Day: 13 March 2023

Wei Li – Global Chief Investment Strategist, Alex Brazier – Deputy Head, Kurt Reiman – Senior Strategist for North America, and Carolina Martinez Arevalo – Portfolio Strategist 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

Equity earnings: Stocks are starting to reflect the economic damage from higher rates – and we see more hikes due to sticky inflation. But expected earnings still look rosy to us.

Market backdrop: U.S. stocks fell over 4% last week and erased most of their gains for the year, partly after Fed officials made clear they could step up the pace of rate hikes.

Week ahead: This week’s U.S. inflation report will be a critical gauge before the Fed’s next policy meeting. The European Central Bank is likely to raise rates by 0.5%.

Stocks are starting to reflect the economic damage of rate hikes. We think earnings offer little support – expectations for this year are still too rosy. We think corporate margins could get hit by higher costs and reduced pricing power as goods shortages ease. We see an earnings hit on top of that from recession as central banks fight sticky inflation – and are poised to hold rates higher for longer. We prefer short-term bonds for income and emerging market (EM) equities.

Profit margins at risk

We are not in a typical economic cycle. Tight labor markets are driving persistently higher inflation. That’s why we see major central banks creating economic damage and recession as they try to bring inflation down to their 2% targets. We think this is a tough backdrop for earnings – and could get worse as profit margins are squeezed. Companies’ pricing power had increased as the pandemic-driven demand for goods created shortages. But now spending patterns are normalizing back to services and away from goods, so that pricing power is waning. This comes just as cost pressures are mounting from higher wages and funding costs. We expect a recession to hit sales and higher costs to pinch margins still near historically high levels. See the chart. That should crunch corporate earnings and is why we think the consensus for flat earnings in the S&P 500 for 2023 as a whole is still too optimistic.

Good economic news – as seen in the February U.S. payroll gains, confirming a tight labor market – only adds to the risk that central banks will push policy rates even higher and keep them there, we think. This is an important lens through which we see the new regime of greater macro and market volatility playing out – and why good growth news could actually be bad news for markets.

Sector lens

We prefer short-term government bonds offering attractive income over developed market (DM) equities given the risks we see to earnings. Equities are starting to better price in the economic damage we see ahead. Yet we think being selective is key. We prefer the energy sector as tight supply buoys energy prices. We also like healthcare for its defensive characteristics in a downturn and financials due to higher rates and profit margins – even with potential risks. The U.S. stock market’s concentration of tech and consumer discretionary companies make it more exposed to the wage pressures from a tight labor market, in our view. Earnings results from the fourth quarter of 2022 showed revenue growth slowing, and earnings contracted for the first time since late 2020. Both managed to top already lowered consensus expectations – but the earnings beat was the smallest in a decade, we find. We think this shows how inflation can hit earnings – especially with pressure from higher costs related to wages.

European companies face similar constraints in the labor market. Yet we see some support for European stocks because of a large concentration of financial and energy companies we like. We also think the consumer discretionary sector in Europe is set up to benefit from higher demand for luxury goods from China’s economic restart.

Emerging over developed markets

China’s restart is also an important reason why we prefer EM stocks over DM. We think it helps brighten the overall economic backdrop in EM compared with DM economies. We also think risks are better priced: EM central bank rate hiking cycles are closer to their peak, and the U.S. dollar is still broadly weaker from its 2022 peak – even with its strength this year.

Our bottom line

We think markets are waking up to the risks from the fastest rate hiking cycle since the 1980s. For now, we like short-term government bonds for income. We’re overweight EM stocks and prefer them to DM peers: We think risks are better priced in EM. We’re modestly underweight DM stocks. We think earnings expectations are still too high, so we look for granular opportunities in sectors instead.

Market backdrop

U.S. stocks fell more than 4% last week and erased most gains for the year after Fed Chair Jerome Powell suggested it could pick up the pace of rate hikes and financial cracks emerged. We think the market is also starting to reflect the economic damage stemming from the rapid rate hikes of the past year. U.S. two-year yields fell sharply after hitting 16-year highs to price out rate hikes. We think rates are headed higher and the inflation problem for central banks remains the same.

