Jean Boivin Head of the BlackRock Investment Institute together with, Wei Li, Global Chief Investment Strategist, Alex Brazier, Deputy Head and Kurt Reiman, Senior Strategist for North America all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points

Hope rally: Surging stocks show markets believe hopes of a soft landing by the Fed to be true. We disagree and stay underweight developed market (DM) stocks.

Market backdrop: U.S. stocks jumped and bond yields plunged after October CPI rose less than the market expected. But sticky core inflation keeps the Fed on track to overtighten. 

Week ahead: We’re watching UK unemployment, CPI and the fiscal update. The data may show more signs the UK is falling into a recession with inflation staying high.

One economic release overshadowed the U.S. midterms for markets. Stocks surged last week after the October core CPI rose less than expected, stoking market hopes a Federal Reserve pause on rate hikes is nearer. That’s optimistic, we think. Goods inflation is easing as it needed to, but the labor constraints driving wage growth and core inflation persist. So the Fed is still on a path to create a recession via policy overtightening. Stocks aren’t pricing that in, so we stay underweight.

Stocks and earnings expectations part ways

S&P 500 price and 2023 earnings growth estimates

Equities have repeatedly jumped this year on hopes the Fed may be getting closer to stopping the fastest hiking cycle since the 1980s, letting the economy enjoy a soft landing that avoids recession. We think those hopes will be dashed again as the Fed pushes ahead with policy overtightening. With the S&P 500 jumping 13% from its October low, stocks are even further from pricing in the recession – and earnings downgrades – we see ahead. See the yellow line in the chart. Earnings estimates are set to be downgraded further. The consensus expects earnings growth of just over 4% in 2023, down from about 10% at the start of 2022 (orange line). We expect zero growth. Third quarter annual earnings growth would already be negative without the energy sector, Refinitiv data show. We need to see stocks fall more or more good news of easing inflation to turn positive on stocks.

Good news and bad news

The slower rise in core CPI inflation, which excludes volatile food and energy prices, due to falling core goods inflation is good news. We’d expected this to happen at some point as spending patterns normalize after the pandemic, when a sharp shift in consumer spending toward goods and away from services drove the initial spurt of goods inflation. Spending is starting to return to services, easing supply constraints on goods. We expect declining goods inflation to continue. But high core inflation also reflects constraints on labor supply that are driving up wages, seen in services inflation. We don’t expect this to improve much because many workers retired during the pandemic. We also see the U.S. labor pool shrinking as people over 65 account for a larger share of the population in coming decades.

The Fed can only try to push wage and overall core inflation quickly down to its 2% target by crushing demand with a deep recession, in our view. We expect the Fed to pause its sharp hikes only after having caused a recession and when confronted with the economic pain. We don’t think a soft landing is in the cards. Yet it took just one downside surprise in CPI – one data release, not a trend – to revive hopes that the Fed would stop hiking soon and a soft landing could still be achieved. That helped to quickly wipe the U.S. midterm election – the original subject of this week’s commentary – from the market’s mind. This is a good reminder that in this new regime of higher macro and market volatility, we should not be surprised by surprising data. We think the Fed’s “whatever it takes” approach to bringing down inflation means that no single data release or catalyst is about to change the Fed’s path to overtighten policy.

Our bottom line 

We’re tactically underweight DM stocks, including the U.S., because they’re even further away from pricing in recession after last week’s surge. But we think some sectors like energy, financials and healthcare allow us to take advantage of thematic, near-term and structural trends. Landmark U.S. legislation over the past year, like the Inflation Reduction Act, has brightened the outlook for renewable energy and the industrial sector. Earnings for traditional energy are still strong given ongoing supply shortages. Healthcare is a favorite of investors looking for shelter as recession looms given its stable cashflows in economic downturns and attractive valuations. The sector will also benefit as an aging world population ramps up medical spending. Lastly, deposit rates not rising as much as policy rates has boosted bank earnings, making their income from lending greater than the amount paid on deposits. We believe the new regime warrants a granular approach as themes like production constraints, dollar strength and geopolitical fragmentation are better implemented through sectors.

