Soft-landing confidence continues to rise

Chief Investment Officer's team
28 November 2023
Soft-landing confidence continues to rise

AT A GLANCE

  • Last week was relatively quiet, and shortened in the US by a holiday…
  • … But it was positive as the soft-landing narrative continued to support all asset classes
  • Our positioning has so far fully benefited from the rally and we are working on the 2024 outlook

“There are decades where nothing happens; and there are weeks where decades happen.” There are also weeks, like the one which just ended, where not much happens, especially when the world’s leading financial market is closed for Thanksgiving.

Still, we had some food for thought. First, the flash PMIs for the major regions were consistent with the current scenario of a soft-landing: the main divergences compared to forecasts were some softness in US and Japanese manufacturing, and a bit more resilience than expected for activity in Europe. A surprise came from China, as authorities are reported to have drafted a list of 50 developers eligible for specific financing support, and to encourage banks to offer unsecured loans to cover the working capital needs of the real estate sector. Markets have not really reacted yet, but if confirmed, this could address one of China’s most critical issues. Finally, the week ended with the start of a 4-day truce in the Gaza war, which could hopefully be extended.

Markets appreciated. All asset classes gained last week, especially in dollar terms, as the greenback was -0.6% weaker against trade-weighted counterparts. Our three profiles fully benefit from the recent rally, up respectively 5%, 8% and 10% (with a bit of generous rounding) so far in 2023. We haven’t changed our positioning into year end, and are obviously dedicating our efforts to 2024. However, as the consensus gets stronger on a benign top-down scenario, we note that pessimism is quickly dissipating in investor positioning, creating vulnerability to any bad news.

The coming days will provide November PMIs, inflation data for the US and the Euro area, and will see the COP28 kick-off in Dubai. Have a great week.

Soft-landing confidence continues to rise

Cross-asset Update

After the recent rally that sees global equities up about 15% year-to-date and technology gaining twice as much, investors may be wondering whether the current positive phase can be sustained into 2024. Though there are reasons to see the glass half full as well as half empty, we would tend to err on the positive side for the next few months.

Investors that prefer to be cautious usually base their assessment on leading indicators at depressed levels and on rich valuations. It is indeed true that business confidence indicators, in particular on the manufacturing side, are pointing to a contraction in the Western countries, especially in Europe, while in China they suggest ongoing stabilisation with not much economic momentum. Yet, at least in the United States the services sector is expanding, accounting for an economy that is not in recession despite woes elsewhere. And this time it is different: pre-Covid when manufacturing was contracting services followed, with the former playing a leading role in signalling a contraction. But now the services sector is still in expansion mode, decoupling from manufacturing due to the post-pandemic changed dynamics. So, unless we see services inflect lower too, we cannot draw bleak conclusions about the outlook. As for valuations, in theory we should be concerned, as bonds have become much more appealing in terms of their yield versus equities, that have not derated much in aggregate. Yet, though sensible on paper, expecting that the earnings yield rises simply because the bond yield did rise does not work in practice.

It rather seems to us that, barring a recession that is not in sight now, markets should be supported. Investors are following the disinflation narrative, whereby inflationary pressures are abating, hence central banks are expected to be on hold. Also, US earnings are exiting a contraction phase, one more positive factor against the recovery backdrop. As long as disinflation does not turn into deflation, there should be no concerns about growth and the focus should remain on the Goldilocks scenario. Now, going back to the glass half empty, as steep as the credit impulse that caused inflation was on the way up, it is on the way down. And since it leads inflation by more than one year, it suggests that disinflation could temporarily turn into deflation, about mid-2024. Hence, while we think it is too early now to be pessimistic, at some point next year we should be prepared for a bumpier ride.

Equities and credit should benefit from the disinflationary phase, as long as it lasts. Yields should finally find a peak, and gold hit new all-time highs with central banks on hold and expected to ease policy at some point.

Soft-landing confidence continues to rise

Soft-landing confidence continues to rise

Soft-landing confidence continues to rise

Fixed Income Update

US Treasury yields are up from their weekly lows. UK Gilts and European bond markets led the sell-off in the second half of the week as the PMI numbers came in stronger than anticipated. UK consumer confidence also bounced back in November. Moreover, supply concerns continued to weigh on the market as Bloomberg reported Germany will suspend its debt brake, and the UK supply announcements were more than expected. The benchmark 10-year treasuries hover around the 4.5% mark. Last week’s 20-year auction was uneventful. However, the traders would look at the 2 and 5-year note auctions due this Monday to gauge market concerns about growing supply. The Bloomberg Govies index is up 2.5% in November headed for the best monthly gain since March. There isn’t much top-tier economic data on the docket this week, though traders will get the PCE deflator, which is the Fed’s preferred inflation measure and is forecast to show a step down in the pace of price growth. Next week, though, will be more critical as the November job data is due after the unexpected decline in October.

