Has The Market Hit The Bottom in May or Is This Just a Mirage ?

Equity Markets in May 2022

After ups and downs, or more accurately, downs and ups, May ended flat to slightly negative for most bond and equity markets, thanks to a strong rebound at the end of the month, after almost two months of falling markets, and even a bear market for the Nasdaq. Indeed, only the tech sector and consumer discretionary stocks lagged the others. They have erased 25% of their aggregate value since the beginning of the year.

Of course, and like the high price of the VIX (the closely watched volatility index) reminds us by being in the 25-35 range, neither the macro nor the micro risks are behind us, and there are lots of issues that need to be resolved before we again become optimistic, but this kind of breather was welcome by each and every (long only) investor.

Fundamentals

In fact, global problems are still very present. The war in Ukraine has entered its third month, and the geopolitical situation in Europe is getting worse. European Union’s leaders have agreed to ban 90% of Russian oil imports, sending the oil price back to a 14 years high, of $119.

China is slowly easing up on its Covid restrictions but still not enough to take it out of the current mess or to help with inflation, which remains a huge concern worldwide, for both households and central banks, with supply chain disruptions still in the background. On top of that, the last US earnings season showed that across the sectors, growth is slowing, higher costs are putting pressure on profit margins, companies are having difficulties forecasting consumers’ behavior and some have even been pushed to issue profit warnings.

A good indicator of stability though is the 10-year treasury yield, which was trading close to or even above 3% at one point, before stabilizing around 2.80% during the last week or so of the month. Another good indicator last month was the CPI (inflation rate) which fell for the first time since August 2021. If the rate missed analysts’ expectations and is still relatively high at 8.3%, and even if we cannot talk about a trend yet, it’s nevertheless going in the right direction, cooling off.

A drill down into the data also showed that the strong demand for goods is slowly transferring to services. Regarding one of the main sources of inflation in the tech sector, the global chip shortage that has lasted for over a year, President Biden was in Asia in May, and among other visits, he went to Samsung Electronics in South Korea, surely seeking to resolve this issue and to reduce reliance on China’s production. From a more political side as well, US Commerce secretary Raimondo said that a potential reduction of tariffs was on the table, in order to solve the” untenable” inflation rate. Maybe a bit of light at the end of the tunnel after all.

Federal Reserve Minutes and US Dollar

The minutes of the last Fed’s meeting revealed that most of the members don’t think a recession is underway, although lately most of the highly watched economic data has missed expectations. Actually, after the minutes of the last Fed’s meeting it was clear that all the members are determined not to crash the economy into recession. However, like in May, June and July as well should see rate hikes of 50 bps each, as combatting inflation remains the main goal. The Fed’s balance sheet reduction will also start in June with an amount of $47.5 billion at first and this is set to double three months later.

These Fed’s measures have a direct impact on the US dollar, which has strengthened this year vs the other currencies. Indeed, the US Dollar traded below 1.04 against the Euro, before returning to 1.07. Also, the late pricing of an aggressive monetary policy stretched the yields so much that USD denominated high yield corporate bonds reached an aggregate yield close to 8% at some point. Since last week, we see that this pricing gave a buy signal to investors who returned to the bond markets, and especially to the USD high yield universe.

Trading Strategy

From our side, only a few hints that things could improve soon are not enough for us to deploy right away the cash we have piled away so far, and so, we stay on the safe side, underweight equity, waiting for fundamental good news.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

Sweetwood Capital Investment Team

If Only Inflation Took a Recess…

Global Macro Analysis for April 2022

The same concerns as in previous months called the shots, but in a much more extreme and pessimist way since it is beginning to look like a possible trend. The peaking inflation resulting in increasing rates, the conflict in Ukraine and China’s Covid outbreak, are all the main factors driving the market’s negative momentum.

Things didn’t get better during the last days of the month, after data showed the US GDP contracted in the first quarter, compared with the small increase that was expected. It caused panic selling at first with increasing fears about a potential recession. When one investigates it a bit deeper however, one can see that it has mostly resulted from a trade deficit (more imports than exports), while consumer demand, businesses’ investment growth and housing market stayed resilient during the last quarter.

Federal Reserve Meeting

This week, the Fed’s policy meeting is expected to be a turning point: an aggressive rate hike of 50 bps is expected (and is already priced in) as well as the start of the Fed’s balance sheet reduction, at the largest scale ever, since it reached an incredible record of $9 trillion. Of course, each and every comment of Fed chairman Jerome Powell will be broken down, in order to assess if markets recently overreacted or not, when pricing the bad news. Markets will no doubt adjust accordingly if necessary.

ECB Meeting

From its side, the ECB meeting did not provide a clear time frame yet regarding its own tightening policy. As of today, the market is pricing an 85-bps rate increase in the Euro interest this year, and the yield of the 10-year German Bund returned to close to 1%, something that has not occurred since 2014.

Ukraine War and Fertilizer Prices

Still in Europe, the war in Ukraine is continuing, and beside a humanitarian disaster, a huge energy crisis is threatening Eastern European countries. Russia blocked gas flows to Poland and Bulgaria, expecting payment from them in Rubles. Russia already stated that more countries will be cut off from its gas if there is no sanctions’ reversion on its currency.

Moreover, Finland and Sweden are considering joining NATO, decisions that could possibly end in World War III, according to Putin. Finally, Russia, together with China, is one of the most important global suppliers of fertilizers. Both countries supply the world with close to one quarter of global fertilizers. Now Russia has stopped providing fertilizers to some countries as a response to the sanctions that have been imposed on it.

To put things in perspective, 96% of the US’ potassium fertilizer is imported from Russia, meaning the latter has the power to put the Western food industry at a high level of risk. And as time is passing and no positive outcome is taking shape from this conflict, the risk for a huge global food crisis is increasing.

French Elections

Another major event in Europe in April, was the French Elections, with Macron securing a second term. If it was relatively good news for markets, it also brought attention to the fact that 50% of the French people voted for extremes and so basically half the country said it is not happy with the current regime.

