The case for Goldilocks is still live

Chief Investment Officer's team
04 September 2023
The case for Goldilocks is still live

AT A GLANCE

  • Risk appetite came back last week as an avalanche of data painted an overall constructive picture
  • In the US the job market is softening while inflation continues to moderate and growth remains resilient
  • The situation is diverse across regions but confidence on a forthcoming monetary pause is building

We knew from Jackson Hole that Western central bankers are data-driven, a nice way to say that they keep all options open. There was no shortage of data to look at last week. In the US, the labor market showed signs of softening, with less job openings and creations, while wage growth decelerates. The core PCE measure of inflation was also favorable, and consumer confidence is in decline, while leading indicators continue to indicate that the recession risk is not material in the short-term. This supports the possibility of the Fed not hiking in September, and markets enjoyed it with a sharp drop in the front-end yields of the US Treasury curve, and a rally of pretty much everything.

Europe, by contrast, is still having a serious inflation issue, with the core CPI still way too high for their central bankers. But as their economies are also getting more vulnerable to higher interest rates seeing some moderation in tightening is also not impossible. Finally, China continues do add, now on an almost daily basis, measures to stabilize and support the economy, while carefully designing them to avoid collateral damage on excessive leverage. The latest include lower FX reserve requirement ratios for financial institutions, and an incentive for banks to lower the burden of mortgage repayments. Patience is still required there, but some stabilization in the PMIs provides some hope as well.

Our positioning remains relatively balanced in our three profiles. We keep favoring safe sources of income, including a large overweight to money market funds, but do not have large active positions – we are actually close to neutral on stocks, and not far on fixed income. Unpredictability remains the name of the game. Have a great week.

The case for Goldilocks is still live

Cross-asset Update

Data releases in the United States reinforced investor confidence about the unfolding of a Goldilocks scenario, with a softening labor market and an ongoing disinflation process. If August saw the reacceleration narrative prevail, September has ushered in more evidence of a soft landing. Hence, investors extrapolated that the Fed will be on hold possibly till year-end, pointing to a still positive backdrop for stocks, and capped upside for Treasury yields. But the US story is not only about softening growth. The ISM manufacturing report, while still in contraction territory, saw activity stabilise rather than slide further, as the index climbed to its best level since February. And if a recession indeed is not in the cards, then the economy should be sustained by a manufacturing rebound as services pull back. This is in stark contrast to underwhelming dynamics in other major economies, like the euro area, where stagnation is taking hold, or the UK, where price pressures are expected to last through 2024 according to Moody’s. The bottom line is that we should be in for one more bout of so-called US exceptionalism, whereby dollar-centric assets are expected to outperform. And this may be true not only of US equities, but also of the US dollar, that could surprise to the upside supported by an extremely favorable mix of loose fiscal and tight monetary policy, the former boosting growth, the latter the yield differential with other major crosses.

Beijing has been less lucky trying to boost activity with an endless list of piecemeal measures since the post-pandemic recovery lost steam. Last week the attempts continued, and Chinese stocks outperformed the broader EM benchmark. From the reduction to bank reserve requirement ratios, and fresh stimulus for the property sector, to plans to expand some tax breaks for families, the goal of such targeted efforts remains to stimulate while avoiding excessive leverage. Activity seems to be stabilising, judging from the rebound in manufacturing confidence both in the official and the Caixin indices still in contraction territory. It may take time for the effects of the latest measures to show up in the economy, but eventually the recovery should gain traction.

A US soft landing and China stabilizing would be quite supportive of EM stocks, and we still think that a rally in the asset class is overdue. Even renewed US dollar strength would not be a challenge to that rally, considering how weak the reserve currency still is as compared to last year’s peak, and how much cheaper EM stocks are versus DM peers. In summary, it seems to us that equities in the developing countries are now vulnerable to upside surprises after a poor performance so far this year, and catalysts supporting the investment case are now in place.

The case for Goldilocks is still live

The case for Goldilocks is still live

The case for Goldilocks is still live

Fixed Income Update

US non-farm payrolls painted the picture of a robust employment market. But there were some green shoots for anyone looking at a Fed pause in September. The unemployment rate went up to 3.8%, the highest since February 2022. Meanwhile average hourly earnings increased only 0.2% last month, the lowest sequential increase since February 2022, bringing the year-ago gain down to 4.3%. The slight slackening of the jobs market gives impetus to the case for a Fed on hold later this month. We did not see a large movement in the future rate path expectations post the Friday release. The UST yield curve bear-steepened with the long-end moving up by 7 to 8bps as the front-end remained anchored.