The U.S. CPI inflation data for February will be a critical gauge ahead of the Fed’s policy decision later this month. Markets are waking up to the risk that rates could stay higher for longer as labor market tightness persists and core inflation proves sticky. In Europe, the ECB is likely to raise rates by 0.5% to 2.5%, and we’re watching for updated economic projections.

Week Ahead

Mar 14: U.S. CPI inflation

Mar 16: ECB policy decision

Mar 17: University of Michigan consumer sentiment survey

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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 13^th March, 2023 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.

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

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 Information Document (KID), which may be obtained from MeDirect Bank (Malta) plc.

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

Markets sprang into action last week. Investors had been looking for a catalyst, but they probably got more than they expected. Federal Reserve (Fed) Chairman Jerome Powell’s testimony was closely watched, and we also saw the first major bank failure since the global financial crisis. Friday’s release of the February US employment report also brought some market turbulence.

The MSCI World Index finished the week down 3.6%, while regionally, the S&P 500 Index closed down 4.5%, the STOXX Europe 600 Index closed down 2.3% and MSCI Asia Pacific Index was down 2.0%.

Volatility returned to markets last week, with the CBOE VIX up 34% on the week, with the entirety of that move coming on Thursday and Friday. The risk-off moves were seen in fund flows too, with US$18.1 billion going into cash, which brings the year-to-date total to US$192 billion. Also, US money market fund assets surged to an all-time high of US$4.9 trillion.

All eyes on the United States

Powell testimony

Powell’s two-day testimony to Congress was the first event to get markets moving last week, as he gave a series of hawkish statements which signalled the Fed would be willing to increase the pace of hikes if inflation remains uncomfortably high. Powell was giving his latest testimony at a time of significant scrutiny of the Fed in its attempts to tame inflation whilst maintaining a level of economic growth.

Powell stated: “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.” Yet, he later reiterated that the pace of hikes had not been decided yet. He also noted that the terminal rate is likely to be higher than was anticipated. He said: “Nothing about the data suggests we’ve tightened too much…[on current terminal rate assessment] as I indicated in my testimony, I think the data we’ve seen before—and we still have significant data to see—suggest that the ultimate rate we write down will be higher than in December.”

The odds of a 50 basis-point (bps) hike at the 22 March Federal Open Market Committee meeting were upgraded and the US dollar rallied to new year-to-date highs as risk assets sold off through Tuesday and Wednesday.

Later in the week, with such a focus on employment data, the release Friday of the February employment report was closely watched. The report was mixed, with the market unsure on how to take it overall. The headline nonfarm payrolls umber came in hot at 311,000 (higher than expected), which would usually be supportive of higher interest rates as the jobs market remains resilient. However, the unemployment rate nudged up to 3.6% and average hourly earnings came in at 0.2%—still up, but lower than expectations. As a result, Fed swaps downgraded odds of a 50 bps hike back to under 50%. The Fed is now in blackout period until next week’s meeting.

On Tuesday of this week, the February US Consumer Price Index (CPI) report will be closely watched, as it is the last meaningful data release before the Fed meeting and will likely provide key guidance on what we might expect.

Silicon Valley Bank (SVB) collapse

Despite the focus on Fed action last week, the key market mover came on Thursday. Risk assets were rattled after SVB launched a US$1.75 billion share sale to shore up its balance sheet, sparking fears of broader systemic risks to the banking sector. The bank services venture capitalists, with a relatively small percentage of its deposits coming from retail clients. SVB announced the sale of US$21 billion in securities, which had resulted in an after-tax loss of around US$1.8 billion in the first quarter. That particular loss was due to the sale of fixed income securities, which were showing large unrealised losses as a direct result of the Fed’s tightening cycle.

These long-duration bonds are usually safe; however, when the Fed hikes significantly, the value of these securities falls too. These developments have increased focus on large, unrealised losses on banks’ balance sheets and the risk of deposit withdrawals from aggressive Fed tightening and rising yields. The Federal Deposit Insurance Corporation (FDIC) said it will resolve SVB in a way that “fully protects all depositors.”

