A welcome string of good news

06 May 2024
awelcomestringofgoodnews

AT A GLANCE

  • A relatively dovish FOMC, a cooling US job market, great earnings from Apple, reassuring PMIs…
  • … Triggered a clear market relief last week after the trauma of US GDP and inflation
  • Volatility is and will remain elevated, but fundamentals are not challenging yet

Our previous weekly publication was titled “A welcome string of good news”, and markets kindly proved us right last week – with huge volatility, but a happy end driven by unequivocally positive news.

PMI reports confirmed a broadening of growth sources, from industry to non-US regions. Then, crucially, the Fed’s May FOMC was much less hawkish than many had feared. The non decision on rates was expected, but the reduction in the balance-sheet runoff (QT) was deeper than forecast, while chairman Powell, in his press conference, sounded extremely balanced: patient yet not pessimistic on inflation, and highlighting the risks of keeping a restrictive policy for too long. The next move will not be a hike, even if its timing is uncertain. Markets loved it, recalibrating their implied forecast to two rate cuts again this year (our house view), with US treasury yields falling -15/-20bps across the curve, especially helped by the monthly US job report: 175k job creations, way below the 240k median forecast, no acceleration in hourly earnings, and a slight drop in hours worked. Add a reassuring set of numbers from Apple to the mix, and it was a great week for both stocks and bonds. It’s also worth noting that emerging markets outperformed, helped by a weaker dollar and falling oil prices, led by China which, in the MSCI methodology, is now 2024’s best performing major country in dollars.

Overall, we are reassured in our key view that central banks have limited leeway, that keeps fundamentals in the driver seat. Q1 was buoyant, Q2 could be slower but broader. Inflation can continue to surprise, but as long as central banks can live with the current levels, this shouldn’t be an issue. We haven’t changed our positioning, overweight pretty much everything except alternatives, and keep on expecting high volatility. Have a great week.

A welcome string of good news

Cross-asset Update

Last week some major macroeconomic shifts emerged, that point to a more consolidated path towards a slowing of US activity, despite seemingly conflicting signals from different datapoints. Markets closed on a positive note, interpreting the softening of data as a green light to an investor-friendlier policy from the Fed in the second half of the year. And asset-implied financial conditions eased substantially, with Brent crude, the US dollar, and the yield on the 10-year Treasury note all losing ground. At the same time, more encouraging signs emerged both in the euro area and in the Chinese economy, where positive economic surprises are overpowering inflation surprises, an emerging trend running opposite to the one in the United States. We tend to think that the new developments in the US can for now still be seen as one more iteration of the Goldilocks scenario, as the slowdown is not coming with the hallmarks of the recession, and the disinflationary process seems to continue, despite the recent uptick in price pressures. It is yet to be seen whether a growth scare will follow down the road, and how policymakers would manage to avoid the nasty impacts. For now, we can only register that Powell did all that is in his power to strike a dovish note at the late-month FOMC meeting in terms of forward guidance, and more, since planning to cut the Quantitative Tightening pace by more than half starting from June will materially add to market liquidity. Overall, the transition to a US slowdown has no dramatic traits yet, supported by a Fed more than willing to help, and earnings that are surprising to the upside. Considering that other major areas are picking up, though from a low base, we conclude that the bull market remains intact, maybe on a bumpier road ahead.

China stocks technically entered a bull market last week. The Politburo signalled that policymakers intend to support the economy with fiscal and monetary stimulus and highlighted plans to curb structural hurdles to growth. Also, manufacturing confidence improved, with the goods and services sectors both in expansion territory. Investors will be now looking forward to the third plenum in July, one of China’s most important meetings focusing on long-term policies and reforms. The feared Yuan devaluation seems to be out of the question, as in the past similar measures backfired by being destabilizing. Rather, a managed and gradual weakening of the currency remains more likely, jolting financial conditions in the right direction without upsetting markets. With valuations remaining extremely favourable, the stage seems to be set for Chinese stocks to continue to surprise to the upside.

A welcome string of good news

A welcome string of good news

A welcome string of good news

Fixed Income Update

Last week was very eventful and positive for the markets in general. We had a confluence of factors resulting in yields diving down by 15 to 20bps across the curve in the last two trading days. Treasury yields posted their first weekly decline in over a month. The key trigger was the more dovish than expected Q&A of Chair Powell post the conclusion of the FOMC meeting on 1st May.

