Preparing for a hot summer ahead

24 June 2024

AT A GLANCE

Last week was volatile but overall slightly positive, with significant moves in currencies
Flash PMIs showed a comeback of US exceptionalism with disappointments in Europe and Japan…
Watch next Friday with the US Presidential debate and the May core PCE inflation release

Last week was short (Eid break in our region, Juneteenth holiday in the US) but volatile: a strong start, followed by a decline in risk appetite and a tepid US close in a key expiry date for derivatives. Overall, it was not too bad. The dollar rose, affecting global bond indices, stocks and oil prices gained, US Treasury yields were flat week-over-week, and gold gave back a bit of its gains.

June flash PMIs released last week raised some questions on the global picture, with disappointments in Europe and Japan, and positive surprises in the US. China showed better than expected retail sales but some deceleration in industrial production, while the exact opposite was seen in the US. Overall, data is consistent with some moderation in activity in the second part of the year, which may finally deliver the widely expected “soft landing” scenario and open the door for rate cuts from the Fed after the summer.

The issue, however, is that many things can happen in the meantime, with the potential to move markets as many asset classes are already discounting this consensual outcome. Our calls for the year have so far not been challenged: central banks are risk adverse, markets are volatile, but returns are positive and differentiated. Still, our performances in almost 6 months are not very far from what we were expecting for the entire year. Part of it is due to stronger growth of course, but we see some potential vulnerabilities ahead. We will carefully look at our positioning and come back to you in July with some mid-year update inputs. In the meantime, this week is all about Friday 28th: the US Presidential debate at 5AM Dubai time, and the May core PCE inflation at 4.30PM Dubai time. Take care.

Preparing for a hot summer ahead

Cross-asset Update

There are some subtle signs that liquidity may be shifting less favourably for risk assets. Bitcoin has been on a tear till its top in March this year, followed by range-trading that has seen crypto currencies in general lose steam. The asset class is sensitive to liquidity patterns and bitcoin in particular has been correlated with the Nasdaq, and usually has been leading the equity index. Also, some gauges of credit risk premia, the difference in spreads between weaker and stronger segments of the credit spectrum, are pointing to the market sensing higher risks, as this differential has started to widen. In equities, the relative performance of cyclical versus defensive sectors is also suggesting a less pro-cyclicals stance amongst investors. And June is a month where there is a seasonal pick-up in the Treasury account with the Fed, due to increasing tax receipts that suck bank reserves out of the system, a key gauge of short-term liquidity for markets. In summary, there are fledgling signs across asset classes of a rollover of market liquidity. Anecdotally, it is important to mention that according to Bloomberg insiders at Nvidia sold the stock “in droves” amidst a “dearth” of insider buyers last week. It seems we may be in for a bout of volatility following an impressive and impressively narrow equity rally.

This could partially explain re-emerging dollar strength, as well as gold pulling back. It could also be conducive to some profit-taking in the expensive technology trade, a foretaste of which was seen on Friday with the underperformance of the Information Technology sector in the S&P 500. The release of strong business confidence numbers could also be a trigger for investors to eventually reassess the more cyclical pockets of the market, trading at less expensive valuations. A broadening of the rally at sector level would make the bull market more sustainable, that we all wish for, though it has so far failed to happen give continued focus on technology and little else. In general, the US economy remains strong and the outlook for earnings favourable, so pullbacks would be considered as buying opportunities.

In the shorter term the combination of a more resilient US cycle and political turmoil in the euro area could see the dollar break out higher and lead to a significant rebound. This in turn would be marginally tightening financial conditions further. We continue to think that our barbell tactical allocation, where we are overweight both high-quality assets and equities and underweight alternative investments, is appropriate for the current times marked by overbought markets and shorter-term uncertainty.

Preparing for a hot summer ahead

Fixed Income Update

A holiday-shortened week was not short on volatility. SNB provided a surprise cut its rates while BoE stayed put but the meeting was considered dovish with rate cuts expected in August. The Us Treasury curve bear-steepened with long-end yields going up by 4 bps. The 10-year has repeatedly failed to break the 4.2% levels this year. French OATs versus German Bunds spreads have widened to close to 80 bps and with French fiscal deficit under scanner could be the new normal.

The recent French political turmoil has presented an interesting opportunity for bond investors. The French G-SIBs which earn a significant portion of their revenue outside the country have also been negatively affected. Analysts suggest that the recent widening of spreads for French banks bonds, prompted by potential political changes following the snap election, is a short-term phenomenon. They believe there will be no significant impact on the fundamental value of these bonds in the near term, presenting a good opportunity to buy now and exploit the current spread widening. Investors should select these bonds which currently trade at more than 70 percentile YTD spread or where the spreads have widened by more than 20 bps at least in June.