Shares of SVB closed Thursday down 61% and were suspended on Friday. As fears of contagion gripped the market, the US banking sector was hammered, finishing down 6.5% on Thursday alone. Given the nature of SVB’s business, small-cap stocks struggled in the United States, with the Russell 2000 Index finishing the week down 8%.

There were significant moves in credit markets too. US two-year Treasury yields plummeted nearly 70 bps in the space of three days as markets began to anticipate a Fed pause. Moves of this magnitude in credit markets happen during extreme events. These moves represent some of the biggest moves in US bond yields since Black Monday in 1987.

So, what is the read-across to Europe? The extent of the market moves last week were a result of an effective bank run as depositors withdrew funds. Investors are naturally worried that other banks could be vulnerable to moves such as this. However, banks hold a portion of liquid assets to prepare for moments like this, and EU banks specifically have comfortable liquidity coverage ratios. While the event will likely bring some regulatory attention, SVB was a fairly niche, tech-focused lender.

Yet, despite various news and investment commentaries noting that this should be a fairly isolated incident, markets are weaker again as we kick off a new trading week. The European banking sector was particularly weak as concerns over credit quality still grips investors. The market is now anticipating a European Central Bank (ECB) peak (“terminal”) rate of 3.394% in October, compared with 3.984% predicted just one week ago—a near 60-bp change in the space of a week.

Credit spreads have also widened. The German two-year yield fell 40 bps in early trading 13 March, by far the largest one-day decline ever. Also, in the United States, the market has wound back rate hike expectations again, with consensus now for a 25-bps hike in March.

Week in review

Europe

The STOXX Europe 600 Index closed last week down 2.3% but is still trading within the same 4% range it has held since mid-January. On Friday, the index dipped below its 50-day moving average (a key technical marker) for the first time since the very start of the year. There were very few market catalysts originating from Europe last week. On a positive note, European fourth-quarter earnings growth ticked higher again. Also, inflows resumed into European-focused equity funds. Friday’s UK gross domestic product (GDP) data came in a bit stronger than expected at 0.3% month-over-month, lending some optimism to UK equities.

In terms of sectors in Europe last week, given the risk-off move, defensives outperformed cyclicals quite significantly. Unsurprisingly, telcomms utilities and food and beverage stocks outperformed but still finished lower as investors sought safer spaces as the week went on. In terms of the laggards, basic resources gave back all of the previous week’s gains and some. The broad risk-off tone hasn’t helped, but the more conservative growth targets given at the National People’s Congress (NPC) in China over the weekend and the softer Chinese CPI number also influenced the market. Real estate and European banking stocks also fell last week.

United States

The main catalysts for the US market last week were undoubtedly Powell’s testimony before Congress on Tuesday and then the collapse of SVB later in the week.

The S&P 500 Index closed last week down 4.55%, giving back a chunk of its year-to-date gains, dropping down through its 100- and 200-day moving averages (important levels for the technical traders). The smaller-cap Russell 2000 Index declined 8.07%.

Powell’s statement to Congress was tough listening as he highlighted the fact that the Fed still had work to do in controlling inflation and the tight labour market. Stronger employment figures didn’t help the inflation situation.

Financials stocks led the decline lower last week with regional banks hit hard on the back of the SVB news. Trading in the stock was halted Friday morning, and the FDIC then placed the bank into receivership to protect depositors. And then state regulators closed New-York based Signature Bank,  underscoring the urgency of extraordinary US efforts to backstop the nation’s banking system and quell mounting concerns among customers about the safety of their deposits.

Asia-Pacific

Asian market lost ground last week, with Chinese equities leading the way lower after the Chinese NPC meeting failed to deliver any meaningful stimulus measures. With that, Hong Kong’s Hang Seng fell 6% and Shanghai’s market fell 3%. By sector, basic materials led declines. In addition, the latest CPI data undershot expectations, increasing by only 1% in February from a year earlier, while the Producer Price Index remained in deflationary mode, dropping by -1.4%. This points to a sluggish economy.

