Market Review 08/2023

Markets are awaiting central banks’ next monetary policy meetings in September and therefore the month of August was rather indolent though boasted a few important summits. At Jackson Hole Economic Symposium Jerome Powell was quick to state that the Fed is prepared to raise rates further until inflation starts to move sustainably towards the Fed’s 2% objective. Mr. Powell acknowledged that inflation has been gradually declining from its peak in June 2022, but it is too soon to consider this decrease as confident and maintainable. Powell pointed out that with GDP growth being above its long-term trend, housing showing signs of revival and gradual normalization in labor market conditions, monetary policy is experiencing certain pressures. While “navigating by the stars under cloudy skies”, Fed will continue to be data-dependent. CB’s assessment is further complicated by uncertainty about the duration of the lags with which monetary tightening affects economic activity and (especially) inflation.

Lagarde’s three points and BRICS’ expansion

Christine Lagarde emphasized shifts in the global economy, identifying three key points: labor market, climate change, and geopolitics. ECB’s president stated that the pandemic has accelerated digitalization, remote working, and elasticity of labor supply. She also refuted the idea that the “AI revolution” will necessarily lead to a decline in employment. The EU is now aiming for more than 40% of energy generation to come from renewables by 2030, with number of trade restrictions in place increasing tenfold, while industrial policies aimed at reshoring and friend-shoring strategic industries multiplying.

The long awaited BRICS annual summit took place in Johannesburg, South Africa, where the bloc announced its first expansion since 2010. Starting January 1, 2024, Saudi Arabia, Iran, Ethiopia, Egypt, Argentina and the United Arab Emirates will become new members, with 14 more countries having their formal applications pending. BRICS’ share of global (nominal) GDP will rise to 36% and will cover nearly half of the world population. Goals of the bloc are numerous, but so are challenges, and it will be of great interest to see how these plans and initiatives materialize in real actions and achievements.

European and US equity markets

Equities and rates tread waters

In August, equity markets finally saw some selling with S&P 500 falling from just above 4600 points back to 4400 area and Russell 2000 losing more than 150 points after poking a 2000 mark in the end of July. However, after Powell’s speech during Jackson Hole Symposium at the very end of the month the indices managed to retrieve half of their losses.

Prices of U.S. Treasury bills and German bunds tried to push lower, but those moves were insignificant. We still favor a drop in bond prices as an “emotional” final step in this leg of the upward yield trend and then look for a medium-term reversal. The spread between the 10- and 2-year treasuries continued to narrow. 10-year yields increased by 11 basis points and stood at 4.1% at the end of the month, while a 2-year yield decreased by four basis points to 4.9%.

Gold price, USD/oz

Good month for the dollar, PMs consolidating

FX markets are still locked within recent ranges; however, EUR/USD saw same downside pressure off the July 1.1200 highs. Move below the 1.1000 level added to the selling pressure, but the pair still has no clear direction. Although generally we favor stronger dollar, a move above 1.1200 will again be a strong warning signal of greenback’s weakness. On the downside, there are quite a few strong technical support levels all the way down to EUR/USD 1.0500.

Precious metals still stay within large sideways consolidation patterns. Gold traded almost flat during August, so the XAU/USD 2000 “triple top” resistance zone is still alive and well. Silver was weak at the beginning of the month, but saw a good bounce off the 22 dollars per troy ounce support level and managed to test a XAG/USD 25 resistance zone. We still see 20 dollars per troy ounce as a very strong support area (ideally, we should not see silver below that level for a long time) and eventually XAG/USD 25.50 should be broken on the upside for a run all the way to 30 dollars per troy ounce.

Oil prices kept their steady progress with technical picture supporting the recent uptrend, and we could see another 7-8% move until the next important resistance level is reached. Nothing new on our views on natural gas – it is worth having some long positions here going into fall/winter.

Benchmark 10-year bond yields

Manufacturing still suffers worldwide

In August, China’s services sector increased at its weakest pace in eight months with the Caixin/S&P Global services PMI falling by 2.3 points to a 51.8 reading. The data was essentially consistent with official numbers, which showed that the sector continued to decline even after Beijing’s recent announcements of a number of policies aimed at reviving sluggish growth and assisting homeowners. Despite a string of stimulus measures, China’s new house prices declined for the fourth consecutive month.

The decline of economic activity in Eurozone continued at a faster pace than previously expected. Services industry contracted by almost two points according to HCOB’s final composite PMI, indicating that Eurozone may not be able to avoid recession in the second half of the year. At the same time, HCOB’s final manufacturing PMI increased to a three-month high of 43.5 in August, up from 42.7 in July (reading below 50 mark still indicates contraction). Meanwhile, investor sentiment continued to plummet faster than predicted, and inflation was unexpectedly persistent, despite easing price pressures for underlying goods. Inflation remained constant at 5.3%, as energy prices were rising strongly throughout the month.

Manufacturing in the U.S. fell for the tenth consecutive month in August, but the rate of decrease slowed. According to the Institute for Supply Management, manufacturing PMI climbed to 47.6 from 46.4 during the previous month. Although job growth in the U.S. increased, the unemployment rate climbed slightly to 3.8%. After two consecutive monthly improvements, consumer confidence in the U.S. dipped more than expected in August – the Conference Board’s index fell to 106.1 from 114.0 in July, as consumers’ 12-month inflation expectations increased.

High Yield bond Indexes

Source: Bloomberg and Signet Bank

Ratios to worry about

What worries many (being an interesting observation by itself) is a significant discrepancy between valuations of companies with large and medium capitalization. Forward P/E for the S&P 400 MidCap index is at a 10-year low (14), while for the S&P 500 it is at a historical maximum (19.1) according to Yardeni Research, Inc. The S&P 400 MidCap includes US companies with a capitalization of $1.4 to $19 billion (median capitalization of $5.5 billion). The total capitalization of the entire index was $2.5 trillion at the beginning of September 2023. The S&P 500 is valued at $40 trillion, with a median capitalization of $31 billion.

Forward P/E of S&P 400 MidCap between 2013 and 2019 was in the range of 15-19 about 96% of the time, with an average forward P/E of about 17. In 2023, the fluctuation range is 13-15 with an average just below 14, i.e. 15-18% cheaper than in 2013-2019. Meanwhile, forward P/E for the S&P 500 during 2013-2019 was in the range of 13-18 (16 being the average). Levels above 18 were only seen during the dot.com bubble and monetary frenzy of 2020-2021, when an average estimate was 20.7. That means that the S&P 500 is now at least 20% more expensive than in 2013-2019 and only 7-8% cheaper than during aggressive bubble periods.