Since last year, the Fed’s balance sheet has shrunk by roughly $1.2tn to $7.8tn, and balance sheet runoff has proceeded smoothly. In 2022 the Fed’s balance sheet shrunk via lower bank reserves, while in 2023 it shrunk through lower RRP balances. Goldman Sachs analysts have come out with an interesting report on QT timelines. According to the report, FOMC would begin considering changes to the speed of runoff around 2024Q3 to slow the pace in 2024Q4 and to finish runoff in 2025Q1. The necessary condition for this shift is for Bank reserves to move from abundant to ample. GS estimates bank reserves to be around 12-13% of bank assets and the Fed’s balance sheet to be about 22% of GDP then (vs. approximately 30% currently and 18% in 2019). The key risk will be disruptions in the Treasury absorption due to higher issuance volumes. This may force the Fed to stop the QT earlier than expected.

Risk-on sentiment led to the riskier Fixed Income segments outperform the safer ones. Treasuries underperformed as yields rose towards the second half of the week. Investment Grade followed suit as spreads compressed by 3 bps, with the primary market remaining closed since Wednesday. A total of $80bn IG debt has been priced this month. High yield and EM Debt spreads compressed by 14 and 12 bps, respectively, leading to positive returns in both indices.

China’s policymakers appear to be racing to fill a liquidity gap facing developers, which some analysts estimate to be 15% of GDP. The government has apparently prepared a list of 50 real estate developers eligible to receive a range of financing support, including unsecured loans from banks. Asia HY index spreads have compressed by 150bps since the announcement. However, according to Bloomberg, the banks have been reluctant to lend to the property sector despite recent encouragement from the regulators. This may indicate that the effort to rejuvenate the sector is far from over.

Soft-landing confidence continues to rise

Soft-landing confidence continues to rise

Equity Update

A fourth positive week for global equities making it a spectacular November so far, +9% month to date, with outsize gains from the technology sector continuing. A largely broad-based rally, however pockets of outperformance with US equities up 10% in November (20% year to date) and the Nasdaq a little better in November (almost double the S&P 500 YTD). The Russell 2000 while rallying recently, still lags the large cap US indices.

Underlying is the conviction that the Fed is done raising interest rates and will start cutting them in 2024, contiguous with the ECB and BOE. Fed minutes published Tuesday reinforced unity among policymakers in proceeding “carefully” as they seek to rein in inflation back down to their 2% target. The Fed looks willing to pause here and look through the strong data: a soft-landing scenario is increasingly ours and a consensus view too. The recent weaker USD has also been a factor in the global equity rally.

The resumption of earnings growth in the US at 4.3%y/y for Q3 marks the end of a trough in earnings, and revenue growth at 3.3%, and with S&P 500 margins at 12.1%. depicts a still buoyant consumer. With the S&P 500 forward Price/ Earnings multiple at 21X and the Index just above our 4500 fair value we need earnings to rally for this level to be sustained into 2024 and to see further upside. Also, though recession fears are currently less in focus, (fewer companies spoke in Q3 guidance), higher rates for longer means that earnings need to be resilient to weather the higher borrowing costs. US 10-year Treasury yields are 10% below beginning November level, however volatility in yields could continue with a small spike seen at the end of last week. Also needs to be watched, the S&P 500 has a Tech bias with the Magnificent 7 accounting for nearly 30% of the benchmark and risks include high valuations: the top 7 stocks trade at 35x trailing PE vs. 17x for the rest of the index.

We increasingly look to Japan as it transforms its capital market strategy. A strengthening Yen is also positive for USD denominated returns. The Tokyo Stock Exchange has asked the 4000 listed companies to submit comprehensive plans outlining key performance indicators (KPIs) such as asset and capital allocation, return on equity, and dividend policies, among many others as many companies trade below book value. This should unleash value and a bull market phase. Japanese equities are + 25% YTD in local currency and our recent neutral stance was positioning resulting from the earlier Yen weakness. The Japanese economy has experienced a structural shift—deflation is gone and seems to be not coming back anytime soon. This will lead to companies releasing much hoarded cash and investing it for growth.

We are still on the fence on China, low valuations are attractive and property developers get a liquidity boost however new high-profile insolvencies emerging and subdued growth at Chinese industrial companies in October y/y. Also, Zhongzhi Enterprise Group, a large shadow banking lender under investigation, declared a shortfall of $36.4 billion in its balance sheet adding to property sector woes.

Soft-landing confidence continues to rise

Soft-landing confidence continues to rise

Soft-landing confidence continues to rise

Written by:

IMPORTANT INFORMATION

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), licensed and regulated by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”) and subject to regulation, supervision and control of the Central Bank and SCA, having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

Data/information provided in this document are intended solely for information or illustrative purposes and are not designed to initiate or conclude any transaction.

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accepts no responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they maynot be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investormay lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.