In Australia, the Reserve Bank of Australia (RBA) delivered a 25 bps increase in interest rates, (in line with expectations) taking the cash rate to 3.6%. In a statement, the RBA said “further tightening of monetary policy will be needed” but it could be close to the point of pausing interest rate hikes for now to allow more time to assess the state of the economy.

Japanese markets outperformed last week, with the benchmark Nikkei up 0.8%, as the Bank of Japan kept its policy settings for its negative interest rate and yield curve control programme unchanged. The decision was in line with expectations. The central bank signalled its continued concern over the economy by downgrading its view on exports and production, though it left its overall economic assessment unchanged. It said it would continue to allow 10-year bond yields to fluctuate by 0.5 percentage points above or below its target yield of zero.

Note, it was also confirmed last week that economist Kazuo Ueda will take over from Governor Kuroda on 9 April.

We also need to keep an eye on geopolitical tension in Asia. At the NPC, China’s President Xi Jinping was elected to his third term by a 2,952-0 vote. In his address to the NPC, he reiterated his commitment to a reunification with Taiwan and criticised foreign interference in the region. It was also reported this morning that Xi will travel to Moscow next week to meet Russian President Vladimir Putin. He also pledged to strengthen China’s miliary into a “great wall of steel.” That said, Chinese Premier Li also spoke today and struck a more constructive tone, talking down a “decoupling” of the Chinese and US economies.

Week ahead

Macro week-ahead highlights

• Importantly, Tuesday will see the release of the latest US CPI report.
• In Europe, the ECB takes center stage in the week ahead as it perseveres with the fastest tightening cycle in its history. The focus will be on any signals from the Governing Council on what comes after a likely 50bp interest rate increase on Thursday.
• In the United Kingdom, the spring budget package will likely consist of several temporary policies that take advantage of the space created by the better-than-expected near term borrowing picture.
• UK unemployment data will also highlight why the Bank of England (BoE) is not yet done raising rates, even if it is nearing the end of its hiking cycle.
• Euro-area data are set to show the industrial sector started 2023 on a stronger footing than initially anticipated, as indicated by a rebound in Germany’s output.
• A second reading of euro-area inflation will offer the details needed to better understand the drivers for the increase in underlying price gains and their likely persistence.

Key events

Tuesday 14 March: UK unemployment rate; US CPI

Wednesday 15 March: Sweden CPIF Inflation; Euro-area Industrial Production; UK spring budget

Thursday 16 March: ECB main refinancing rate & deposit facility rate

Friday 17 March:  Euro-area final CPI inflation

Monday 13 March    

• Eurozone March Economic Survey
• Germany March Economic Survey
• France March Economic Survey
• Italy March Economic Survey
• Spain March Economic Survey
• UK March Economic Survey
• US state employment; New York Fed Consumer Expectations

Tuesday 14 March

• Sweden PES unemployment rate
• Netherlands CPI
• Switzerland producer & import prices
• UK Claimant Count & ILO unemployment rate
• Spain CPI & house transactions
• Italy Industrial Production
• US CPI; NFIB Small Business Optimism

Wednesday 15 March

• UK Chancellor presents spring budget to Parliament
• Sweden CPI
• Norway trade balance
• France CPI
• Italy unemployment rate quarterly
• Eurozone Industrial Production
• US MBA mortgage applications; Core PPI & retail sales; Housing Market Index & business inventories

Thursday 16 March   

• Netherlands trade balance & unemployment rate
• Norway GDP
• Spain labour costs
• Italy CPI EU Harmonized
• ECB main refinancing rate & deposit facility rate
• US housing starts & jobless claims

Friday 17 March

• Sweden unemployment rate
• Italy trade balance total
• UK BoE/Ipsos inflation next 12 months
• Eurozone CPI
• US Industrial Production & manufacturing production

 

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Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 13^th March 2023, 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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MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

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 Information Document (KID), which may be obtained from MeDirect Bank (Malta) plc.