2 December 2022
Weekly Market View
Santa Claus rally?
The last quarter of the calendar year is historically one of the strongest quarters for risk assets. This year, global stocks have already rallied around 15% from the start of the quarter on expectations of a peak in Fed rates in H1 2023 and a faster relaxation of mobility restrictions in China.
The S&P500 index now faces major resistance. A break higher is possible if inflation slows. However, we believe fundamentals do not support chasing the rally into 2023. Records show none of the US bear markets in the past 100 years ended before the associated recession has begun.
We expect a recession to start in the US and Euro area by mid-2023. More indicators are flashing warnings. The evolving scenario calls for a defensive allocation. In the following pages, we discuss some of the cyclical and tactical opportunities.
Should we chase the rally in Hong Kong and Mainland China equities?
Is credit risk in Developed Markets likely to escalate given rising recession risks?
What are the tactical opportunities arising from the recent USD slump?
Charts of the week: Challenging technicals and fundamentals
The US equity rally is facing technical resistance, while bond markets are signalling heightened risk of a global recession
S&P500 index, with 200-day moving average (DMA)
Global and US government bond yield curves
Source: Bloomberg, Standard Chartered; *Fed’s preferred recession indicator: implied yield on 3m T-bills in 18 months minus 3m T-bill yield
Editorial
Santa Claus rally?
The last quarter of the calendar year is historically one of the strongest quarters for risk assets, with global equities delivering an average 3.6% return since the turn of the century. This year, global stocks have already rallied around 15% from the start of the quarter on expectations of a peak in Fed rates in H1 2023 and a faster relaxation of mobility restrictions in China. The rally has helped investors recover some of this year’s losses. The S&P500 index now faces major resistance around 4120 (top of a downtrend channel since January). It could potentially break higher if we see signs of inflation slowing. However, we believe fundamentals do not support chasing the rally into 2023. Records show none of the US bear markets in the past 100 years ended before the associated recession has begun.
We expect a recession to start in the US and Euro area by mid-2023. More indicators are flashing warnings. This week the global bond yield curve inverted for the first time in 20 years. This follows inversions of several US government bond yield curves (see chart). In November, the US ISM Manufacturing index fell into contractionary territory (below 50) for the first time since the depths of the pandemic, and the forward-looking ISM New Orders PMI remained below 50 for the third straight month. Moreover, the Chicago PMI plunged below the critical 40 level which has historically signalled an imminent recession. In Europe, the German government bond yield curve inverted from one year out, a rare occurrence which has historically led to a recession in Europe’s largest economy.
The deterioration in activity data signals pain ahead for US and European corporate earnings and, by extension, equities, since earnings estimates in these markets have not yet factored in a recession, in our opinion. Central banks are unlikely to come to the rescue soon enough. This week, Fed Chair Powell did signal a likely slowdown in the pace of rate hikes from this month but hastened to add that there is still “a long way to go” to restore price stability (US core PCE deflator rose 5% y/y in
October). He also reiterated that the Fed terminal rate will likely be “somewhat above” the 4.75% projection in September. This implies that the Fed is likely to keep hiking rates into 2023 after possibly delivering a 50bps hike to 4.5% on 14 December. Meanwhile, ECB President Christine Lagarde warned that the central bank must continue to hike even as the economy weakens into 2023 as inflation remains well above its 2% target (Euro area core inflation was 5% y/y in October).
Investment conclusions: The evolving scenario calls for a defensive allocation. This involves, among others:
- Fading any US and European equity rally going into Christmas and rebalancing into Investment Grade bonds and other income assets. Bond yields at multi-decade highs offer attractive income as investors wait out the coming downturn.
- Within equities, rebalance into Asia ex-Japan equities, which are still inexpensive and have the tailwind of China’s sustained policy stimulus and a gradual normalisation of economic activity (see page 4). Major Mainland China cities including Guangzhou this week relaxed mobility restrictions after authorities unveiled a plan to accelerate vaccinations. The USD’s 9% decline since its 20-year peak in September amid lower US government bond yields is also likely to revive flows back into Emerging Markets.
- In the US, rotate into more defensive equity sectors, such as healthcare; the energy sector remains preferred in the US and Europe given the sector’s strong earnings outlook.
- With increased recession risks, we see tactical opportunities in FX: we expect EUR/JPY and GBP/USD to weaken (page 5).
What we are watching: US payrolls (consensus: 200,000 jobs); OPEC+ meeting on Sunday to decide whether to cut output; EU agreement on the price cap on Russian oil exports before embargo starts 5 Dec; US Services PMI (consensus: 53.5); Euro area retail sales; and China exports (-4.8% y/y).
— Rajat Bhattacharya
The weekly macro balance sheet
Our weekly net assessment: On balance, we see the past week’s data and policy as neutral for risk assets in the near term.
