TUG OF WAR

Chief Investment Officer's team
17 October 2022
TUG OF WAR
The antagonism between central banks’ tightening and growth keeps volatility at extreme levels

AT A GLANCE

  • The antagonism between central banks’ tightening and growth keeps volatility at extreme levels
  • Inflation stays elevated especially in the US, but economic activity is equally resilient so far
  • Government support builds in Europe and China, and Q3 earnings will help assess equity valuations better

Volatility remains the name of the game, week after week. Inflation is a slow-moving shock which doesn’t find any quick fix, in sharp contrast to the various crises of the last decade. Last week confirmed broadening inflation in the US, supporting more tightening ahead. This is a simple explanation to another collection of negative weekly returns. But this would ignore the pattern: last Thursday, a few hours after the US CPI came out higher than expected, stocks were actually sharply rallying, wih the SP500 reverting from -2% to +2.6%. Friday was then, more understandably, negative.

As our regular readers know, our strongest conviction for 2022 has always been to expect extreme volatility. Last week’s post-CPI rally, which surprised everyone, is an indication that the current levels of pessimism, and to some extent valuation, start to balance an objectively terrible policy backdrop. Don’t get me wrong: volatility will continue and any form of equilibrium before we see convincing evidence of an imminent Fed pivot will remain unstable. However, uncertainty can move markets in both directions, which is at the end of the day not bad news and the reason why our positioning is close to risk neutrality. With regards to valuation, the Q3 earnings season will bring more clarity on the denominator of equity multiples, and it may be overall positive. Staying on the bright side, early reports from China’s 20th Communist Party Congress emphasize some policy continuity around the concept of “modern socialist country”, with a focus on innovation and security. This doesn’t sound too hostile for markets. Fiscal support is also building in Europe to face the energy crisis, while the UK made a fiscal U-turn, also indicating that markets’ voice can be heard. This is not the end of the tunnel, but we keep going. Stay safe.

Cross-asset Update

Welcome to a new world order where friction between the United States and China is set to continue, and, if anything, increase. Following President Xi’s two-hour speech at a crucial party gathering, we know that China’s priorities have not changed. It is now about two clashing views of the world, one upholding democratic values and the free market, and the other based on authoritarianism and the state driving the economy. And it is also about the unwillingness of the incumbent power to see a competing power rise. President Xi wants the reunification with Taiwan, that was mentioned early in his speech, economic development as a ‘top priority’ though alongside security, and an independent technology sector driving innovation in the country. Xi’s message is that China will stand its ground, and whoever tries to thwart that process will fail. Not only that, he offered China up as an alternative system to the US and its allies. It is very hard to tell who will survive this test. Superpowers tend to last on average 250 years, with America’s ‘expiration date’ and the theoretical start of its decline in set to be in 2026. The divisiveness of the United States, its monetary and debt excesses, and its overstretching on the international scene on many fronts could be causes for concern. The same we could anyway say for China, over leveraged as well, and with structural economic challenges. The main difference between the two countries is the cohesiveness and united Chinese front posed by a society strictly driven by the authorities with clear objectives to achieve.

The consequence of this new geopolitical development, on the one hand, is a more hostile investment environment. The rift between the two superpowers will bring about the dismantlement of the existing supply-chains, a structurally inflationary event. Also, China looking inwards and relying less on exports and more on internal consumption for economic growth, alongside Chinese salaries no longer that competitive with the rest of the world, again have inflationary implications. There are many global forces fostering price pressures, and the China-US confrontation is but one driver of the future trends. But there is also positive forces generating opportunities. According to historian and market researcher Russell Napier we should be in for a capex boom, whereby Western governments will drive credit creation to boost nominal GDP via higher inflation in order to bring down debt-to-GDP levels. This was previously done after World War II, and with financial repression. Yields were kept artificially low by central banks, to avoid higher nominal growth translating into unsustainably higher yields given the large debt levels. And in China the capex boom would shift from the real estate to the IT sector, to ensure that Xi’s vision of technological independence is fulfilled. It is interesting times, and radically different to the previous two decades marked by low macroeconomic volatility and tepid inflation.



Fixed Income Update

Last week US treasuries saw an increase in yields following higher than-expected inflation, a resilient labor market, and release of the minutes of the Fed meeting. The yield on the 2-year US treasury rose by 15bps to 4.46%, and the 10-year UST yield increased by 10 bps to 3.99%. US CPI for September was 8.2% which is slightly higher than the consensus expectation of 8.1% and little changed from August’s inflation of 8.3%. However, core inflation for September remains high at 6.6% vs. 6.3% in August. This higher inflation is indicative of aggressive tightening to combat inflation, i.e., a 75bps rate hike in Nov meeting. Also, Fed’s September meeting minutes released on Thursday showed officials are committed to tightening and keeping the policy in restrictive territory for some time but also conscious of rising risks and the need to calibrate policy accordingly. James Bullard, from his statement, opened the possibility of a 75bps rate hike in Nov and Dec meetings by indicating that the Fed could bring some of the planned hikes for 2023 into this year. Currently markets are pricing in a peak Fed funds rate at around 5% in six months. US corporate spreads remain at three months high, at around 165bps.