Zero Covid Policy in China

China continues to suffer from its zero Covid policy, a property crisis, the consequences of last year’s crackdown on techs and now, on top of that, the depreciation of its currency. In order to resolve the latter, the People’s Bank of China announced that it will cut the Reserve Requirement Ratio for foreign exchange currencies, from 9% to 8%.

US Earnings Season

Last month also marked the kickoff for the Q1 earnings season. So far, about half the S&P 500 companies have reported. This quarter again, the surprise rate is above the historic average, but we clearly see lower corporate earnings and how higher costs put pressure on profit margins. Also, the growth forecast for this year is sharply lower than last year. Overall, even if earnings calls have been kind of depressing, inflation apart, it fits the process of normalization we all expected.

Conclusion

In this context, our call would be to stay defensive as long as volatility remains high, and the bearish momentum continues. To do so, we suggest building cash position on each technical rebound, and continue to favor value over growth companies.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

Sweetwood Capital Investment Team

Recession May Not Come From Inversions – But It Still May Come

The exceptional financial occurrence in March was undoubtedly the US curve inversion: the two main treasury spreads, 2y/10y and 5y/30y, entered negative territory while shorter notes started to trade at higher yields than longer ones. Historically, such a movement in Treasury yields, when it lasts for more than several weeks, predicts an oncoming recession (normally within 6 months to 2 years).

The reason for that is the negative impact on the financial system, since banks’ profits are strongly reliant on rates: banks traditionally use short term deposits to grant long term loans, therefore if they are paying more than they actually receive, they will no doubt avoid giving loans in order not to be hit by losses. Having said that, and as we see now for quite a long time, traditional signals do not always lead to anticipated results.

And this could be justified by the fact that bank loans are not such an important part of the total US credit universe anymore, as it was the case back in the 80’s, (indeed today they represent only around 30%). In fact, corporations are now mainly issuing bonds to fund their activities and additionally, the emergence of fintech companies has brought some aggressive competitors into the credit world. Also, a large part of loans and mortgages are now securitized and sold on the capital markets, so the banks can further leverage their capital.

Finally, when we look at the charts, financial companies are more correlated to the US 10-year treasury yield than to the spread’s curve, since the 10 year is considered being the ultimate indicator for growth, and since the beginning of the year, as opposed to past curve inversions, the 10-year treasury yield has risen from 1.51% to 2.44%. Therefore, it is far from certain that this particular curve inversion will in fact, lead to a recession.

During the March meeting, Fed Chairman Jerome Powell announced a rate increase of 25 bps, the first since 2018. He also said that a total of seven rate hikes (if each will be of 25 bps), would be a possibility for this year. Details regarding the Fed’s plan for quantitative tightening will be announced during the next meeting in May.

Powell is confident the labor market is strong enough and the economic data resilient enough, so he can increase rates aggressively to fight inflation, which continues to hit a 40 years’ record. However, what the Fed seems to (deliberately) ignore is the impact of higher rates combined with more job offers than demand, on companies. Indeed, the next recession could come not from the curve inversion and its impact on banks, but rather from the unbearable burden of the cost of both labor and funding which could lead some companies to slow or even stop production.

Powell may be mistaken by thinking that companies and households have strong enough balance sheets to stay resilient in front of so many changing conditions. Time will tell.

Despite the war in Ukraine, the ECB kept an hawkish tone during its meeting and although the rates were left unchanged for now, the exit from the Asset Purchase Program will happen faster than expected.

For both Central Banks, inflation expectations were revised higher and GDP growth expectations lower, for this year.

The war in Ukraine seems to be at its worst. Despite some progress in talks, and an apparent Russian withdrawal from Kyiv, the latest images of devastation from Bucha (a suburb of Kyiv) caused a fierce reaction from world leaders. Further sanctions could be imposed on Russia, and even Germany’s leaders, who opposed an energy ban until now because of the repercussions on their own economy, are considering banning Russian imports of gas.

In the meantime, oil prices are evolving in the 100-120 USD range and are the main trigger for higher Consumer Price Indexes globally.

Among the different aid packages for Ukraine, the most significant one was the approval by the US congress of a $13.6 billion support bill. In the meantime, the generosity of the Americans has been well rewarded: the Biden administration has signed an agreement with the European Union which aims to boost the sale of US natural gas to European countries.

In China, a new Covid wave in the middle of the zero Covid policy brought further risk of delays in global supply chains since China is kind of the world’s main manufacturing engine. On top of that, Chinese credit is still vulnerable.

Perhaps because of this economic deterioration, the Chinese government announced last month that it was done with the crackdown on techs and no new harsh regulations should disturb the companies from now on. Chinese tech companies’ stocks jumped by more than 40% on the news. The downside regarding this good news, is that regulations put in place last year continue to impact the companies’ growth and earnings…

There are certainly some threats looming above the financial markets and global economies, but we don’t see them as imminently dangerous. Therefore, for now we just stay invested, but hands on and ready to react. To paraphrase Jerome Powell “we need to be alert and nimble”.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

Sweetwood Capital Investment Team

After The Dark Comes The Light. Eventually.

For now, despite invasion, sanctions, threats and talks, no clear outcome is predictable. But one important thing is notable: Russia (and to a lesser extent, Ukraine as well), is a major player in the global commodities market. Therefore, this conflict could have a huge impact on global inflation and supply chains are being, even more than before, challenged.

As reflected in the markets, Europe is especially impacted by this crisis. In fact, the dependence of Europe on Russian commodities (40% of gas imported, 30% of crude oil, raw materials, wheat etc.) makes unlikely the fact that sanctions imposed on Russia by the European Union will be related to these sectors.

Actually, if energy prices soared at first, with oil approaching the psychological barrier of $100, since the beginning of the conflict, and at the time of writing, it surprisingly seems to have stagnated a bit. And that’s because Europe doesn’t rush to sanction Russia in areas that it can be itself hurt, like the energy sector. Also, some OPEC members have already announced an increase in production to offset the potential sanctions on Russian oil.

