Policymakers recognize a new regime, and it's not pretty

Wed, 07th Sep 2022 18:32

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POLICYMAKERS RECOGNIZE A NEW REGIME, AND IT'S NOT PRETTY (1330 EDT/1730 GMT)

Monetary policymakers are recognizing a new macro regime, but are ignoring the trade-off between inflation and growth. And according to BlackRock, the resulting recession is bad news for risk assets.

As BlackRock sees it, the recent Federal Reserve Jackson Hole symposium was a big deal in that the main takeaway was that the Fed intends, at least for now, to crush demand with a recession in order to get inflation back under control.

Given this, here are BlackRock's strategic (long-term) and tactical (6-12 month) views on a number of broad asset classes:

EQUITIES: BlackRock is strategically overweight equities saying that a "higher risk premium and worsening macro backdrop lowers our expected equity returns. But we expect central banks to ultimately live with some inflation and look through the near-term risks."

BlackRock is tactically underweight DM stocks given that central banks look to "overtighten policy."

As for the U.S. specifically, BlackRock is tactically underweight since they believe the Fed intends to raise rates to a restrictive level. The year-to-date decline only partly reflects a restrictive fund rate, in their opinion, since valuations have yet to fall enough because of weaker earnings.

CREDIT: BlackRock is strategically overweight publicly traded credit - from high-yield to global investment grade. However, tactically, they are overweight investment grade, but neutral on high-yield.

GOVERNMENT BONDS: BlackRock has a modest strategic underweight on government bonds. Tactically, they are also underweight as they see long-term yields headed higher, even in the wake of 2022's yield surge.

(Terence Gabriel)

PAST MID-QUARTER, BANKS ARE HOLDING UP (1304 EDT/1704 GMT)

The S&P 500 banks index is just over 1% on Wednesday, but trading around the same levels they were in May, and still down 22% year-to-date, putting them on track for their biggest annual decline since 2008.

Against this backdrop, Credit Suisse analyst Susan Katzke issued a relatively upbeat update for the third quarter so far.

Katzke points to loan growth continuing to advance at a 'healthy clip' with Federal Reserve H8 data (commercial banking asset and liability data) showing average loan balances tracking up 2.6% qtr/qtr vs a 3.4% increase in Q2 vs Q1. While growth is balanced across loan categories and C&I is still leading, Katzke notes that its lead has narrowed and is "well off" the Q2 pace.

Securities balances are down about 1% while deposit balances are down about 0.4%, though stabilizing, according to Katzke.

She writes that "more loan growth and higher interest rates (with still relatively low deposit betas) should support more net interest revenue growth."

In capital markets elevated volatility is supporting trading but "stifling investment banking activity," according to Katzke.

On credit costs, the analyst sees "relatively stable/low loan portfolio loss rates and relative stability in loan loss reserve ratios."

In aggregate, "the achievability of third quarter estimates should be supported by NII growth and still low/stable credit costs" while Katzke sees the biggest estimate revision risks from macro and market shifts.

Her highest conviction recommendations however include Bank of America, Goldman Sachs, JPMorgan and Wells Fargo each with a ~30% total return potential.

Of those names JPMorgan is down ~27% YTD while Bank of America is down ~25%, Goldman is down 14% and Wells is off ~10%.

(Sinéad Carew)

UBS TRIMS S&P 500 TARGETS FOR 2022 AND 2023 (1206 EDT/1606 GMT)

UBS strategist Keith Parker cut his year-end targets for the S&P 500 for 2022 and 2023, noting that without improving growth or easing financial conditions into the end of the year, the focus will be on earnings.

While Parker said a fall in rates volatility would be supportive of a near-term tactical rally, with a "tepid" CPI print key, he lowered his 2022 EPS forecast to $228 from $234 and 2023 view to $235 from $247, citing Q2 earnings that were below forecast and a lowered second half GDP growth view for the 2022 cut. For 2023, Parker noted the lower base in 2022 earnings, a 1.4% average for GDP growth quarter-over-quarter along with a 1.2% hit from tax changes stemming from the Inflation Reduction Act.

However, Parker said the "risks around the baseline are considerable, both for earnings and valuations" and laid out scenarios for recessions and an upside case.

Assuming a mild, consumer-driven recession where real GDP falls about 1.5% on a seasonally adjusted annual rate for two quarters, Parker said the benchmark index could fall toward 3,400 in Q4 and recover toward 4,500 in 2023 if the Fed reverses course and cuts toward zero. A more severe recession, where the fed hikes to 4.5%, could see the S&P drop toward 3,100, "with the Fed cutting again a key to a bottoming in stocks."

