Chart of the week
The chart shows in black the interest rates on 10-year government bonds in the USA and in yellow the key interest rates. Based on the prices currently paid for futures contracts, it is possible to calculate what interest rate investors will expect in the future. This is the "SOFR curve" drawn in orange. Then in purple are the opinions of the individual members of the FOMC, the committee in the Federal Reserve that decides the key interest rates.
Why this is important
Investors are currently expecting a peak in key interest rates of around 5%. Currently it is at 4.25-4.5 %. So only a moderate increase is expected. In view of the looming recession, investors then already expect interest rates to fall again in mid to late 2023.
Compared with the opinions of the key FOMC members, investors are probably a bit too optimistic here. Interest rates could well rise above 5% and are likely to stay high for longer and not fall again so quickly.
But still, after the rise in key interest rates from 0.15% to 4.5%, the further expected increase looks small. In the coming months, therefore, one can again consider investing in bonds.
Inflation expectations and earnings statements
What is the outlook for inflation? Many market participants compare the current situation with the period from 1954 to 1957 or from 1972 to 1984:
The chart shows the course of inflation in the two market periods in which we have also had very strong increases in inflation and key interest rates in the past. The parallel progression of inflation to these two periods is amazing. If it continues in the same framework, we should see falling inflation for the next two years.
The chart shows the inflation of goods (in blue) and of services (in red). 90% of the price increase of services is based on rising labor costs. That is, goods can become more expensive and cheaper, and labor costs can rise but not actually fall. It is therefore often called "sticky" inflation. An all-clear for inflation can only be given when wages stop rising.
The chart shows the results of a survey of institutional investors conducted by J.P. Morgan, one of the largest banks in the US. The majority of the largest investors expect a recession this year. This conviction has never been higher in the last 50 years. The only question that remains is how severe the recession will be.
The chart shows the Philadelphia Fed Regional Index (blue). This is an indicator that measures current conditions in the manufacturing sector in Philadelphia County, the third largest in the United States. It is derived from a survey conducted by the Philadelphia Fed on the general state of the economy and businesses. The index consists of several components, including prices paid, prices received, employment, hours worked, new orders and backlog, delivery times and shipping orders.
The index has great predictive power for the ISM Index (Purchasing Managers Index), one of the best known leading indicators for the development of the economy in the US.
The very low values of the Philly Fed Index suggest very low values of the ISM. This is an indication that the slowdown in the economy could be stronger and harsher than most currently expect.
The chart shows the annual change in the S&P 500 (yellow) and an index showing how much analysts adjust their earnings estimates (blue). The decisive factor for the development of the stock market are the companies' profits. Here, a big drop of almost 20% is expected.
The earnings season started this week with the results of the major banks in the USA. The earnings reports were rather disappointing. It will be exciting to see which earnings figures will be published next week.
Finally, let's look at the technical analysis of the market.
The chart shows the price development of the S&P 500. Since November, the price has been moving in a falling channel. Currently, the fifth attempt to break out of this channel is underway. If the price breaks out to the upside, the stock market should be able to continue to rise over the next few months, but if it fails, a drop to the lower end of the channel is possible.
The next few days will therefore be decisive for the further development of the stock market for the next 2-3 months.
Substance titles vs. growth titles
After the good return of substance titles (value) in 2022, the voices are increasing that value is overvalued and want to bet on growth titles again.
The chart shows the outperformance of value vs. growth since 1975. From 2007 to 2021, there was a very long phase in which growth stocks had a massively better return than value stocks. In this long-term view, the out-performance of value in 2022 only appears as a small bounce.
In our view, the outperformance of value can last even longer. Certainly as long as interest rates continue to rise and remain high.
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