Stock markets recovered some of last week's losses on Friday with tech stocks leading the way. The NASDAQ posted its third consecutive week of gains and is already up c.6% YtD, well ahead of the S&P 500, which remains the laggard in the DM space, as we recently predicted in our House View 2023. 4Q22 earnings reports are set to dominate market attention with some big IT names releasing this week, a good test of how the ‘real economy’ performed at the end of 2022 and, more importantly, expectations for 2023.
Markets have moved a lot since last October’s low. There is some element of symmetry between the high-to-low moves during the summer of 2022. The asset classes that, despite the rally, have seen the steepest declines since January 2022 are long-duration fixed income assets and growth equities. The S&P Growth index, for example, has only recovered 10% of the drawdown it suffered between December 2021 and October 2022. Among the asset classes that have recovered by less than 25% include the NASDAQ.
When we compare this rally with that of the summer of 2022, the striking difference is related to lower inflation, higher base metal prices and the strong depreciation of the dollar. These three indicators suggest more confidence in a global soft landing, as the tail risk in the economic cycle outside the US diminishes thanks to China’s reopening and a warmer winter in Europe, together with increased fiscal support.
This said, there are still two significant developments: i) the inversion of DM yield curves; and ii) the bond equity correlation, which still casts doubt on the sustainability of the soft landing hypothesis, and even the intensity of the disinflation trends.
Over the last three weeks, the US OIS curve started pricing even more aggressive rate cuts in the second half of the year. As such, it seems that investors are generally convinced the ongoing Fed tightening will need to be reversed quickly early in the second half of next year. In our view, a pause in Fed rates will likely happen at 5%, but rates will remain above what is priced by OIS curves into 2H23.
DM yields are breaking down along most of the curve, with the US 10Y yield falling to lows of 3.37% last week. We do not see this move as sustainable, and without the curve pricing in more aggressive rate cuts, we could be approaching the maximum levels of inversion for the US yield curve.
Disinflation bets have dragged bond yields lower in Europe, despite a hawkish ECB, while improving economic sentiment has pushed equities up, despite fears of an earnings slowdown that is likely to materialise in companies’ guidance for 2023. Against this backdrop, and given that European indexes are close to our fair value levels for this year, it would, in our view, be wise to secure, at least partially, year-to-date gains, through active hedging.
Actionable idea: given the challenging macro scenario ahead, infrastructure stocks remain one of our favourite sectors. They are real assets providing inflation hedging, with clear growth prospects, together with increasingly attractive payouts. In the case of TowerCos, we celebrate that M&A is back on the table after the limited progress made towards consolidation in 2022, supported by inexpensive valuations.