In an upside "goldilocks" case, Parker said, assuming a fall in inflation leads to lower real yields and higher price-to-earnings multiples of about 18 times, the S&P could rally to 4,400 this year if growth stays strong.

(Chuck Mikolajczak)

EUROPEAN SHARES END MIXED AHEAD OF ECB (1142 EDT/1542 GMT)

Britain's FTSE 100 fell as energy and mining stocks weighed following weak Chinese data, while a jump in utilities shares helped lift Germany's DAX and France's CAC.

At the close, the broad STOXX 600 was down 0.4%, recovering from an earlier drop of more than 1%. Germany's DAX ended up 0.4%, while the FTSE lost 0.9%.

"While European and U.S. markets have stabilised, the FTSE 100's commodity contingent is once again turning from a help to a hindrance," writes Chris Beauchamp, chief market analyst at online trading platform IG.

"The FTSE 100 has not been able to recover this afternoon, as mining and oil stocks act as a drag."

Renewables were the bright spot in Europe and lifted the utilities sector after a leaked EU proposal which included an electricity price cap for non-gas power producers.

Eyes in Europe are now turning to Thursday's ECB policy announcement with a record 75-basis point rate hike in the cards.

Here's your closing snapshot:

(Samuel Indyk)

EPS ESTIMATE DECLINE NOT A RECESSION HARBINGER -CS (1120 ET/1520 GMT)

The bulls and bears are still slugging it out in the U.S. equity market, with no capitulation (yet!) in sight.

Earnings estimates are in decline as normally happens as a quarter progresses, but the recent trend is surprisingly much weaker than normal, says Jonathan Golub, the chief U.S. equity strategist at Credit Suisse.

Still, the decline in estimates is not a recession harbinger if the high inflationary periods of 1973, 1980 and 1981 offer insight, Golub says in a note on Wednesday.

Earnings peaked just two months before a recession's onset and EPS growth projections are still positive, indicating revisions would have to fall much more to signal an economic contraction, according to Golub.

Bottoms-up earnings estimates for the third quarter and 2023 are down 5.5% and 3.7%, respectively, since the S&P 500 hit bottom in mid-June, says Golub.

Revisions for the two periods are negative across all groups, with the exception of energy, while TECH+ has fallen the most as it continues its recent weakness, Golub said.

But EPS growth rates are still projected to be positive for the remainder of this year and next, he says. EPS should expand by 9%-10%, if the second-quarter beat rate remains intact.

Since the growth projections are still positive, revisions would have to fall much more to signal an economic contraction, he said.

The market is hovering about 40 points off the 3,900 level that marks a 61.8% Fibonacci retracement of the summer rally. Falling below that level could hail further declines, said Ipek Ozkardeskaya, senior analyst at Swissquote Bank SA.

ALL ROADS LEAD TO JEROME: TRADE BALANCE, MORTGAGE DEMAND (1047 EDT/1447 GMT)

Two disparate economic indicators released on Wednesday are likely to be viewed through the lens of Fed policy tightening, and the rising odds of a third straight 75 basis point interest rate hike this month.

The difference between the value of foreign goods and services imported to the U.S. and domestic goods and services shipped abroad shrank in July.

While exports edged up to a record high, the more substantial $9.7 billion drop in imports is largely responsible for the headline trade gap narrowing by 12.6% to $70.7 billion, according to the Commerce Department.

It was the lowest reading since October and just a hair wider than analysts anticipated.

The closely-watched U.S.-China merchandise trade deficit narrowed by 6.9% to $34.40 billion.

"Under economic headwinds domestically and internationally, trade flows have become more balanced," says Matthew Martin, U.S. economist at Oxford Economics (OE). "As the Fed continues to battle still high inflation levels through restrictive policies, we expect the slowing economy activity to hamper trade flows for the remainder of the year."

But for now, a narrowing trade deficit bodes well for current-quarter GDP growth, which could help reassure Powell and Co that the economy can withstand the central bank's aggressive rate hikes.

It's worth remembering that prior to its contribution to second-quarter GDP, net trade had been a GDP detractor for seven straight quarters, as shown in the graphic below:

Separately, demand for home loans softened last week as mortgage rates surged, according to the Mortgage Bankers Association (MBA)

The average 30-year fixed contract rate jumped 14 basis points to 5.94%, the second-highest reading since late 2008 after touching 5.98% in June.

As a result, applications for loans to purchase homes and refinance existing mortgages dropped by 0.7% and 1.1%, respectively.