Chairman Powell cheekily said he neither sees 'stag nor flation' during the post-meeting press conference. But that truly summarizes the meeting and its outcome. The FOMC kept rates unchanged for a sixth straight meeting. Chair Powell said it will take longer than expected to become confident about returning inflation to the Fed's 2% goal, essentially ruling out a rate cut in the near term. He also closed the door on the rate hike as well. The FOMC still aims for a near-mythical soft landing, saying risks to achieving employment and inflation goals "have moved toward better balance over the past year." Powell also noted that, with inflation having fallen over the year, there is now a greater focus on the full-employment mandate. The Fed announced that it would slow its pace of quantitative tightening beginning June 1, lowering the cap on the amount of Treasury securities rolling off the balance sheet by more than half, to $25bn each month from $60bn. This was more than most analyst expectations. Officials maintained the pace of runoff for mortgage-backed securities at a maximum of $35bn a month.

The bullish move in Treasuries gained pace after the weaker job report last Friday. The change in NFP came in at +175k, which was substantially lower than the previous figure of +315k. Wage increase at 0.2% MoM was lower than the estimate of 0.3%, while the unemployment rate rose to 3.9%. Yields took a nosedive, and the 2-year closed the week at 4.81%, while the 10-year traded close to 4.5%. The yield curve bull-steepened sharply.

The US Treasury also announced its financing estimates, projecting $243bn in net privately held marketable borrowing in Q1 and $847bn in Q2. These estimates were higher previously communicated and imply the US budget deficit could be larger than anticipated. However, the Treasury maintained the coupon auction size unchanged, while continuing to increase TIPS sizes. We remain neutral on duration for now, as the next CPI report is still nearly two weeks away, and this week’s mid-month Treasury auctions could provide a bearish impulse over the near term. According to JPM, Treasury is set to auction approximately $112bn in 10-year Treasury equivalents spread across 3-, 10-, and 30-year maturities next week, and there has been some tendency for long-end yields to move higher in the days around and after the new-issue refunding auctions.

The issuance volumes remain robust as spreads remain supportive across IG and HY. Gross IG issuance was $105bn in April, but the net was only $24bn. HY new-issue volume totals $113bn ($22bn non-refi) YTD, which compares with $59bn ($22bn ex-refi) in YTD23. The Bloomberg Barclays credit spreads remain near their lowest levels for the year.

A welcome string of good news

A welcome string of good news

Equity Update

All the larger regional markets are in positive territory as we start May, even though developed markets fell in April, with tech volatility up on the rally in yields. However, Fed Chair Powell said that a rate hike might not be needed, and better-than-anticipated mega cap tech earnings are helping markets settle as May starts. The US and tech sector absolute and relative higher valuation multiples imply that for gains to be maintained earnings growth should stay buoyant. April saw EM regions gain 0.4% led by China, with India up too while DM equities fell 3.7%. The S&P 500 ended last week 0.56% higher recovering from its 4.1% drop in April. European equities ended last week flat with rate cuts still on the table starting June, though Euro area inflation printed above consensus expectations.

Whilst we are currently overweight Japan we could look to a shift to overweight Europe in May, as the first DM region to cut rates should boost sentiment and corporate earnings. We would retain a neutral outlook for the US with earnings growth improving, elections and consumer demand supportive, while valuations and rates are worrying. Within EM, performance for India has been dwarfed by China in April, which has played catch up and is at par with c.8% YTD USD returns. India remains a strategic long as corporate leverage is at 15 years low, though that should bottom out as the capex cycle revives. Domestic demand and growing investment into equities are attractive catalysts as is a diversified Index. Global companies are shifting production to India. iPhone production in India is up from <1% in 2017 to 10% in 2023.

For Q1 2024 with 80% of S&P 500 companies reporting the blended (y/y) earnings growth rate for the S&P 500 is 5.0%. The blended revenue growth rate is 4.1%. The Communication Services sector is reporting the highest (y/ y) earnings growth rate of all eleven sectors at 34.8% and not surprising that it is the best performing global sector YTD. EPS estimates for Q2 have been revised up. For Q2 2024, analysts are projecting earnings growth of 9.6% and revenue growth of 4.5%. S&P 500 repurchases are expected to total $925 billion in 2024 (13% y/ y) and reach $1,075 bn in 2025 (16% y/y).

The outlook for big tech remains good, with revenue growing though EPS growth is mixed, the cost savings’ and layoffs narrative moving to ‘capex’ for Microsoft, Meta, and Apple ($150-200bn budgeted in 2025 among the big 4, Amazon, Google, Microsoft, Meta) and A.I. driven cloud, software, data initiatives growing and adding to top and bottom line. Public cloud trends are accelerating, Buybacks on the rise: GOOGL $70bn buyback + dividends. Apple $110bn buyback, higher than the $90bn buyback in each of the last 3 years and raised its dividend by $0.01 to $0.25. Its performance in China was also better-than-expected. Tesla rallied last week as Chinese officials as per reports gave Tesla approval to launch its Full Self Driving (FSD) technology in the country. China is the world's largest automotive market by new vehicle sales and electric vehicles.

A welcome string of good news

A welcome string of good news

A welcome string of good news

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