global perspectives

    Four bullish charts you need to see before your summer vacation

    Four bullish charts you need to see before your summer vacation
    Graham Burnside - Trader, Fixed Income

    Graham Burnside

    Trader, Fixed Income
    Florian Ielpo - Head of Macro, Multi Asset

    Florian Ielpo

    Head of Macro, Multi Asset

    In the latest instalment of Simply put, where we make macro calls with a multi-asset perspective, we try to see past current extreme market pessimism to offer investors a few glimpses of possible optimism.  

     

    Need to know:

    There are four things that could challenge current market pessimism:

    • July is usually very positive for equities
    • Excessive pessimistic sentiment could potentially open the door to short squeeze periods
    • We have most likely seen a peak in US inflation pressures
    • Valuations were expensive for bonds and equities at the start of the year but have rerated following market declines

     

    The current macro environment is clearly not conducive to risk taking. We have been quite vocal about this point in the past, advocating our use of a large cash exposure as a diversifier. Markets have now entered a “declining growth” regime which typically comes with subdued risk appetite. This difficult environment has been made more challenging by central bankers’ tardy recognition of inflation risks. A sharp turn in policy, which may take rates higher than they would otherwise have needed to be, has prompted recession fears. “Whatever it takes” no longer applies to supporting markets and the economy. It now applies to fighting rising costs and price pressures around the world. We are faced with a market environment of pervasive pessimism and negative trends; sentiment is another market engine we have lost over the year. Finally, heightened geopolitical risks have added another brush stroke to this bleak picture. But is everything really so negative? Here are four simple charts that may provide some comfort to any remaining bulls – although we acknowledge they are now hard to find.

     

    Summer seasonality is generally supportive

    As shown in Chart 1, when analysing monthly market performance – we have used the S&P 500 for the depth of its price history – a very striking image is presented: the summer period, especially July, is usually a positive month for equities. Over the past 80 years, the S&P 500 delivered average returns of +1.5% in July: its highest average monthly performance. In terms of frequency, 58% of Julys have seen a positive equity performance. Furthermore, positive July months have produced an average +3.6% performance while negative July months returned -2.8% – an interesting asymmetry.

     

    Chart 1. S&P 500 seasonality (1930-2021)

    Multi-Asset-simply-put-SP500 seasonality-01.svg

    Source: Bloomberg, LOIM

     

    Pessimism is extreme

    When looking at the wide breadth of sentiment indicators, the prevailing market pessimism is now extreme. The AAII Bull/Bear survey presented in Chart 2 is calculated by smoothing the spread between investors that consider themselves “bulls” (positive) versus those identifying as “bears” (negative) at the time of the survey. This survey has been low throughout this year but has now reached record levels. Investor pessimism is now extreme – potentially to an unnecessary extent. This creates the risk that short-squeeze periods could lead to violent and rapid market rallies. This risk is increasing as we enter the summer season.

     

    Chart 2. AAII bull/bear survey

    Multi-Asset-simply-put-AAll Bull-Bear survey-01.svg

    Source: Bloomberg, LOIM

     

    US inflation is due to slow down

    The latest US inflation report sent a shockwave across markets, changing the correlation between equities and bonds1. While this report showed high headline numbers, very interesting signals could be found if you looked beneath the surface. Once the influence of energy and shelter costs (which is survey-based data) were stripped away, the rest of the inflation components actually showed a moderation. Chart 3 shows the most recent evolution of our US inflation Nowcaster: its current reading of below 50% indicates that we are now likely to have passed the peak of inflation in the US and, once the market starts to take stock of that, we could see better price action.