For the central banks there is a real dilemma now: on the one hand, the conflict increases fears for more inflation and supply chain issues, but on the other hand, the tool expected to be used to combat inflation, rate hikes, could put further pressure on financial markets. Therefore, for their next meetings, we expect the ECB to drop the hawkish tone it adopted lately and the Fed to be a bit less aggressive than anticipated (our call would be a rate hike of 25 bps in March instead of the 50 bps expected).

On the fixed-income side, we now see spreads not seen for more than a year. At these levels, we start to see the return of buyers of US high yield bonds (5.2% yield for 10 years duration for the corporate BB universe).

We must note that, even if the context is related in the news in a kind of apocalyptic way, there are some indicators that are somewhat encouraging, in regard to financial and economic matters. For example, The University of Michigan Consumer Sentiment Index shows that we are near all-time low, levels seen only in extreme cases, like in early 80’s and 90’s or in 2008. If, at first sight it seems bad news, it can also suggest that we could be bottoming out in terms of bad sentiment.

Another light at the end of the tunnel is the economic data showing that the recovery post Covid-19 is continuing on its way: we see the Purchasing Managers Indexes (PMI) both in the Eurozone and in the US being boosted by services as we expected, after the first part of the recovery was a manufacturing boom.

On a micro side, numbers are also positive. The last earnings results and companies’ forecasts indicate that balance sheets are strong, and disruptions in production have a limited impact or at least are manageable for most companies.

Finally, if we saw outflows since the beginning of the year, we don’t see many net sellers. Indeed, short interest ratios on big names are not jumping, meaning that investors are rather waiting on the sidelines with cash to be deployed (and there is plenty of cash out there) but are not bearish on the long term.

It’s not always that the real economy or the geopolitical tensions have a direct impact on capital markets. These last two years however, they not only had an impact, but they really called the shots. First the pandemic, now the war in Eastern Europe.

And yet again, we don’t think that trying to time the market is the right response. We made minor changes in order to be protected from a possible huge commodities crisis, but fundamentally we stay confident on the positive turn of the markets when light returns, as eventually, it will.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

Sweetwood Capital Investment Team

The Value of Growth

It ended up being the worst month for US equity markets since March 2020, led by a strong sell off in tech stocks. So far, almost each day of 2022 has been rocky, starting in the green and ending in the red or vice versa. Also, the selloff didn’t spare any asset, and bonds traded at record yields not seen since the end of 2020. In fact, they had their worst yearly start in decades. The US 10-year Treasury Note was itself very volatile, ending the month with a yield of 1.78%, its pre-pandemic level and almost 30 bps above where it started the year.

The main triggers of this correction were on the one hand, inflation and the anticipated rate hikes, and on the other hand, a reassessment of growth companies’ stocks. Of course, the threat of a Russian invasion in Ukraine didn’t help to enhance the general feeling and only the energy sector seems to benefit from such news so far, with oil prices back to 2014’s levels.

During its first meeting of the year, the Fed adopted a particularly hawkish tone, hinting that there will be as many rates hikes this year as needed in order to assure price stability. Indeed, Chairman Powell left the door open to any possible change in policy, given the inflationary environment. When asked about asset bubbles, he simply replied that companies are strong financially, banks are well capitalized, and he doesn’t see any vulnerability that is not manageable. Encouraging.

The issue is, using rate hikes to fight inflation caused by supply / demand imbalances could prove to be quite useless. Even Jerome Powell noted that these imbalances could start resolving themselves only during the second half of the year and regarding semiconductor shortages, it could even last until 2023. Moreover, a too aggressive use of this monetary tool could make the debt burden unbearable for those households or companies who took advantage of cheap credit and are, at this point, highly leveraged. Therefore, it’s possible that rate increases won’t fix the inflation issue and on top of that may cause a real credit mess.

Concerning the correction of the tech sector: the upcoming rate hikes could not possibly be the only reason for that strong pullback. We rather see a reevaluation of the future growth for some companies / sectors. Indeed, until now investors were ready to tolerate high ratios if expected future growth was worth it. But when the growth appears to be capped, or slowing, like the growth of value companies, they may not want to pay such elevated prices anymore. Therefore, there is a general reassessment of growth companies’ stocks. Only when the market experiences a serious correction, and both overvalued and well valued assets are sold, then, it’s the moment opportunities emerge, and in our opinion, some companies with strong growth ahead (like in the semiconductor sector, to name only one example) suddenly appear relatively cheap.

January also marked the kickoff of the earnings season. At this point, slightly more than one third of S&P companies have reported, and more are beating EPS estimates than the historic average, but by a smaller margin (4% vs 8%). So, it matches what we said above: there is still growth, but it is starting to flatten.

As for China, Chinese markets (Hong Kong and Mainland) are closed this week for Lunar New Year celebrations, but there is not much to celebrate when we look closer. China is still dealing with a real estate crisis and the zero covid policy is hurting both consumption and production.

From our side, although it’s tempting to buy the dip at these levels, we must be very selective. Also, we don’t know if the correction will continue further or the rebound will be similar to that of April 2020, therefore, we prefer, in doubt, to stay on the safe side and continue to overweight Value vs Growth. So, to conclude, alongside a defensive approach, don’t miss the real opportunities!

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

Sweetwood Capital Investment Team

When the Facts Change, I Change My Mind. What Do you Do, Sir? (Keynes)

For a second year, Christmas and New Year celebrations took place within travel restrictions, as we enter the third year of the pandemic.

But despite this strange end of year, swinging between an Omicron sell off and a Santa Claus rally, overall, it’s been another positive year for developed markets’ risk assets. On the other hand, investment grade bonds were mainly sold off, with the US Treasury yield ending the year 50% higher from where it started. Among equity sectors, the big winner of the year was definitely the energy sector which converted 2020’s losses into the highest earnings in years.

During the last Fed meeting of the year, Chairman Powell removed ‘transitory’ from the Fed’s official statement and neither Omicron nor the bad November jobs report was a game changer in terms of policy. Indeed, the ultimate goal seems to be now the battle against the inflationary pressures, since they are now expected to be higher and stickier than anticipated, mainly due to demand and supply imbalances.

