China remains a drag on Emerging Markets and the world
China’s stock market (based on the MSCI China Index, which includes local Chinese listings and listings in Hong Kong) has lagged badly, whether compared to rest of the Emerging Market universe or to the developed market universe. The underperformance began in early 2021 and mostly continued since then, with a short rebound earlier this year that has since been reversed.
And the underperformance relative to developed markets (based on the MSCI World index) in US dollar terms (reflected in the US-listed ETFs that track the indices) has been quite dramatic. Since the interim peak in relative performance in mid-February 2021, the MSCI China ETF (MCHI) has returned -49%, while the MSCI World Index (ticker URTH) has returned -4%, a 45% underperformance in about 18 months.
Are we fighting the Fed now?
The stock market has rallied sharply since mid-July, while long-term bond yields have been stable to lower. Even the mighty US dollar has paused a bit in its uptrend. But inflation remains high (though likely peaking) and Fed officials continue to say they will continue to raise rates (and reduce the balance sheet) well into next year. The old market adage says “don’t fight the Fed” (i.e., be cautious when the Fed is tightening policy, and more aggressive when they are loosening), but it looks like markets have in fact been rallying in spite of the Fed lately.
Large vs Small Caps: Fundamentals vs Risk
One of the asset allocation decisions we research is whether to favor large-caps or small-caps within an equity portfolio. Currently, we see a stark divergence in the broad categories of indicators: the fundamentals of earnings estimates and valuations are now more favorable for small-caps, while low risk appetite among investors and later cycle economic conditions have been favoring large-caps.
Fed concerns easing despite recent big rate hikes
Yesterday’s decision by the Federal Reserve to raise rates by 75 basis points for a second consecutive time was historic, as it marks the most aggressive back-to-back rate hikes (150 basis points in less than two months) since the early 1980s, before the Fed was formally targeting the fed funds rate as its key policy focus.
The Fed’s statement and press conference yesterday clearly indicated that the Fed is not done with raising rates yet, but gave some of the first indications that they are acknowledging the signs of slowing economic growth and that the lagged effects of the rate hikes to date have not been fully felt yet. Markets reacted favorably to the news (75bps was well anticipated before the meeting), as it brings the potential for smaller rate hikes and the eventual end of the rate hike cycle closer.
Sector Earnings Estimate Revisions Update: Divergence in Commodities
Tracking analyst earnings estimate revisions activity (i.e., are estimates rising or falling, and by how much?) is a key feature of our research. With earnings season underway, we can check in on how revisions activity looks across the 11 US sectors, where we find, among other things, a big divergence between the commodity-related sectors of Energy and Materials.
Is the Fed closer to its goals than we think?
Markets remain volatile, but the narrative driving the volatility has been shifting recently, a topic we have written about and discussed with clients recently. For much of the year, the concern was that the economy was “too strong” and inflation was out of control, and thus the Fed would need to raise rates and reduce their balance sheet quite aggressively to combat inflation. The Fed has taken several steps in that direction, but now conditions have changed such that investors are more worried about growth slowing too quickly and turning into a recession rather than excessive inflation.
Store shelves are filling again, just not car lots
A growing concern among economists and investors is that retailers have been rebuilding inventories rapidly recently, potentially turning what had been partly empty shelves into excess supply. And indeed, the data on inventories held by various categories of US retailers, while lagged, shows evidence of rapidly normalizing (or even excessive) inventories in many areas except for those selling cars and related products. While this might relieve some of the inflation pressure facing consumers and the Fed, it would also imply lower earnings and economic growth, at least for a while.
Rare event: Europe looking better than the US
After nearly a decade of US equities mostly outperforming those in Europe, our indicators are finally more decisively aligned in favor of Europe now.
Fundamental momentum has shifted to Europe now
All of the indicators in the chart below are based on bottom-up aggregations of the constituents of the iShares Core MSCI Europe ETF (ticker IEUR) and the SPDR S&P 500 Trust (ticker SPY). The middle section of the chart shows our key metrics of “fundamental momentum” for Europe relative to the US.
Commodity prices diverging: energy vs the rest
Last month we commented that while the CPI readings remain very high, there are signs of moderation in commodity prices. With commodity prices remaining center stage as a macro driver, we continue to closely watch the various commodity indices, including the S&P GSCI index and its subcomponents.
There now seems to be a greater divergence between energy prices and other commodities.
The chart below shows the S&P GSCI Commodity Index (top section) along with its component indices over the last three years.
A closer look at gasoline and oil prices
Gasoline prices remain in the headlines, and leave an impression every time a driver fills their tank as prices hit new highs.
Oil prices are a global issue, with OPEC and the US being the biggest producing regions. Producers face mixed incentives about increasing production longer-term, including messages from the futures markets.
Gasoline and diesel refiners face reduced capacity, leaving them struggling to meet even historically normal levels of demand despite high potential profit margins.