to continue lending during severe recession (see release and results here). Data out Friday put new home sales up 10.7% MoM to 696,000 SAAR in May, beating expectations, but the University of Michigan consumer sentiment reading was revised downwards to a record low of 50.0 in June (from the preliminary reading of 50.2), while inflation expectations for the year ahead was little changed at 5.4%.
In Europe Data out Monday showed German producer inflation surged to a record 33.6% YoY in May, higher than market forecasts; while EA construction rose 3% YoY in April, easing from March’s revised 3.4% figure. Tuesday brought news that the Euro Area recorded a current account gap of EUR5.4 billion in April as the goods account switched to a deficit of EUR 4.6 billion from a 28.4 billion surplus on surging oil and gas prices due to war in Ukraine. Flash consumer confidence out Wednesday showed the indicator fell 2/4 points in in June to -23.6, below expectations of -20.5. Euro Area flash PMIs published Thursday by S&P global were at 52 (vs 54.6 expected) for manufacturing and 52.8 (vs 86.1) for services; the composite at 51.9 (vs 54.6). The Ifo Business Climate indicator for Germany fell to 92.3 in June (from the previous month’s 3-month high of 93).
UK retail sales fell 0.5% MoM in May, following a 0.4% increase in April yet still beating expectations of a 0.7% fall, while the GfK consumer confidence indicator fell to a new record low of -41 in June; Data out Wednesday showed UK inflation rose to a 40-year high of 9.1% YoY – as expected.
In Japan the Jibun Bank manufacturing PMI flash reading for June came out of 25.7 (a miss) while the services gauge beat at 54.2 as did the composite (53.2 vs 52.3); while the inflation figure for May out Friday was at 2.5%; core at 2.1%; both in line with expectations.
What’s coming up this week?
This week we have G7 leaders in Bavaria and central bankers in Sintra; while key inflation data out of the US and the Eurozone as well as US and Chinese PMIs are among the major macro events as the first half of the year draws to a close.
- Monday: BoJ Summary of Opinions; China industrial profits, US durable goods orders (May), US pending home sales and the Dallas Fed manufacturing index (June);
- Tuesday: Germany Gfk consumer confidence; US goods trade balance, S&P/Case-Shiller Home Price YoY (Apr), US house prices; US CB consumer confidence; Richmond Fed manufacturing index;
- Wednesday: Japan retail sales, EA economic and industrial sentiment, consumer confidence and inflation expectations (June); US MBA mortgage data; Germany preliminary inflation data (June); US GDP, PCE and real consumer spending (Q1; final);
- Thursday: Japan industrial production; China NBS PMIs; Germany retail sales (May); UK GDP growth business investment Q1 (final); France inflation; EA and Germany unemployment; US personal income and spending; US initial jobless claims; US PCE price index (May);
- Friday: Japan unemployment; Tokyo CPI; Japan Tankan surveys (Q2); China Caixin Manufacturing PMI (June); UK house prices; BoE consumer credit; UK mortgage data; EA flash inflation and CPI (June); US ISM Manufacturing (June);
What themes and topics have we been following?
- The Technical View: While the longer-term outlook remains more challenging (with caution still warranted), such oversold markets nonetheless reflect fertile ground for some more short-term tactical opportunity;
- Recession risk: we look to our own simple ISM proxy model to see where we are in the economic cycle, and discuss the role of oil, the US dollar and Treasuries as possible indicators on the potential stabilisation in equity markets;
- Playing the more resilient: we have been screening names that have been underperforming YTD but failed to make a new low in the latest selloff (on the basis that such names may be undervalued and have more rerating potential in a short-term rebound);
- Has tactical opportunity started to emerge in China? The longer-standing risks remain, but the short-term outlook just got brighter.
We summarise each of these below, and, as ever, wish all of our readers a good week ahead.
The technical view
From inflation concerns to recession fears
In May, the S&P 500 enjoyed a relief rally which allowed the US equity index to narrowly avoid a bear market. However the April CPI data release early in June, which was followed by a University of Michigan survey that flagged rising inflation expectations, put a pin in any hopes of a Fed policy ‘pause’ and moreover resulted in the swift pricing of a (duly delivered) 75 basis point rate hike at the June meeting. The S&P500 fell into a bear market as the prospect of recession became the primary concern of market participants, with many markets toying with key technical levels representing the ‘last bastions’ against further drops.