So, unsurprisingly, the Fed took a hawkish turn last month, and the tapering pace has been doubled. This process should end by March, opening the way to an eventual, much predicted, rate hike. Altogether, three rate hikes in total are expected in 2022. The question is now if an interest rate of 1% will be enough of a tool to fight inflation, whose rate reached 6.8% in December, the highest level seen since 1982.

Similarly in Europe, the new wave of Corona didn’t change the ECB’s plan to taper. However, unlike the Fed, the ECB will remain very supportive through its Asset Purchase Program and no rate hike is to be expected until year’s end since Chairwoman Lagarde still sees the inflation as temporary.

As for China, it has been the big loser of the year. The property developers’ debt crisis is still in a state of extreme confusion and the contagion effect of Evergrande is hugely impacting the whole Chinese financial system. Also, the economic situation is not improving and once again retail sales disappointed, showing signs of consumption weakness and staying below pre-pandemic levels. Therefore, in order to boost the recovery,

The People’s Bank of China cut its loan rate for the first time, since April 2020, from 3.85% to 3.80%. We expect more easing to come in 2022, putting the world’s second largest economy on the complete opposite direction than the rest of the world. On top of that, on a geopolitical matter, President Biden officially announced that he would not send any diplomatic representation to the Winter Olympic Games in Beijing next month, due to human rights issues.

From our side, with inflation still around we continue to favor value companies, as we think they will continue to outperform growth companies in 2022. Within value, we feel that US Banks should have another great year, benefitting from higher rates. Within tech exposure, Metaverse could be the hottest topic of the year.

If 2021 was a rebound year in terms of companies’ earnings and economic growth, 2022 is expected to be a year of ‘normalization’, with a strong focus on Corona’s new variants, supply chain issues, inflation, interest rates and tax hikes and more potential events to come related to the new generation of investors.

But after two years of “Black Swans”, we must be able to adapt, and like Keynes said it well, it means reassessing our allocation when facts change. Having said that, we must not underestimate the markets’ resilience (and especially the US’ one) and therefore, every downturn could be an opportunity to buy the dip.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

Sweetwood Capital Investment Team

Sweetwood Capital Monthly Market Insights

Equity and bonds markets were down across the board in November, first because of inflation concerns, then at the end of the month, because of omicron, the variant of concern. Indeed, this new variant, which was recently detected, made the world return to a high level of uncertainty: restrictions and travel bans came back, as it is spreading worldwide.

The financial consequences have been a sell off for recovery stocks as well as profit taking on growth stocks, during what should have been a long and calm Thanksgiving weekend. Since then, it’s been a back-and-forth week for the markets, as right now no investor has a clue what is the correct thing to do.

However, what did rally last month was the US Dollar. The EUR/USD even traded below 1.12 at some point, the lowest level for the Euro in almost 18 months. With a rate hike soon expected to happen, the USD strengthened versus all currencies, or almost all.

The Israeli currency, the Shekel, came close to a level of three Shekels to the Dollar, its mid-90’s levels, and even if the USD has been getting stronger, the Shekel is now surprisingly the world’s strongest currency. Because of this, in a table published by The Economist on December 1st, Tel Aviv is now rated to be the most expensive city in the world.

Inflation rates also continue to rise nearly everywhere. A new record was reached in the Eurozone (4.9%) while the US is revisiting 1990, with an inflation rate of 6.2%. Transitory? As Powell clearly stated, this is not a term to be used any more when talking about inflation.

Nevertheless, supply chain issues started to show signs of easing: according to some companies they are now encountering fewer shipping bottlenecks, and the prices of some components are trading slightly lower (but are still high compared to historical levels).

During its last meeting, the Fed announced the details of its well anticipated cutback in bond purchases: a $15 billion monthly reduction, so that by June the reduction of the $120 billion monthly purchases should be completed. A couple of days after the meeting, a strong jobs report came to reinforce the idea that the time has come for less support.

Now, with such an inflation increase, in between two meetings, Chairman Jerome Powell (who has been reappointed for a second term) said that the central bank should announce a faster than expected tapering, so a rate hike could come quicker as well if needed.

Of course, all this is not doing any good to Joe Biden’s agenda, whose spending could be largely impacted by rising costs and rising rates. Although, his argumentation is that, on the contrary, his social bill will significantly reduce the Americans’ cost of living. The Republicans, needless to say, are not yet convinced.

Finally, Black Friday and Cyber Monday sales disappointed slightly, which didn’t help the most skeptical to build back a bullish sentiment.

As for us, the relatively high volatility in this year’s end, reminds us that even if companies show strong financial results and positive estimates ahead, we are still in a fragile environment and the uncertainty related to the resurgence of COVID cases or the emergence of new variants can be a sudden game changer for capital markets.

Having said that, and while we tend to lower the risk by balancing our allocation, in terms of assets, geography and even sectors, being under allocated can be even more hurtful than any temporary downside. Finally, the one thing we do not recommend is selling in time of general panic, since we learn from history that this is never the correct policy to adopt.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.
Best regards,

Sweetwood Capital Investment Team

The Beginning of The End is Sometimes a Fresh Start

On the other hand, bonds continued to sell off across the board.

During ECB’s October meeting, Chairwoman Lagarde announced that the Pandemic Emergency Purchase Program will end by March 2022. However, the ECB will continue to purchase assets within the general plan (APP), including maintaining accommodative measures, like Targeted Long-Term Refinancing Operations etc.

Today, the Fed meeting will be the main event, although the outcome is already known and well-priced into the markets by now. What’s more important than tapering details, will be the comments on inflation since that’s the major factor which could change the rate hike prospects. Indeed, the inflation rate is still at its highest levels in decades in most of the developed countries, with the largest contributor to that being energy prices. Also, demand remains strong and supply chain issues are not yet resolved.