Gilts market remain volatile. The 10-Year Gilt yield rallied from 4.33% to 3.98% as tax-cutting policies were scrapped. In Europe, inflation pressure continues to build. Europe's high yield spreads remain wide at around 640bps. As per a Goldman Sachs report, EUR HY issuers have larger medium-term refinancing risk compared to the USD HY bond market, indicating more financial distress in 2023 in the euro HY sector. For 2023 Euro HY is expected to have a net supply of €18 billion and decline of €25 billion in the EUR IG category. Gross issuance in Euro segment is expected to reach €450 billion in the current year and €50 billion in 2023. On the Asia front, Indian bonds saw a rally after the RBI minutes showed that the members are divided on the pace of future rate hikes.

As per the IMF chief’s statement, IMF is close to agreeing on a new deal with Egypt, the bonds are expected to remain volatile in near term. Coming to the MENA region, the ADGB curve bear flattened with two-year yields wider by 8-10bps, while the longer ended was wider by 1bps. High-yield sovereigns like Oman & Bahrain remain flat. Separately, IMF downgraded its global growth forecast from 2.9% to 2.7% for next year, however the Middle East and Central Asia are expected to be global growth outperformers.


Equity Update

Intraday and weekly volatility is getting magnified however, developed market equities are at the same level two weeks into October as at end Sept, at -25% YTD, justifying our neutral positioning into Q4. However bond yields have risen, continuing to affect longer duration growth i.e. the tech sector. Last week saw extreme moves, with the S&P +2.6% on Thursday, an almost 5% intraday move, despite inflation numbers that disappointed, only to fall 2.3 % on Friday, as earnings disappointed. The UK FTSE 100 surprisingly held steady, in spite of unfunded tax cuts much in the news. The UK faces a set of challenges with high topline and core inflation, a large current account deficit and a weak currency driving higher costs on imported items. Also, Brexit has reduced the supply of labor and increased the costs of trade. Emerging market equities, where we recently went slightly underweight, fell 3.8% in the first 2 weeks of October with YTD losses at -28%. China continues to disappoint, whilst the GCC and India remain outperformers. The 20th China National Party Congress is ongoing, and Premier Xi Jinping signaled that growth is the main focus. On the global level, all 11 sectors were flat to negative last week. YTD, only the energy sector is positive in line with the oil price rise.

We recommend remaining invested and adding to equities systematically as the market remains unpredictable for the short term. We reiterate focus on the quality of balance sheets and businesses in selection of stocks. Markets will continue to trade in an up and down pattern as this remains an exceptional year for inflation and accelerated monetary policy impacting the growth outlook. The 3Q earnings season will give guidance not only on cost inputs but the stability of corporate profits. On the political and policy front moving markets are headlines around Ukraine, and the ECB and Fed raising rates and US mid-terms. Whilst an argument for peak inflation can start being made, last week’s US CPI surprise reminded us of broad and persistent inflationary pressure, more so from the services sector. A defensive positioning in markets, with the USD retaining its strength and tighter financial conditions all around.

On the earnings front, weighed against growth are a strong US dollar, high inflation and recession concerns. 7% of S&P 500 companies have reported Q3 results, +01% against estimates, and Q3 earnings growth rate has been revised down to 1.6%. Negative earnings surprises in the financials sector the main contributor to the lower estimate. Revenue growth rate estimate for the S&P 500 for Q3 steady at 8.5%. 9 financials sector companies reported last week, including Citigroup, JPMorgan, Morgan Stanley and Wells Fargo. Despite the recent rise in interest rates, this industry is reporting a y/y earnings decline of -13%, with significantly higher provisions for loan losses relative to 2021. FactSet estimates the blended provision for loan losses for the 18 banks in the S&P 500 at $6.0 bn for Q3 2022, compared to -$4.9 bn for Q3 2021 and to increase further into 2022 H1. The largest five S&P 500 companies (Apple, Microsoft, Google, Amazon and Tesla) earnings are expected to be below S&P median earning growth in the near term and 2023. In 2Q, the group posted EPS growth at 2.8%, and both Amazon and Apple recorded y/y declines.



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.