Market backdrop

U.S. stocks surged and Treasury yields fell sharply after the core October CPI rose a lower-than-expected 0.3%. We think this is finally an encouraging development on inflation but doesn’t yet change the overall picture. Core goods prices declined. But core services inflation remains sticky. We don’t think one data release will change the Federal Reserve’s path to overtightening policy – and think it would need to see more sustained signs of core inflation slowing.

The UK takes center stage this week with unemployment and CPI inflation data, as well as the announcement of the much-anticipated fiscal statement from the new government. The UK fiscal update will factor into the Bank of England policy tightening plans depending on the size and timing of any austerity unveiled as the UK heads for a deep recession.

Week Ahead

Nov. 15: UK unemployment; euro area GDP; U.S manufacturing PPI

Nov. 16: UK CPI; U.S. industrial production

Nov. 17: UK fiscal statement; U.S. Philly Fed Business Index; Japan CPI

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BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 14th November, 2022 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.

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Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. As part of Templeton Global Equity Group, the European equity desk is manned by a team of professionals based in Edinburgh, Scotland, whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Global equities continued to recover ground last week, with almost all indices and sectors trading higher. The MSCI World Index closed up 6.7%, its biggest weekly gain since November 2020. Regionally, the S&P 500 Index was up 5.9%, the STOXX Europe 600 Index was up 3.7%, whilst the MSCI Asia Pacific bounced back after some recent underperformance, up 8.4%.

Newsflow was very supportive for equity markets last week. The softer-than-expected US Consumer Price Index (CPI) print was the main headline-grabber, as hopes rose that tighter monetary policy conditions were bringing inflation under control. With that, rate-hike expectations fell globally, which in turn saw bond yields fall. Given bearish positioning, equities surged higher. Hopes of an easing in China’s COVID-19 policy also helped drive market moves last week. The US midterm election garnered a little market attention too—there is a strong correlation between a gridlocked Congress and positive market moves for the 12 months after mid-term elections. There was turmoil again in the crypto space following the bankruptcy of FTX.

Week in review

Europe

European equities were broadly higher last week, with the key drivers coming from outside the region. The STOXX Europe 600 Index was up 3.6%, its biggest weekly gain since mid-March. There were more positive headlines out of Ukraine. Russian forces were reportedly pulling back from the city of Kherson, despite the Kremlin’s claims that Kherson was still part of Russian territory. There were also reports that Russia and the United States will hold nuclear arms treaty talks in Cairo.

This morning it was reported that the European Union is “ready to go” with an effort to impose a price cap on Russian oil. European Commission President Ursula von der Leyen said: “It is important not only to dry out the war chest of Russia but also very important for many vulnerable countries to have an acceptable level of prices”.

Defence stocks struggled last week, with headlines suggesting a defence budget cut from the UK government not helping matters. Separately, oil and gas stocks suffered; year-to-date winners were sold and year-to-date underperformers rose last week, with some notable short covering aiding the rally. Growth stocks surged, with technology stocks strong outperformers last week. Retail, financial services and real estate stocks were also higher.

Despite the overall macro-driven strength last week, investors still need to focus on corporate earnings to see the effects flowing through. In Europe, 79% of the companies in the STOXX Europe 600 Index that were due to report earnings have now done so, and have beaten expectations across all four key metrics: sales surprise, sales growth, earnings surprise and earnings growth. No sector has been a notable best performer, although consumer discretionary stocks have been a clear underperformer, reflecting conditions in Europe’s cost-of-living crisis. Overall, earnings per share (EPS) growth has been higher than expected, with strength in energy stocks a big driver.

United States

US equities were higher across the board last week, with a softer-than-expected CPI print driving hopes of a Federal Reserve (Fed) pivot. The S&P 500 Index was up 5.9%, its biggest weekly gain since late June. The CPI print on Thursday saw an increase of 0.4% month-over-month, which was a smaller gain than expected. This meant the annualised rate faded to 7.7%  vs. 8.2% previously. With inflation now seemingly on a downward trajectory, interest rate-hike expectations fell sharply last week, with the Fed now expected to take a more gradual approach to managing rates. Fed officials noted that rates are still going up, but the ascent would be less steep.