In China, during the last month, a few property developers defaulted on their bonds, and regulators are now busy dealing with the contagion effects of Evergrande on the whole real estate sector. While they are trying to set up some metrics in order to limit the leverage of the companies in this industry, the other sectors recently impacted by harsh regulations, like the tech sector, are enjoying a little breath – after all the ups and downs, the Chinese tech sector ended the month flat.

October also marked the start of the earnings season for the third quarter. So far 82% of S&P 500 companies have reported better than expected EPS, which is above average. Tech companies however whose results usually exceed expectations and are above estimates, were split this time. Among the giant techs, only Microsoft surprised on the upside and replaced Apple as the world’s most valuable traded company. After a record quarter in all measures, Tesla joined the very select group of trillion market cap companies.

Finally, Facebook had a hard time last month: after a whistleblower testified to the Senate on the “toxic” effects deliberately spread by the company’s apps, the social media faced an outage that cut off all its apps for six hours. Then after, when the company reported its earnings, it missed estimates for the third quarter. By the end of the month, as if he wanted a fresh start after this unfortunate period, Zuckerberg revealed Facebook’s new brand name: Meta.

Finally, the month ended with meaningful events: the G20 in Rome, where an international tax agreement was signed. We also saw the opening of the COP26 in Glasgow, the two weeks’ climate change conference which should deal with the timeline of net zero carbon emissions.

With now half the world vaccinated against COVID-19 and kids soon to get vaccinated as well, the pandemic seems to be slowly coming under control and a kind of normalization is occurring. But this comes with some consequences such as constant high demand and not enough supply, caused by shortages in both goods and labor.

We don’t think this situation will improve in the near term and that’s why the first concern would be to stay protected against stagflation. For that matter, we stay overweight equity and on the fixed income side we stay focused on short duration high yield bonds which give a sufficient protection against inflation together with a limited correlation to rate increases.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

Best regards,

Sweetwood Capital Investment Team

Not Only Leaves Are Falling

This time again, it didn’t bypass the rule and last month was indeed negative across the board for both equity and bond markets. Mostly impacted was the tech sector, because of higher treasury yields implying higher rates and thus weighing on growth companies’ future relative returns.

The other reasons for this pullback included the global resurgence of COVID-19, supply chain issues and concerns around the withdrawal of Central Banks’ support. On top of that, the US is in somewhat of a political crisis. After a shutdown had been avoided in extremis last week, the Congress has now two weeks to avoid what could be a first US default. In order to do so, the Republicans must agree to increase, or at least to suspend, the debt ceiling.

For now, they are playing with fire and unless they join the Democrats in voting to raise the debt level, the US could face a catastrophe and historic consequences, namely a US Treasuries’ default. Of course, a US default would have itself systemic consequences and the global impact on capital markets could possibly be much worse than any Pandemic or Subprime Crisis. However, to put things in perspective, this scenario has occurred before, in 2011 and in 2013, when Republicans tried to put pressure on the Obama administration.

Eventually it ended in the extension of the Treasury’s capacity. Finally, even without Republicans, Biden can invoke extraordinary measures to increase the debt limit. Therefore, even if it creates some turmoil in the near term, a US default is highly unlikely.

Central Banks’ meetings last month were pretty much in the same tone than before and with the same focus: the fast recovery allows to gradually tighten the policy and reduce the support; inflation now appears less temporary than expected and price pressures could probably continue into 2022. An interest rate hike is not imminent, and we wait for November’s meeting to have more details and timeline about the Fed’s tapering.

September was also the month of some international political changes. In Germany federal elections were held and for the first time in 16 years, Angela Merkel’s CDU party was defeated and lost its majority. Olaf Scholz of the center-left Social Democrat Party won the elections and talks are now being held to form a coalition either with the Free Democratic Party or with the Greens.

In Japan, elections also took place after Suga announced he was quitting his post of President of the LDP (Liberal Democratic Party), the majority party in the National Diet (the Japanese Parliament), and by doing so, automatically ended his term as Prime Minister after only one year.

Since then, the former Foreign Minister, Fumio Kishida, won the leadership race of the LDP and therefore became Japan’s new Prime Minister. Kishida is known to be market friendly, however he was left with quite a lot of economic issues to resolve and so some tough measures could be taken soon by the new administration.

As for China, if when the month started, some investors seemed to think that a certain balance was reached between political control and market efficiency, by the end of the month, the Evergrande huge debt crisis again overwhelmed the general sentiment. One of the most dominant Chinese companies in the most important sector (Real Estate accounts for 30% of Chinese GDP), gave us all a great example of how dangerous corporate debt could be for the entire economy when it is not limited.

And we can’t help thinking about how ironic this whole story is: after a full year of efforts of cracking down on tech companies and setting other harsh regulations to make profitable companies non-profit organizations, the biggest threat was in fact in the highly leveraged companies, one issue regulators didn’t take care of. The outcome of Evergrande’s crisis could be what will define what’s next for China.

From our side, as we continue to see record inflows to US equity ETFs, and while the current concerns over a potential US default seem to have little chance of materializing, we find that any pullback offers buying opportunities, whether it’s in strong companies moving down with the market or into bonds offering higher yields after the sell off. Also, if September unfolded by the book, then maybe we can follow the rule and expect a positive fourth quarter, as historically the last quarter is the best quarter of the year.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

Sweetwood Capital provides asset management and investment advisory services to qualified high net-worth individuals. Our aim is to achieve consistent cash-flow generation for our clients through direct investments in transparent and liquid instruments. We offer a highly personalized service and construct investment portfolios that are calibrated to the risk vs. reward preferences of each client. Our clients do not take any counterparty risk through us as their assets are held in their own bank.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

Sweetwood Capital Monthly Market Insights

August was mostly positive for risky assets of the major developed economies with lower volatility in the background. On the other hand, safe assets such as investment grade bonds, were trading lower, with the benchmark 10-year Treasury yield starting the month below 1.20% and ending it above 1.30%.