S&P anticipates the US High Yield default rates to reach 4.5% in early 2025 close to current levels. Most indicators of future defaults have declined slightly. Positively, economic growth and corporate profits remain broadly healthy, and many issuers recently refinanced upcoming maturities, easing near-term pressure. Market sentiment has also been supportive, providing liquidity where needed. Although robust, the vast majority of recent issuance was used for refinancing, rather than for more growth-oriented ends such as capital expenditure or mergers and acquisitions. While this relieves near-term refinancing pressure, it also resets a large amount of debt to current, higher yields. many of the lowest-rated issuers are in consumer-reliant sectors such as media and entertainment, consumer products, and retail. These sectors may suffer from consumers pulling back on spending as higher rates limit their available funds. Cumulative excess savings from pandemic supports have finally disappeared, and stress is already showing up in rising delinquency rates particularly for credit cards and among younger borrowers.

GCC issuance continues full steam. This week we already have two mandates announced. SIB (-/A-/BBB+) will be issuing a 5-year senior $ sukuk. This will be the first issuance from the bank since 2020. SIB has a very strong relationship with the Sharjah government, which directly and indirectly owns 37.5% of the bank. Around one-third of the bank's Islamic financing book comprises financing to the government and GREs. Oman’s EDO (-/BB+/BB+) will also issue a 7 year $ sukuk. EDO produces approximately 65% of Oman's oil and gas and about 50% of Oman's combined oil, non-associated gas. The company also accounts for more than 60% of Oman's proven reserves.

Preparing for a hot summer ahead

Equity Update

What could move markets this week is the first US presidential debate, Core PCE on Friday and French elections. Global equities added half a percent last week, and it’s been a good June so far with US Tech leading and India recovering post-election wobbles. Massive quarterly expiration of options left the S&P 500 still up 0.6% and tech flat for the week. Leading global sector YTD returns are tech and communication services, with real estate still a laggard and some AAA MBS defaults raising concerns but still too small to cause ripples. We have lower 2 and 10 yields, mixed eco data with a strong labour market though consumer demand looks to be less buoyant.. Nvidia midweek touched a valuation to $3.3 trillion, just above Microsoft and Apple but shares ended 4% lower for the week (does it really matter with over 750% gains since 1st Jan 23; the Nasdaq+70%). No fundamental reasons behind Nvidia’s lower end to the week.

The FTSE 100 rose 1.17% last week as inflation reached its lowest level since 2021 and the Bank of England delivered commentary that appeared to be consistent with an August cut. Eurozone equities haven’t fared well in June with France weighing down on the Euro Stoxx performance though last week was a positive close.

We expect mild pullbacks in the equity market as the year progresses though earnings growth backed by economic resilience should lead to current gains being maintained into year end. Technology has been a driving theme for investors since 1990 driven by the internet explosion, ecommerce, connectivity and the more recently the use of data in AI in the last few years. Recent developments in generative AI, powered by large language models, have the potential to bring transformational change across industry with data centers being built and upgraded globally. The infrastructure requirements of AI – semis, data centers and the energy resources to power generative AI models – are huge. While Nvidia remains the poster child for AI infrastructure investment plenty of other companies that are also involved in the build-out of AI data centers.

We are currently overweight both DM and EM equities which have performed well in May and June to date. However, in addition to the existing risks around stretched valuations on many markets, as well as geopolitical tensions, DM central banks’ shift to an accommodative policy for the ERCB, BOE and SNB is clearer than the Fed which is dependent on future data points. We also expect heightened election risk. There is uncertainty in the size and scope, tariff increases appear likely in the event of a Trump victory and would likely strengthen the USD, lift consumer prices, and could potentially boost government revenues. Trump has floated several potential tariff policies, including a 10% across-the-board tariff on imports along with a 60% tariff on imports from China. Stay diversified and invested but watch concentration risk.

Preparing for a hot summer ahead

Written by:

Maurice Gravier Chief Investment Officer , MauriceG@EmiratesNBD.com
Anita Gupta Head of Equity Strategy , Anitag@EmiratesNBD.com
Satyajit Singh Fixed Income Analyst , SatyajitSI@EmiratesNBD.com
Giorgio Borelli Head of Asset Allocation , GiorgioB@EmiratesNBD.com

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