In credit, we continue to like the attractive returns in IG debt from a total return standpoint as the yields hover around the highest percentile in the last 15 years. Moreover, carry will likely be the dominant component of future returns, with upside from spread compression likely to remain muted given current valuation constraints as marked by the small yield pick-up of IG versus cash. According to a recent analysis by GS, at around 37bps, the extra yield provided by the USD IG market over cash remains at historically depressed levels. Under the surface, the share of bonds yielding less than 3-month Treasury bills has declined to 31% from a peak of 62% in May - using the constituents of the iBoxx index - but remains elevated by historical norms.

One key point that has supported credit spreads is the lack of transmission of the current high rates to the actual interest expenses on the company balance sheets for both IG and HY. The 5.25% worth of cumulative hikes delivered by the Fed over the last year and a half have had a limited impact on interest expenses, which have only modestly increased due to the large refinancing that happened in 2021. However, there is continued deterioration of liquidity positions on balance sheets. The ratio of cash to total assets moved to the low end of its post-global financial crisis period range in both the IG and HY markets. This decline should stimulate refinancing activity on a forward basis which would impact the debt servicing costs going forward.

As we have mentioned several times earlier, we like the financials space within credit. Central bank stress tests in the US, the EU and the UK have demonstrated resilient balance sheets and limited impact to capitalization ratios in the case of a turbulent market event. Hence, we believe subordinated debt of the banks offers a nice yield pick-up to fixed income investors. We prefer sub financial debt to corporate HY for this reason. For perpetual AT1 securities, we think non-call is the biggest risk. However, it doesn’t impact bond holders much as the reset rates then to be pretty high due to the increased level of yields. For example, Banco Santander repeated its 2020 policy to avoid calling a EUR perpetual with 5.25% last week. But the coupon would reset higher to around 8.2% on 29th September benefitting the bond holders.

The case for Goldilocks is still live

The case for Goldilocks is still live

Equity Update

Last week was volatile but a very positive one across regions. The main driver was not optimism about the economy and its impact on future earnings, but as often, another bit of multiples expansion backed by falling interest rates, as the case for a moderation in monetary tightening is still live, following the deluge of data from last week.

All regions were in the green for different reasons. The US obviously enjoyed hopes on the Fed outlook, with lower treasury yields propelling further the tech sector, now approaching year-to-date the +40% mark. European stocks were also driven by central-bank speak, though in a subtler way: inflation remains an issue, but as the PMIs highlighted a material risk of recession the overall sentiment was that the room of maneuver of the ECB might be less ample than their comments suggest. This in turn supported a stronger dollar, which is a positive for European stocks. As well as for Japan, which had another week of outperformance.

Our positioning remains unchanged. We overweight emerging markets within our broad allocation to the equity asset class, but this is not massive. Within this universe, India and the UAE remain our preferred regions, while we are close to neutrality on China. Valuations, earnings growth prospects, and a low level of ownership among international investors are reasons not to be too underweight. Having said that, the never-ending financial issues on the real estate sector, and some uncertainty regarding the trajectory of economic growth, are reasons to be patient. It will take time and probably some back-to-back convincing sets of numbers before more international inflows materialize. We however were pleasantly surprised to see Chinese authorities announce measures targeting the stock market. This is a change compared to the crackdown measures on various private sectors from the previous years.

Within developed markets, our positioning is also balanced, in line with our theme for 2023 which is all about unpredictability. We are close to neutral on most regions, even if the euro area is certainly our least preferred due to a higher recession risk. Among sectors, while our constant presence in tech continues to deliver, we keep on recommending healthcare as one of the best defensive areas – even if it hasn’t delivered so far.

As a conclusion, diversification is the main recommendation, rather than radical active positioning. This is especially true in terms of regions, with very different top-down dynamics taking place between and within the large DM and EM groups.

The case for Goldilocks is still live

The case for Goldilocks is still live

The case for Goldilocks is still live

Written by:

IMPORTANT INFORMATION

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), a public joint stock company incorporated in Dubai, UAE and licensed, regulated supervised and controlled by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“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.

This publication is prepared without regard to the individual financial circumstances and objectives of persons who receive it. Data/information provided in this publication are intended solely for illustrative purposes for the general information or its recipients, irrespective of their customer classification as an Ordinary Investor or Professional Investor under the SCA Regulations. 

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

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 accept any 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 may not 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 investor may 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.