Despite the fast spreading of the Delta variant and the vaccines’ declining efficiency against infection, global data continues to reflect optimism: consumption spending remains high, and we are witnessing a shift from goods to services lately. Two signals confirming that the recovery is on the right path. Also, since the Pfizer/BioNTech Covid-19 vaccine received FDA’s full approval, reopening is expected to accelerate further.

Two huge plans advanced in the US Congress during the summer: the infrastructure bill of $1 trillion, the largest federal investment into infrastructure projects ever made, and the reconciliation bill of $3.5 trillion, which is a social plan that Democrats will try to pass without Republicans’ support. This huge federal cash deployment will be highly supportive to sectors such as infrastructure, electric vehicles, cybersecurity and 5G.

Last week, the Jackson Hole Symposium, the annual Fed members summit in Wyoming, was held virtually, for the second consecutive year. This meeting focused on inflation and unemployment. After Chairman Jerome Powell stated that the economic recovery from the pandemic has exceeded expectations, he confirmed that the time has come to tighten the Fed’s purchase program. Therefore, tapering is now highly likely before the end of the year, while a rate hike is still not expected before 2023.

According to Powell’s statement, the supply chain disruptions (shortages and bottlenecks) alongside wage increases are still the main source of inflation. The spike in some prices is impacting only goods and services affected by the pandemic yet, and this trend tends to disappear with time (for example used cars prices). As for wages, the increase is welcome because it supports a rising standard of living, and it is still consistent with the long-term inflation target.

After the summer break, September will see the return of Central Banks’ meetings. From the Fed we expect more details regarding the upcoming tapering: when exactly, what, how much etc. Of course, a huge focus will be put on the August jobs report, that needs to confirm the “substantial progress” made in the labor market in July. September will also mark the end of the enhanced unemployment benefits from Covid-19, and so we may well have a wave of people returning to work in the US. The ECB’s meeting may be focused on inflation, since the last data released this week showed an unexpected 3% inflation rate in Eurozone, the highest level since 2011.

News from China was less dramatic this month, but the momentum has not yet returned to Chinese stocks. Some investors are starting to think that the new regulatory measures are now coming to an end, but the vast majority still await concrete positive moves in order to build back a bullish sentiment and bring capital back to the world’s second largest economy.

In terms of earnings, it was another strong quarter: 87% of S&P 500 companies reported positive surprises for EPS (earnings per share) and revenue. However, in terms of future guidance, it was split: about half the companies warned of slowing growth for the coming quarters but that’s to be expected after the boom experienced in some sectors during the pandemic.

While closing a seventh straight winning month, it’s hard to remain in the skeptical zone. Also, since the Fed remains very transparent and tapering has been highly predictable for quite some time now, we don’t expect any “tapering tantrum”, as we experienced in 2013. We continue to see stocks more appealing than bonds, and the fact that major financial institutions recently increased their target for US equity indexes comforts us in our overweighting choice.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

An Olympic But Not All Epic Month

On the fixed income side, investment grade bonds rose slightly with the 10-year treasury yield down 24 bps during the month, returning to February levels, at 1.16%. High yield bonds were trading slightly lower.

Rates and policies were left unchanged by both the European Central Bank (ECB) and the Fed, however while the tone remains dovish in the Eurozone, the Fed is already preparing the ground for a future tapering, indicating that it could start with lowering Mortgage-Backed Securities (MBS) purchases before Treasuries.

Another divergence between the Fed and the ECB is how they see Delta Variant impact. If the Fed doesn’t yet consider it as a potential game changer, ECB’s chairwoman Lagarde admitted it constitutes a growing source of uncertainty for the economic recovery.

Regarding inflation, divergence continues between the different Fed members, some of them see it stickier than Powell’s acolytes, who see its effects mainly coming from the reopening of the economy, and therefore transitory. The latest data showed indeed that a surge of 45% year-on-year in used cars prices drove the inflation rate up to 5.4%. However, even Jerome Powell has now admitted that the inflation rate was higher, and that inflation was lasting longer than originally anticipated.

Economic data is still mostly encouraging for the US as well as for the Eurozone. The latest numbers showed that the US economy grew by 6.5% during the second quarter (quarter-over-quarter) while the Eurozone’s GDP second quarter growth came in at 2%, after two quarters of contraction. Regarding the unemployment rate, while it disappointed in the US with a rate at of 5.9%, it was lower than expected in the Eurozone, but still close to 8%. This Friday, the July jobs report will be released in the US, an event highly watched by the Fed and that could be crucial for its future decisions.
After weeks of negotiations, the bipartisan infrastructure package of $1 trillion was drafted and amendments are now being voted for both the plan and its budget. This is a key legislation for Joe Biden’s agenda, and a huge process for the whole US for years to come, with major projects planned for roads, bridges, ports etc.

Once again last month, the bad news came from China as it continues to crack down on Chinese companies, not only from the tech sector but also from the education and healthcare industries. This new crackdown on the private tutoring sector is meant to reduce educational gap between poor and affluent families and lessen the disincentive for larger families, as private education is usually expensive and so it could discourage Chinese couples to have more than one child.

The issue is that becoming non-profit companies overnight makes their stocks practically worthless as well as causes huge job losses right across the industry. Therefore, since restrictions and regulations could possibly hit every sector now, from big companies to small ones, not only foreign investors prefer to stay away, but also Chinese business confidence took a hit, because these kinds of measures tend to discourage young entrepreneurs from building new businesses.

Alongside these moves, The Peoples Bank of China, (PBoC) decided to lower the Reserve Requirement Ratio by 0.5 % to 8.9%, meaning that banks would be able to hold less cash and therefore to grant more credit. Although the PBoC said it was “nothing special”, this cut is seen as an easing tool and is not usually used if growth is doing well. Investors will need concrete moves or announcements to build back a positive sentiment on China, and we assume the Chinese government is fully aware of it. Therefore, the ball is firmly in their court.

To a lesser extent, President Biden signed an executive order last month aiming to expand competition and fight monopolistic practices across all industries. According to him, too much power was given to some companies, and it has resulted in declining standard of living for Americans.

