Macro
US GDP seasonally adjusted growth was at 4.9% annualized in the July-through-September period; biggest gain since Q4 2021. This unexpectedly strong reading is supported by increases in inventories, exports and governemnt spending, but most importantly by increase in the consumer spending. Consumer’s went on the shoping spree in the last months of summer which had an outside impact, as consumer was responsible for about 68% of GDP in Q3.
Despite strenght of the consumer, market reaction was subdue as investors are focusing on challanges ahead. Thy are worrying about slowing business investments, slowing government spending uder mounting fiscal pressure and that consumer will be foreced to slow their spending going forward. Future consumer spending will be negatively affected by decline in household post-pandemic cash reserves and the resumption of student loan payments. Expectation is that this is a peak GDP figure for next few quarters.
Headline payroll number shows the ongoing resilience of the US labour market, and that US has still a full employment economy. Under the surface number where more of a mix. The household survey (CPS) usually is more sensitive to changes in economic outlook, and it was weaker than the payroll survey (CES). This signals that the US economy is more resilient to higher rates than expected, or that the lag of the monetary policy impact has widened. Wider lag can be attributed to changing structure of the credit market, as over the years consumer and business credit increased its bias towards fixed rate relative to variable rate, which softens the impact of changing interest rates.
Rates
A lot of the short positions on the long end of the curve, have been taken off. The reason for that is the speed of the move we had in last few months, which created a lot more convexity in the bond market. This means that in order to make money on the short side, requires much larger move higher in yields.
The question is of timing. It may not be an attractive level to be shorting bonds:
- So from one hand you have yield curve that became much flatter over last few months.
- High convexity makes it much harder to make money on shorting long-term yields even if you are right.
- Two points above combined means you need to be ‘right’ a lot more, which leads to drastic shift in risk-reward of shorting long-term rates
Expectations has changes for longer rates, expecting sever cuts starting from the middle of next year implying tougher recession ahead. Being in cash on the shortest end of the curve has been undeniably the biggest winner. But adding exposure to the longer term rates makes now much more sense given the current market dynamic.
Credit
The financial conditions conditions are continuously tightening. Issuance is much lower as companies are finding the funding costs more restrictive. Demand from investor base is still there, but supply has been reduced as companies not seeing many attractively yielding projects. Risk has increased due to high financing costs to fund capex and opex. Potential reduction in capex and open will have a negative impact on the economic growth.
Generally the total return of corporates look attractive, but the spread component remains very tight. For high quality issuers in IG this should be fine, there are 3 main benefits:
- Slope of the yield curve, at its a tough proposition to accept lower yields for longer maturities we are seeing in treasuries. On the other hand, the IG corporate bond curve is not inverted, therefore you are less expose to the risk from bearish steepening.
- There is a risk that IG spreads will move higher, but in similar periods in the past treasury yields has fallen in a way that offsets the IG spreads increases.
- Locking in the IG yields of 6% is far more attractive in slowing economy than HY issuers, as they are far less sensitive to the rising rates. That’s because IG issuers, on average have relatively stronger balance sheets, larger and more diversified borrowing base, more laddered maturities as well as longer maturities.
Equities
As divergence in performance between individual names increased, and gains has been mostly concentrated around mega cap technology stocks, the active funds performed relatively better than the passive fund. This is in line with the historical relationship, where passive tends to do better in bull markets, especially in the late stages, and to underperform in the bear markets and during the early recovery.
With all geopolitical risk, potential delayed negative impact of rates and slowing down of the economy, factor based investors should consider increasing exposure to quality. From macro perspective as well as due to the new technological growth trend sparket by AI boom, US market maintains robust position amongst the global equity markets. Expectations for looser FED policy and AI productivity gains, adding to the excitement about the US equities.
As we saw big tech unwind since the end of 2021, valuations of many SaaS companies has reset to below the long-term average, creating potential opportunities for a careful stock pickers in that space.