     

    Chart 3. US Inflation Nowcaster

    Multi-Asset-simply-put-Inflation nowcaster-04July-01.svg

    Source: Bloomberg, LOIM

     

    Valuations are much cleaner now

    The last potentially positive element that could support markets is the year-to-date evolution of valuations. We entered into 2022 amid expensive valuations both for bonds and equities. Chart 4 shows the Z-score carry of equities and bonds since 1996. As shown by the chart, when equities’ carry is low (negative Z-score), bonds’ carry is usually high (positive Z-score). However, 2022 has been different: carry for both equities and bonds were low, having been driven by activist central banks, meaning that bonds and equities were both expensive at the start of the year. Now, with the large revision of valuations that has taken place this year, the situation for both bonds and equities is different. The market was broadly expensive but is much less so today. Giving us all the more reason to hope for a better summer.

     

    Chart 4. Z-score carry of equities (dividend yield) and bonds (yield and roll down)

    Multi-Asset-simply-put-Z-score carry-01.svg

    Source: Bloomberg, LOIM

     
    Simply put, as we enter into the summer season, there are reasons to believe the extreme market pessimism could be challenged, based on fundamental, sentiment and valuation drivers.

     

    Source.

    [1] See the latest Simply put.



    Macro/Nowcasting Corner

    The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick. Along with it, we wrap up the macro news of the week.

    In the US, the latest batch of macro data was no longer positive. Three key datapoints published over the week clearly painted the picture of a declining growth situation, and we do not yet know how it will end. The Richmond Fed survey declined from -9 to -11, having been expected to rebound to -7. The conference board’s latest survey showcased expectations for a deteriorating macro situation: the “expectation” component notably declined from 73 to 66, a level that is consistent with the quarter preceding the 2008 recession. Interestingly enough, the “current situation” component of the same survey was not as negative and remains consistent with decent growth conditions. Finally, pending home sales now show the direct impact of higher rates on the health of the US housing market: pending home sales contracted by 12% in 12 months’ time. Apart from being “bad news” for growth, the publication of the core PCE this week provided little reason for markets to feel relaxed about the inflation situation – hence being further “bad news” for markets – which was expected to have grown by 5.1% on a year-over-year basis, whereas it grew by 5.2%. A small tick up, but not the kind of news the market wants to hear right now – nor the Fed.

    In Europe, limited news flow still brought its share of genuinely poor macro news. The publication of the European Commission surveys was not necessarily bad, but underneath the rather stable headlines, a large majority of the sub-components showed a deterioration. Economic confidence notably declined, following a trend initiated in February this year. Inflation data remains extremely high, even though German numbers declined on a year-over-year basis. The ties of European inflation to energy are likely to make it more volatile in the coming months. More importantly, surprise indices for Europe have finally turned negative: economists are now seeing most economic data undershoot their expectations – yet another sign that European growth is declining.

    In opposition to Europe and the US, China saw more positive data. Leading indicators rebounded as the economy reopened: the Caixin PMI again breached the 50 level while the services PMI jumped from 47.8 to 54.7, an impressive progression. Could it be that China may cushion the macro deceleration observed elsewhere? For the first time in a long time, our Chinese growth nowcasting indicator shows that the majority of data is improving.

    Factoring in these new data points, our nowcasting indicators currently point to:

    • Worldwide growth is now clearly declining. The US and Eurozone are showing signs of decelerating growth momentum. In China, growth momentum remains subdued, but more than 50% of data are now improving.
    • Inflation surprises should only remain positive for the Eurozone and are declining elsewhere.
    • Monetary policy is set to remain on the hawkish side: central bankers should remain more hawkish than expected.

    World Growth Nowcaster: Long-Term (left) and Recent Evolution (right)

    Multi-Asset-simply-put-Growth nowcaster-04July-01.svg

    World Inflation Nowcaster: Long-Term (left) and Recent Evolution (right)

    Multi-Asset-simply-put-Inflation nowcaster-04July-01.svg

    World Monetary Policy Nowcaster: Long-Term (left) and Recent Evolution (right)

    Multi-Asset-simply-put-Monetary Policy nowcaster-04July-01.svg

     

    Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

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