Finally, July marked the second quarter earnings season’ “kick off”. More than half of the S&P 500 companies have reported so far and once again a large majority released better than expected earnings and revenue. But the most interesting fact, is the phenomenal 85% growth in earnings for Q2, making it the highest year-over-year growth rate since 2009. From this level, even if earnings will continue to increase for the future quarters, it will surely be at a slower pace.

There is no fundamental reason to have a negative sentiment on the markets right now, but we stay aware that a slower growth is more than likely. However, with a 10-year real interest rate at historical low (negative 1.17%), equities are still the most appealing asset class, and we cannot afford being underinvested. Also, if inflation is going to pay for governments’ spending, as it seems to be the case for the time being, companies’ stocks will be the first to take advantage of it.

As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

From Inflation to Free Popcorn Bubble

Inflationary pressures remain the focus for now. According to Google, search interest for “inflation” is at an all-time high. It has also been largely discussed during the last companies’ earnings calls, especially the two main sources of inflation, that is the increase of supply costs (commodities, transportation, chip shortage, etc.); and the increase in wages, due principally to the difficulty of finding workers.

It seems that people currently receiving unemployment benefits till September are not in a rush to go back to work. As a result, in order to attract employees, many companies announced increases in salaries. With higher costs leading to increased prices, it does not look to us like inflation will be only transitory, as most of Fed and Treasury officials keep saying.

Note, that the only phenomenon that could be temporary is the comparative economic data which compares current economic performance to last year’s performance. This is at best quasi-irrelevant as last year’s numbers obviously reflect an economy that was then shut down.

While a rate hike is unlikely, the Fed could decide to reduce its bond purchases. Indeed, the release of the latest Fed meeting minutes gave some hints that such a move could possibly be announced during the next meetings – but more likely in July or September than in June. In Europe, the ECB made it clear that no tapering would happen before they see further evidence of a full economic recovery.

May was also marked by progress on the President’s massive infrastructure plan. Republicans made a $928 billion counteroffer to Biden’s $1.7 trillion original plan, proposing the use of existing funds for financing instead of a tax hike. A compromise must be negotiated and accepted by each side in order to pass the bill as soon as possible, as the Democrats wish to do.

On the ETFs side, ESG (Environmental, Social and Corporate Governance) ETFs, encountered more inflows than any other ETFs in Q1 and hit new records in terms of size. In addition, the new Ultra Short Bonds ETF of Vanguard, launched in April, has already raised $730 million, indicating that some cash is seeking to be invested on the sidelines for the time being.

Also interesting was the rebalancing of some of BlackRock’s ETFs. The giant asset manager decided to reduce the concentration and the volatility of its clean energy ETFs by adding a component of “energy transition” stocks, making the thematic ETFs a bit more mainstream. Moreover, it heavily rebalanced its USA Momentum Factor ETF, by switching most of the tech exposure with value stocks, especially Financials that now account for 1/3 of the ETF. An interesting new weighting, that although based on the past six months momentum, gives a clear indication of the outlook according to prominent actors.

Finally, May saw the fall of Bitcoin and the comeback of frenzied trading. After the cryptocurrency more than doubled in value in only a few months, one-third of its value was erased following Chinese regulators’ announcements and Musk’s tweets, both against the digital coin. Also, AMC Entertainment stock that was paired with GameStop during the Reddit saga in January made a comeback as traders’ favorite stock of the month: its shares were up more than 500% in one month only, based on nothing but meme-trendy-viral-trading.

The earnings season for the first quarter showed exceptional numbers and overall good guidance for the rest of the year. Since it is too early to price a rate hike, we continue to believe that, despite the current valuations, equity markets could be further supported. Having said that, everyone who follows the markets this year can feel the fragility and keep expecting the unexpected. In this context, we continue to reduce risk, to be prepared for an eventual sharp pullback.

As always, risk management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

Sell in May But Do Not Go Away…

During the different meetings last month, the various Central Banks, the Fed, Bank of Japan, People Bank of China, and the ECB left rates and policies unchanged as expected.

While the tone was quite optimistic on both sides of the Atlantic, Chairman Powell remained dovish and said the “time is not yet” to talk about tapering. Regarding inflation, Powell emphasized again that the Fed’s focus is on actual numbers and not on forecasts, and even if higher this year, the inflationary pressure should only be transitory.

However, last week Treasury Secretary Yellen shook the markets when she said that rising rates would be a necessary tool against an overheating economy. At the end of the day, the decision-maker regarding the rates is the Fed, but since Powell and Yellen are close, we may legitimately ask ourselves if they do not start questioning the inflation’s “temporary” nature.

During its meeting, the ECB said it would expect to lower bond purchases by the end of the year if vaccine rollout is improving and new variants do not represent a threat to the reopening.

In addition, the European Union plans to launch a Recovery Fund in June, under which it will issue a total of 800 billion EUR within five years, in order to support the post COVID economy.

The Central Banks in China, the US, and Europe are planning or checking a potential launch of a digital currency of their own – a move which may counter the original purpose of the cryptocurrency, a non-regulated coin.

Biden seems decided to finance his plans with tax hikes

In the US, President Biden seems decided to finance his plans with tax hikes: his $2.25 trillion infrastructure plan should be financed with an up to 28% corporate tax hike. He announced a $1.8 trillion children and families plan that should be financed with a tax increase as well. In addition, he proposed a capital gains tax hike from 20% to a 39.6% maximum rate for households making more than $1 million per year.

Of course, with a narrow majority in Congress, such increases will likely be compromised, but still, the tone is set, tax hikes will happen for corporates and for investors. An interesting and historical fact though: US markets tend to perform better in years of tax increases than during years of tax reduction. Food for thought…

On the vaccination side, Biden missed his target of 60% for the end of April. Nevertheless, even with 45% of Americans have received their first dose, restrictions are being eased all over the country. The new target is for 70% of Americans to get vaccinated by July 4th. In Europe, the vaccine rollout accelerated and as of today, 25% of Europeans have received their first jab. Israel is still a world leader with more than 62% of the population vaccinated.

