Market Musings 181123: Stick or Twist on Stocks?

Summary:

• Global stocks rebounding - approaching recent peaks

• UK, Emerging Market stocks continue to lag

• Sell at the highs or wait for more? Follow leading sectors

Video this week:

Our investment strategy for November 2023

In this podcast Edmund Shing, Global Chief Investment Officer of BNP Paribas Wealth Management unveils his investment strategy for November 2023.

1.The one rate to rule them all: the US 10-year Treasury bond yield. The global economy is most sensitive to long-term interest rates, because so much depends on them. The US 10-year treasury yield is the key interest rate in the largest economy, in the world’s reserve currency. The single critical indicator to watch.

2.The US 10-year yield is now 1.5% higher than in May 2023: then, the US 10-year yield sat under 3.5%. In just five months, this yield has risen to close to 5%. This sharp increase in bond yields has prompted large inflows to US bond ETFs and funds as investors seek to lock in the highest US bond yields observed since 2007.

3.Higher long-term rates do the Fed’s job for them: house mortgage and corporate loan demand have both declined as long-term rates have jumped. This cools future demand growth, and thus helps to calm inflation pressures. We continue to believe that the Fed Funds rate has peaked at 5.5% and should fall from mid-2024.

4.US longest-duration bonds have suffered even more than stocks did in 2008: 20Y-30Y US Treasuries have fallen in price by 64% since mid-2020. This is even worse than the 57% in stocks during the 2007-08 Financial Crisis. This represents the biggest US bond bear market in over 200 years.

5.Look at US fallen angels within high yield credit: fallen angels have historically offered a superior risk-reward opportunity to traditional high yield credit. Income investors could consider fallen angel ETFs and managed funds.

Global stocks rebounding - approaching recent peaks

Thanks in large part to weaker reported inflation trends, long-term interest rates in the form of US, European and UK bond yields have also declined from recent peaks.

US 10-year Treasury yield eases to 4.4%

Source: tradingview.com

This greater certainty that inflation rates are heading back towards central bank targets more quickly than expected has reduced the risk that central banks raise rates even further and plunge the global economy into a deep recession. This reduction in risk has supported stock markets, with US, Eurozone and Japanese large-cap stock rebounding close to recent highs.

Eurozone, US and Japan re-approaching highs

Source: tradingview.com

Old leaders (US mega-cap Tech) lead again (for now)

Source: tradingview.com

The UK has lagged in this latest rebound, as the higher political risk premium placed on the UK endures. Part of this can be traced to the cooling of oil prices despite the Israel-Hamas conflict, with large-cap oil stocks under-performing as a result over the very short term.

The AIM market is a particular laggard, in concert with small-cap stocks around the world.

UK stocks have lagged since February

Source: tradingview.com

That said, I still believe that UK stocks represent good long-term value for patient investors. .

Emerging market stocks have similarly lagged, in large part due to heavy investor scepticism around China.

Emerging Markets have lagged too, weighed down by China

Source: tradingview.com

Sell at the highs or wait for more?

If the S&P 500 index approaches 4600 once again and the Euro STOXX 50 index rebounds further to 4400, what should investors do then?

On the one hand, since the stock market lows back in October 2022, the MSCI World index has gained 26% (in US dollars) to current levels, to which we can add dividend income. This is an impressive return for investors in just over 1 year.

There is also the risk that the US economy slips into an economic recession early next year, which could impact sentiment and earnings for US and also global stocks.

On the other hand, there are also good reasons for continuing to invest in global stocks:

1. Earnings momentum continues to be well-oriented for US, European and Japanese companies, with relatively high levels of profitability and decent expected earnings growth for 2024;

2. Valuations for stocks outside of US technology mega-caps remain relatively cheap, especially for Eurozone, UK, Japanese and Emerging Market stocks.

3. Corporate demand for stocks is rising via share buybacks - which is probably the largest demand for US stocks in particular. This buyback trend tends to have its largest effect on stock prices towards the end of the year, not only in the US but in Europe too.

4. Sentiment has improved towards stocks (measured e.g. by the NAAIM exposure index in the US) but is far from being extended - so there is no sign of investor over-optimism at present, except perhaps in the Nasdaq 100 index.

In conclusion, I retain a more bullish bias for now, but keep a close eye on the leading sectors - US Tech (Nasdaq 100, Semiconductors), Eurozone Banks and US + European Oil & Gas.

The direction of these leading sectors should tell us if overall stock indices can break out of these recent peaks, or whether instead they will prove difficult resistance levels that cap stock momentum.

Have a great week,

Edmund