The market is now expecting a terminal rate of 4.93% in June next year, down from highs of 5.1%. Fed Chair Jerome Powell pointed to the jobs market as justification for the recently more hawkish tones; however, that picture seems to be changing, as last week there were large layoffs announced across the tech sector.

The US dollar sold off on the back of the CPI print, closing the week lower. Also, to add to the “bad news is good news” theme, the University of Michigan consumer sentiment reading fell to 54.7 in November, the lowest level since July.

The US midterm elections were also a focus last week. It was not the so-called “red wave” for the Republican party, which the market had expected. The Democrats kept their majority in the Senate after they kept control of seats in Nevada and Arizona, two key battleground states for the Republicans. History has shown that the incumbent party typically loses support at the midterms, so last week was viewed as a strong showing for the Democrats. As alluded to above, historically, the US stock market has gained in the 12 months after midterm elections.

In terms of US earnings, 91.4% of the S&P 500’s market cap has reported, and earnings overall have surpassed estimates. Value stocks have been delivering stronger revenue and EPS growth than growth stocks in the third quarter. EPS growth excluding energy was much softer, coming in lower year-over-year.

Asia

Equities in Asia were strong last week, with the MSCI Asia Pacific Index closing up 8.38%.

Hong Kong’s Hang Seng was the outperformer, closing the week up 7.21%, mainly due to a strong rally on Friday after China eased COVID-19 quarantine restrictions amid a series of other relaxing measures.

Chinese real estate developers logged huge gains after China expanded a key financing support program designed for private firms, including real estate companies. Short covering and improving sentiment following changes to its zero-COVID policy and supportive measures for the battered property sector sent the stocks rallying into the weekend. In addition, news that US President Joe Biden would be meeting with China’s President Xi Jinping helped risk sentiment. In a meeting expected to be held on Tuesday, the two presidents are likely to discuss issues including Taiwan, Ukraine and North Korea, and establish red lines between the two rivals.

Japan’s Nikkei Index closed the week up 3.91%. The Bank of Japan (BoJ) said it would retain its ultra-loose monetary policy to underpin the fragile economic recovery. The yield on the 10-year Japanese government bond fell to 0.23% from 0.25%, while the yen strengthened versus the US dollar. The BoJ suggested that its interventions in the currency markets had worked. .

After a late Friday rally, Mainland China’s Shanghai Composite Index closed the week up 0.54%, underperforming other markets in the region due to concerns about new signs of economic fragility and increasing COVID-19 cases. The number of daily cases moved above 10,000 for the first time in over a year, threatening further lockdowns and weighing on sentiment for much of the week.

Yet, a relaxation in China’s strict zero-COVID policy seemed to have aided a market rally on Friday. Reports had surfaced over the previous week that the government was preparing to ease travel restrictions and other measures following the recent reelection of President Xi Jinping. Although Chinese officials stated that the policy remained firmly in place, on Friday afternoon, the government announced reductions in the mandatory quarantine time for in-bound travelers as well as testing requirements.

Last week’s economic reports were limited but demonstrated the toll that lockdowns and slowing global demand have taken on China’s economy. Exports fell 0.3% in October, well below expectations and the first drop since early in the pandemic. Imports also fell 0.7% as weakening domestic demand compensated for increases in purchases of most commodities.

Week Ahead

The G20 summit in Bali will be a key focus for markets this week. Leaders will meet on Tuesday and Wednesday. Geopolitical tensions, the war in Ukraine and inflation levels are expected to be the hot topics at the summit. Outside of that, inflation prints in Europe throughout the week will be closely watched.

Monday 14 November

UK House Prices
Eurozone, German, France, Italy, Spain, UK Bloomberg Economic Survey
Eurozone Industrial Production

Tuesday 15 November

UK employment data
France CPI
Spain CPI
German ZEW Survey
Eurozone trade balance; employment; gross domestic product

Wednesday 16 November

UK CPI; RPI; Producer Price Index (PPI)
Italy CPI

Thursday 17 November

Eurozone car registrations
Italy trade balance
Eurozone CPI

Friday 18 November

UK Consumer Confidence; Retail Sales

 

Franklin Templeton Key risks & Disclaimers:

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This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as o14 November 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.