April saw also the kickoff of the earnings season for Q1: so far 87% of the S&P 500 have reported, with 87% beating estimates. US major banks and giant techs reported extraordinarily strong numbers with good guidance, but little or no change was observed in their stock prices.

In the meantime, in China, regulators are focused on giant tech companies, and in this framework, Alibaba was fined $2.8 billion for breaking anti-monopoly laws, the largest amount ever imposed on a company. However, to put things in perspective, it represents only 2.5% of the forecasted revenue of the company for 2021 and the company accepted and complied with the charge without complaint. But for now, big Chinese stocks are under pressure mainly for that reason.

Virtual Climate Summit and the clean energy sector

Finally, a world leaders’ virtual summit on climate took place last month, organized by President Biden, hosting heads of states as well as philanthropists and activists on this matter. They all committed to efforts of lowering carbon emissions. This commitment has supported temporarily the clean energy sector. However, this sector is now suffering again, because of supply chain issues, despite actual good numbers.

Like automakers, renewable energy companies are being hit by the global chip shortage and by the cost of transport which has more than doubled this year. All that weighs particularly on solar energy companies that are in a period of development and investment.

From our side, as volatility and yields stabilize, and market movements on good news are contained, we tend to think that the recovery is now priced in and not much upside is left, at least in the short term. In this context, any bad news could have a strong and unexpected impact. However, for the midterm, two factors are incredibly supportive of the equity markets: first, the huge increase in dividend rates, even to above the pre-COVID levels, and secondly, the huge inflows into equity ETFs.

Indeed, inflows for the first quarter were the largest ever and more than three times the inflows during Q1 2020. If this trend continues, we could reach a total of $1 trillion cash brought to US equity ETFs by the end of the year, more than twice the actual record set in 2017. These facts tell us that there is plenty of money around and it mostly goes to one place, and one place only.

As always, risk management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

When the Black Swan Became White…

The rotation that had already started accelerated until the end of March: out of growth companies and into cyclicals. However, by the end of the month, investors’ appetite reverted into growth stocks and shares in the tech sector jumped again. This is the result of the recent optimism on the back of a quicker than expected economic recovery.

The fast reopening of the US economy is due to the vaccine rollout and the good news surrounding it. In addition to the available vaccines, Novavax vaccine may be approved next month by the FDA and Pfizer announced that tests showed its vaccine was safe for the 12-15 years old. President Biden’s target is now for 60% of Americans to be vaccinated by the end of the month and by that time all Americans should be eligible for vaccination. On the other side of the Atlantic, Europe is still struggling with more lockdowns and tighter restrictions, only 12-20% (depending on the country) having received the first dose.

Investors’ confidence, as well as the consumers’, was also boosted by the approval of the so expected $1.9 trillion stimulus in mid-March, and checks have already started to be received by eligible Americans.

Moreover, the last jobs report put numbers on this optimistic trend: jobs creation crushed analysts estimates, mainly coming from the leisure and hospitality sectors.

The VIX Index, which measures the market stress level, and which was itself volatile until recently, came back to pre-COVID levels, under 20, which represents a buying signal for traders.

Last month we also saw meetings of the ECB, the BoE, and the Federal Reserve who decided to leave rates unchanged and to maintain a dovish tone. The ECB and the Fed tried to reassure investors regarding inflation and rising yields. ECB chairwoman Lagarde said that the central bank will closely monitor the evolution of long-term yields, but she emphasized that it is not the ECB’s role to control the yield curve. However, after weekly bond purchases were relatively low during the first months of the year, the ECB has decided to increase them again.

On the currency side, while the yield differential is widening between the EUR and the USD, the USD strengthened last month and returned to November’s level which will help control inflation.

As for the markets movers of the first quarter, the best sector so far this year has been the Energy Sector, boosted by the performance of the oil price, +22% year-to-date. The price of oil should be sustained further, as during the last OPEC+ meeting, members agreed to maintain the same output for another month and starting from May, to gradually increase production.

On the other hand, the clean energy sector suffered outflows and a strong downside until Biden announced his $2.25 trillion infrastructure plan, in which clean energy is the epicenter. The sector rebounded by 8% on the news, and if signed this summer, this plan should be incredibly supportive to all the ESG linked investments. However, as the financing should come from a corporate tax hike to 28%, a Senate majority will be hard to obtain.

Among the most negative movers so far this year, Asian, US and European investment grade bonds have all sold off since the beginning of the year. Concerning Asian bonds, the strong sell off in both local and hard currency, was especially due to an improving economy in the US but also because of a stronger USD.

Chinese equities also had a negative first quarter but presented a buying opportunity to build a long-term position, on what is still the fastest growing major world economy. Concerning US-China relations, although two major officials from both sides met in Alaska during the last month to reopen talks, two recent events may have increased tensions again. First, Biden said he will not reduce the tariffs for now and secondly China has signed a 25-year agreement with Iran on economic activity and political affairs.

Finally, at the end of the month, a financial scandal shook markets and especially the banking sector: Archegos Capital was forced to unwind some $20 billion leveraged positions, causing a $4.7 billion hit for Credit Suisse. Following this episode, the Swiss bank announced a profit warning for Q1, and some senior managers even stepped down from their roles. Other banks involved with Archegos better managed the risk of margin calls and did not miss the occasion to congratulate their risk management.

The equity markets rebound is a feat when we consider that we just “celebrated” the anniversary of the pandemic’ first wave. This is not just euphoric: the last round of companies’ earnings showed growth. In addition, as the global economy reopens, data and forecasts will also improve. Therefore, we maintain our high convictions, and lately we took advantage of the weaknesses to increase some of our niche investments.

As always, risk management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

Sweetwood Capital provides asset management and investment advisory services to qualified high net-worth individuals. Our aim is to achieve consistent cash-flow generation for our clients through direct investments in transparent and liquid instruments. We offer a highly personalized service and construct investment portfolios that are calibrated to the risk vs. reward preferences of each client. Our clients do not take any counterparty risk through us as their assets are held in their own bank.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.