It’s worth noting, that as seasons transition so do economies and markets. The latter usually struggles a bit during such periods, states Jay Pelosky of TPW Advisory.
This back-and-forth chop is historical thus September seasonality. But as Bob Marley sang in one of my favorite tunes: “Everything in life has its purpose, find its reason in every season”.
The reason for the cross-asset market chop over the past several weeks is quite clear: the stock–bond relationship and its attendant effect on the USD. Notwithstanding inflation’s sharp fall and an apparent cooling off in the labor market, bond yields continue to back up with the two and ten yr. UST both up about 20+ bps over the past month.
With the stock-bond correlation at a 15-year high at roughly .4 (SPY/TLT) rising rates and falling bond prices mean falling stock prices as well. It also means a rising USD, now up for eight weeks in a row—its strongest run in 15 years actually, back to the last period of a similar high stock–bond correlation.
So, it’s all pretty much tied together. Throw in a more subdued Europe with EU stocks down eight days in a row as Germany tries on the sick man of Europe role (France, Spain August IP #s both BTE and better than Germany), and the Euro is off about 5% over the past few months. The same is true in Japan given the similar Yen notwithstanding JGB rates more than doubling in the past few months.
We would be remiss if China wasn’t included here given all the chatter about Yuan's weakness. We covered China a fair bit last week and suffice to say the press coverage remains slanted to a fantastic degree.
China’s August trade # numbers provide the latest example—both exports and imports were down y/y and so the universal takeaway was that the numbers reinforced the conventional wisdom of China’s economic spiral downward.
The reality is that both # numbers were BTE with new orders suggesting that the production downturn might be ending. The FT noted that the better-than-expected trade data showed the process of manufacturers “destocking” excess inventories built up during the pandemic was gradually ending. “It’s not just China, but if you look at the other Asian countries, their August trade numbers are also better,” said Robin Xing, chief China economist at Morgan Stanley.
We wrote about transition time some two months ago and about traction last week. It struck me post-publication last week that the real key is what gains traction in a time of transition. That is the key to watch.
From a risk asset POV, we are watching to see if the positive earnings revisions of late take hold and gain traction. FInom Group notes that the % of S&P companies with optimistic 12 M forward revenue estimates have just inflected upwards for the first time since Q4 2021, something it notes usually happens early in bull markets, not at their end. Earnings are key, especially for US equities—ROW has valuation support.
We are also very focused on the shift from inventory destocking to restocking given the need for a manufacturing recovery to gain traction. This is critical for Europe given its greater reliance on manufacturing vs. the US. Europe does seem to be the weaker sister with August Services PMI breaking below 50 for its lowest reading since February 2021 bringing the Composite below 50 & back to levels last seen in 2020. The ECB meets next week—could it jump the line and end rate hikes before the Fed? MS notes that EU equity trades at under 12x forward PE & at a record 40% discount to the US. In the price?
In the US, we note the Logistics Managers’ Index for August came in at 51.1, up 5.8 points from July in the first reading of expansion since April, based in part on rising spending on inventories, warehousing, and transportation. We continue to expect US manufacturing to turn higher in the months ahead and remain of the view that the ISM Manuf Index could break 50 before YE. Services remain robust with August ISM Services coming in at 54.5, a 6-month high. Look for the Fed to double its 2023 GDP estimate when it meets in less than 2 weeks.
In China the traction during transition Q is key. When will all the various policy measures put in place over the past few months gain traction and start to show up in the economic data? Bloomberg Economics suggests the combined impact of these measures could be close to 1% of GDP this year and 1.1% next – a meaningful amount of stimulus even if not wrapped up in one giant stimulus package.
We continue to expect that stimulus to gain traction in the coming months – months not quarters - and so remain invested in our China equity positions. Believe it or not, China’s manufacturing PMI rose for the third month in a row in August, climbing to 49.7. The PMIs for 12 of the 21 surveyed industries were each higher than a month earlier, indicating an upswing with sub-indexes for production, new orders, and supplier delivery times already rising again. Consensus China GDP estimates remain at 5.1% this year, 4.5% next vs. 2% and 0.9% for the US.
From a risk asset perspective, Commodities remain robust with the energy-heavy GSG well above its 200-day as oil prices continue to reflect both rising demand and ebbing supply. XLE has been the best sector over the past 3M.
Bonds continue to chop but the post Labor Day financing window opened as usual suggesting both issuers & buyers are comfortable with rates at these levels.
The WSJ reported that nineteen companies on Tuesday sold 47 bond tranches in the US investment-grade market, according to Pitchbook, a record since the data provider began tracking deals in 2012. Tuesday’s bond sales totaled almost $38 billion. It was the best sales day since April 2020 when the Federal Reserve had cut rates to near-zero. High-grade firms paid an average of 5.7% to borrow this week. The average coupon on the Bloomberg investment-grade corporate bond index sits at 3.95%, which implies the average investment-grade company refinancing debt now is paying rates about 2 percentage points higher than on the bonds they are replacing. Not 6%, 2% - that’s far from world ending.
Equities, while choppy, are not suggesting any major sea change with defensive sectors remaining weak vs. Cyclicals and growth segments. The EM rate-cutting cycle we have highlighted continues to march forward with Chile cutting rates again and Poland surprising with a big rate cut. Chile and Brazil, both early rate cutters, are seeing better economic growth and rising stock markets as a result. Brazil’s Q2 GDP came in at 0.9%, more than 3x the consensus estimate.
As we enter Fall and start to turn our gaze towards the horizon and 2024, we remain of the view that the global economy will gain traction led by a manufacturing recovery to support the re-stocking necessary as consumption remains robust given high employment levels across the US, EU, Japan and much of EM.
SC realignment, Climate mitigation spending, and the shift to fiscal/new industrial policy provide further support to our thesis of a global cap ex boom in the coming years. We do not expect the USD run of the past few months to gain traction. As rates stabilize & the Fed goes on hold the USD should weaken further supporting Commodities and non-US equity.
