MACRO
US had already a few good quarters of growth after pandemic. Last quarter US had a significant growth in productivity, and most recent employment report shows modest increase in hours and payroll, which can indicate further boost in productivity. This is how we could have a strong labor market without pressure on inflation, which can secure soft landing, however most analysts haven’t taken at least a mild recession of the table yet.
The slowdown in topline growth engendered by the FED has been deferred by the series of engendered economic supports, that were deployed during pandemic and its immediate aftermath. Those supports extended the timeline needed for a tighter monetary policy, to see its intended effects. Those lags also made for the FED more difficult to estimate a sufficiently restrictive level of policy, to slow growth enough to achieve target inflation level. Eventually, those artificial supports will dry out and unsustainable spending patterns were spending outpacing earnings will fade away and bring consumer weakness.
RATES
This week’s rapid change in yields cause to evaporate 2023 gains in long dates treasuries. We saw rapid sell off in 10Y and 30Y treasuries beating the cycle high. 10Y also reached the highest level since 2007 (just before GFC), and 30Y reached the highest level since 2009. Most importantly, the inflation protected securities (TIPS) above 2% for the first time since 2009.
There is a lot of supply, but the investors are questioning future demand and strength of the US economy which materialize itself in the bear steepening over last few weeks.
The breakeven between TIPS and 10Y, which is market indicator for where 10-year inflation is going to be is 2.3%
Now everyone is looking towards next week’s Jackson Hole symposium where the monetary policy is discussed. Topics in focus will be on recent strong economic data, prevailing strength of the consumer, supply-demand imbalances in the labor market and comments around upside risk to inflation. Expectations are that the FED will remain its focus on inflation and remain data dependent as it will have a full month of data coming before the September 20th meeting. Any change to FED’s willingness to change their hawkish bias, would be a positive surprise for the market participants.
CREDIT
Market is waiting for another round of earnings to judge the implication of the raising rates on portfolios of many issuers. Vast majority of the Investment Grade credit remains in shape.
(…) Falling angels volume where also the fraction of the … (…)
(…) Credit spreads are still tight (…)
EQUITIES
Seasonally August is a weak time for the market. We see now 5 out 7 magnificent stocks, and many other high-flying names in correction territory. However, it is difficult to switch to a bearish outlook given the robust earnings amongst the big caps in the short run. In the longer run forecast for earnings for the next year started coming down, but so far, the market had a muted reaction to those more bearish expectations and maintained high multiples. Those investors who look for better relative valuations would need to lean more towards the energy and natural resources sectors.
More problems are amongst smaller mid-to-small caps who build and expand their businesses on the borrow money due to QE era. They will face increasing pressures from higher rates, especially those with a negative cash flow. And there much more of them now than in the past, with close to 40% of Russell 2000 constituents who didn’t make a profit in the last 12 months. In the current tightening cycle is important to stay focus on companies that can maintain pricing power despite potential weakening of the consumer, can control costs and grow cash flow.
Those investors with negative outlook on US economy will have a hard time taking an extra equity risk, if they can now secure a real yield above 2% guaranteed by the full faith in credit of the US taxpayer.