(+) factor: China reopening, slower US rate hike signal, softer inflation
(-) factor: Contractionary China, US PMIs, strong US job openings
The Fed is likely to keep hiking until US job openings decline significantly, even if activity indicators point to increased risk of a recession
US job openings (JOLTS), ISM Manufacturing and Chicago PMI
Euro area consumer inflation appears to have peaked, although still-elevated core inflation means the ECB is likely to continue hiking rates
Euro area headline and core consumer inflation
We expect China’s economy to recover in 2023 as easing mobility restrictions and easier credit policies revive consumption and business activity
China’s manufacturing and non-manufacturing PMIs
Top client questions
Should we chase the rally in Hong Kong and Mainland China equities?
After dipping briefly at the start of the week, Chinese equities saw strong buying interest in recent days, as seen by the volume in the Hang Seng index this week being 2.5x the average daily volume in H2 22. The easing of mobility restrictions in key Mainland China cities such as Guangzhou and the central government’s plans to boost the vaccination rate among elders have fuelled expectations of further relaxations. These moves, coupled with the “third arrow” to support the property sector, allowing Chinese developers to raise equity to repay debt and fund acquisitions, propelled the Hang Seng index to break key technical resistance levels of 18,400 and 19,200.
We believe further economic reopening would favour sectors that benefit from a rebound in consumption. The Communications Services sector, in our opinion, offers attractive risk-reward in this regard. The sector’s earnings have beaten expectations, and positioning in the sector remains relatively less crowded, based on our measures of investor diversity.
We would consider averaging into Chinese equities on pullbacks. Key support levels for the Hang Seng Index are at 17,400 and 18,100, representing the 61% and 76% Fibonacci retracement levels for the trading range since the end of October (14,600 to 19,200), while 3,767 is a key level of support for the CSI 300 index.
— Daniel Lam, CFA, Head, Equity Strategy
The Communications Services sector in China may benefit from easing mobility restrictions
Earnings revisions* for MSCI China Communication Services and MSCI China indices
Earnings revision = 3 months moving average of (number of earnings upgrades / number of earnings downgrades – 1)
Is credit risk in Developed Markets likely to escalate given the elevated recession risk in the US?
With the Fed policy arguably already at restrictive levels, we believe the recession risk has surged amid tight financial conditions. We observe the corporate bond market is also starting to price recession risk, as illustrated by some portions of the global bond yield curve turning negative (inverting), with investors likely starting to add more longer maturity bonds to lock in long-term yields.
Against this recessionary outlook, corporate credit quality is likely to deteriorate as corporate earnings growth slows and interest burden piles up, resulting in a widening of corporate bond yield premiums (spreads over government bonds). However, we expect this impact to vary considerably across different types of corporate bonds. For Developed Markets (US/Europe) Investment Grade (IG) corporate bonds, we expect the impact to be contained for two reasons. First, credit rating upgrades of IG bonds continue to outpace downgrades, which, in our view, reflects their relatively strong balance sheets and resilient business profiles to weather a recession. In addition, most issuers have pre-funded and strengthened their capitalisation in previous years of low interest rate environment. Hence, despite the possible risks from a recession, we retain our preference for DM IG corporate bonds.
— Cedric Lam, Senior Investment Strategist
Credit rating upgrades in DM IG bonds continue to outpace downgrades, albeit at a slower pace
Credit ratings 1Q 2018 to QTD 4Q 2022
Top client questions (cont’d)
What are the tactical opportunities arising from the recent USD slump?
Fed Chair Powell’s comments this week, where he guided markets towards a slower pace of rate hikes than before amid signs of softness in the job market and elevated recession risks, pushed US government bond yields and the USD index (DXY) lower. As a result, November was the worst month for the USD since 2010. Given this rapid adjustment over the past month, we see a high likelihood of a period of consolidation for the USD, with the 200-dma at 105.50 and Fibonacci retracement at 104.70 acting as key supports.
On a tactical (2-4 week) basis, we see two opportunities in FX markets:
- With most major G10 central banks (with the notable exception of RBNZ) softening their rate hike stance modestly, we see scope for the JPY to extend recent gains as markets start to price in a narrowing of interest rate differentials. In particular, we expect EUR/JPY to head down towards the 141.00-141.50 range.
- GBP/USD is starting to look stretched after the nearly 17% bounce from the September 2022 lows. With the UK’s challenging growth outlook, we see elevated risk of an incrementally more dovish BoE as well. This means GBP/USD could decline to retest the 1.1700-1.1790 support in the next few weeks
— Abhilash Narayan, Senior Investment Strategist
The USD delivered in November the worst monthly return since 2010
Monthly return for the USD (DXY) index
Market performance summary*
*Performance in USD terms unless otherwise stated, 2022 YTD performance from 31 December 2021 to 01 December 2022; 1-week period: 24 November 2022 to 1 December 2022
Our 12-month asset class views at a glance
Economic and market calendar
The S&P500 index faces resistance around 4,119
Technical indicators for key markets as of 01 December close
Investor diversity has improved for gold in the past month
Our proprietary market diversity indicators as of 01 December
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