However we felt it also worth pointing out that some the more volatile price action could be chalked up to ‘quadruple-witching’, while we were also seeing some glimmers of life from the ‘smart money’ indicators, and a rare sign of capitulation (being a phase during which the S&P 500 suffered an opening gap down and ended near its low as bears took control from the bulls for three consecutive trading sessions) suggested on a short-term basis at least that markets might at last be attempting a bottom. We also had an encouraging bullish signal from the Vix to refer to:
While the longer-term outlook remains more challenging (with caution still warranted), such oversold markets nonetheless reflect fertile ground for some more short-term tactical opportunity in the event that markets make a concerted effort to stabilise. See last week’s Technical View again here for out screening of the most oversold stocks also enjoying the most positive insider activity and the most attractive distance to the consensus target prices (update available on request).
Where are we in the economic cycle?
Concern over the rising risk of recession has been growing over recent weeks around the extent to which ongoing policy tightening by the Fed and many other global central banks poses a significant threat to economic activity - especially in the US and Europe. PMI surveys for the US and the Eurozone out last week disappointed, showing significant deterioration across both the manufacturing and services sectors on both sides of the Atlantic, and while they may still be in ‘expansion’ territory, such sharp declines along with the ongoing evidence of persistent inflation and falling business and household confidence continue to weigh on investor sentiment (while equity markets are pricing further deterioration in manufacturing activity).
Anecdotally the consensus now seems to have settled around the idea that recession is inevitable, and the narrative has now shifted to how Fed can avoid a deep one – a key question for investors given the historical relationship between the extent of an economic slowdown and the accompanying equity market price action. While the current data does not (yet) signal an imminent recession, our own indicators nonetheless point to further economic deterioration. But while uncertainty prevails, there are some early indicators that we can watch closely in our efforts to identify a near-term change in the trend as early as possible.
So see Friday’s letter again here in which we look to our own simple ISM proxy model to see where we are in the economic cycle, review historical S&P 500 performance when the economy is slowing, and discuss the role of oil, the US dollar and Treasuries as possible indicators on the potential stabilisation in equity markets (as well as our latest technical outlook on the Nasdaq 100 which has recently formed a bullish ‘island gap’ pattern).
The more resilient through the recent rout could rerate in a Q-end rebound
There may be no place to hide, but indicators suggests some tactical opportunity could be emerging as the quarter draws to a close.
As we have discussed in the sections above, the equity market outlook remains murky at best as recession concerns continue to wrestle control of the narrative from the fear of inflation. Yet breadth, volatility and other technical indicators have recently been suggesting much of the short-term concern is now priced and that the conditions may have been met for an end-of-quarter relief rally.
In our analysis of the most recent market rout we note in particular how it has been the more speculative corners of the market (that sold off so hard earlier in the year) that have actually proven more resilient this time, while sectors such as utilities and materials (those which had been outperforming) that have suffered most – in a capitulation of “last holdout” sectors that has brought market breadth to “washout” levels.
On Wednesday we discussed how even though the hawkish central bank policy shift does threaten the growth outlook over the medium-term, inflation expectations are already showing signs of stabilising in a move that could help stabilise and support equity markets in the near term (while the prospect of slowing growth could by way of reducing some of the recent upside pressure on real yields help ease credit volatility which could help other asset classes too). We also screened for names that have been underperforming YTD but failed to make a new low in the most recent selloff (on the basis that said price action suggests such names were undervalued and moreover had rerating potential in a short-term relief rebound). We also presented our latest technical charts on Chinese tech (see next) and the SPDR S&P Biotech ETFs – some more speculative corners of the market with interesting technical configurations. See it again here.
Has tactical opportunity started to emerge in China?
The longer-standing risks remain, but the short-term outlook just got brighter
The country’s strict zero-Covid policy, property sector woes and regulatory risk are all among the reasons to have been cautious China for the past several months.
However, more recently, Chinese equities have been outperforming, and while the aforementioned risks have not gone away, supportive policy (with lower inflation allowing for more flexibility), falling Covid cases, recent hints of an uptick in the economic outlook and the prospect of a falling dollar all help support the outlook for Chinese equities in the short term.
See Thursday’s letter again here in which we discuss the tailwinds recently falling behind Chinese equity outperformance and present a technical outlook that suggests there is potential for more of the same in the near term:
Banque Pictet & Cie SA
Pictet Trading & Sales
Route des Acacias 60
1211 Geneva 73
Tel +41 58 323 2323
Fax +41 58 323 2324
Should you require any further information, please contact the team
Tel +41 58 323 1250
Email to: email@example.com
Disclosure and Disclaimer information is available by consulting the following link: https://www.group.pictet/strategy