Mortgage rates tend to track the benchmark U.S. Treasury yield, and after hitting an early August trough they've been marching toward reclaiming their mid-June peaks.

"Markets continued to re-assess the prospects for the economy and the path of monetary policy, with expectations for short-term rates to move and stay higher for longer," writes Mike Fratantoni, chief economist at MBA.

That's bad news for the housing market, which has seen its star fade since the heyday of the COVID housing boom, which saw supply plunge to record lows and home prices shoot to the moon.

The cost of monthly payments has slipped through the affordability grasp of many potential homebuyers, particularly at the low end of the market. And as the hawkish Fed continues to attempt to tighten the screws on inflation by hiking the cost of borrowing, that story doesn't appear likely to change soon.

"At current mortgage rates, the monthly payment on a median priced existing home (using July's price of $403,000) would be about $1,865, up 52% from the start of the year," outpoints OE's Nancy Vanden Houten.

And those tempted to refi in order to take advantage of formerly low rates have likely done so already or they've missed the boat.

As illustrated below, overall mortgage demand has tumbled 63.4% from the same week a year ago:

Financial markets have now priced in an 80% likelihood of a 75 basis point increase to the Fed funds target rate at the conclusion of the FOMC's monetary policy meeting later this month, according to CME's FedWatch tool.

Still, Wall Street seems to be taking it in stride on Wednesday, and is tentatively higher in mid-morning trading, with defensive utilities leading S&P 500 sectors higher.

(Stephen Culp)

EXPECT BUMPY RIDE AND WEAKNESS AHEAD -GOLDMAN SACHS (1013 EDT/1413 GMT)

The recovery in equities that we have seen since June has cooled off lately, with the benchmark S&P 500 down around 9% from its mid-August peak.

Using their Bull/Bear Market indicator (GSBLBR) and Risk Appetite indicator (GSRAII), Goldman Sachs believes we have not touched the market bottom yet.

"We expect further weakness and bumpy markets before a decisive trough is established," wrote the GS strategists in a note.

They added that we are in a bear market bounce because inflation and interest rates will likely have further to rise, economic growth is likely to weaken and valuations and positioning are not at extremes.

According to their analysis, the current bear market is more cyclical, meaning it is a function of the economic cycle that is triggered by rising interest rates, impending recessions and falls in profits.

Historically there are four sets of conditions to be met for recovery from cyclical bear markets: Cheap valuations, bottoming in the rate of deterioration in economic activity, a sense that interest rates and inflation are peaking, and negative positioning.

For none of the metrics listed above are we at a level consistent with a market trough, based on the assessment by the GS strategists.

(Bansari Mayur Kamdar)

U.S. STOCKS TRY TO FIND FOOTING (0951 EDT/1351 GMT)

Wall Street's main indexes are modestly green early on Wednesday amid a dip in bond yields. That said, investors are still nervous as fears mount over aggressive moves by the Federal Reserve to suppress inflation.

In any event, the wake of a near-10% S&P 500 slide from its August 16 close, some relief appears to be setting in.

A majority of major SPX sectors are higher with utilities and consumer discretionary posting the biggest gains.

Energy is taking a hit, off more than 2%. NYMEX crude futures are sliding around 4%, after falling to as low as $82.93, or their lowest level since January 24.

The Nasdaq Composite is gaining as it attempts to end a seven-day losing streak. The tech-laden index last fell more than seven days in a row with a nine-day losing streak in October-November 2016.

Meanwhile, Apple is trading slightly higher. The company is set to unveil new iPhones and devices at 1:00 p.m. EDT Wednesday.

Here is an early trade snapshot:

(Terence Gabriel)

S&P 500 INDEX: REELING, BUT RIPE FOR A RISE? (0900 EDT/1300 GMT)

Since its August-16 close, the S&P 500 index has collapsed nearly 10% in just 14 trading days.

Meanwhile, in another sign that the benchmark index may be washed out to the downside, a contrarian measure of sentiment has now risen 14-straight trading days to challenge its June high:

The 5-day moving average of the CBOE equity put/call ratio has now risen to 81.6%, or its highest reading since an 82.4% print on June 16.

June 16 stands as the S&P 500's low close in its 2022 bear market.

Traders are watching closely to see if the put/call measure's rise now stalls around its June high. In any event, a sharp downward reversal in this measure may coincide with a strong SPX snap back.

Of note, however, the put/call measure did hit 105.2% on March 17, 2020, which was four trading days ahead of the SPX's pandemic-crash low.

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(Terence Gabriel is a Reuters market analyst. The views expressed are his own)