2023 January Market update - US & Euro Area

Bond Yields

have fallen in January.

1. Data seems to indicate inflation likely peaked in 2022 and markets could be pricing an end in interest rate hikes 2. The more likely reason: After years of struggling with a low interest rate scenario, Pension funds are derisking from equities and buying bonds at current yields. 3. The market could be pricing in a recession.

Risks: inflationary pressures could persist due to oil. Prices of US crude per barrel is trading in a range between US$ 73 and 81 since Nov 2022. Geopolitical escalation could see prices rising once again.

Inflation & Interest rates

While it is true that inflation shows signs of cooling off, it is too early to call it a win. Inflation is nowhere near the target rates set by central banks in the US and EU.

In the US, CPI has fallen from 9.1% in June 2022 to 6.5% in December 2022. This is still well above the 2% target rate of the Fed, in addition to which Services PMI continues to rise (in yellow).

In the Euro Area, inflation has dipped to 9.1% in December 2022 from a high of 10.6% in October but remains much above the 2% target rate by the ECB.

Monetary tightening is likely to continue, perhaps at a lower pace than imagined earlier. From April to December 2022, the Fed has reduced its US$ 8.8T balance sheet by US$ 500Bn.

The ECB has also begun to shrink its balance sheet.

The Fed is scheduled to announce its interest rate decision and monetary policy on Feb 1, 2023 while the ECB is scheduled to announce on Feb 2, 2023.

GDP

In the US: Real gross domestic product (GDP) increased at an annual rate of 2.9 percent in the fourth quarter of 2022, after increasing 3.2 percent in the third quarter.

According to the US Bureau of Economic analysts, Consumer spending set off the decline in housing investments in Q4 2022.

While there has been an increase in the YoY Consumer Spending data between Q4 2022 and Q4 2021 - it does look like consumer spending is flattening out. It will be interesting to analyze the data over the next few months.

In the EU: according to data released on 31Jan2023, the GDP grew 0.1% QoQ (beating analyst estimates of negative growth) and 1.9% YoY.

Equities

Stock Indices are off to a flying start in January in US and Europe.

With unemployment continuing to remain at multi year lows and inflation cooling off from its highs, investors are leaning towards a shallow recession (if at all). According to recent article, analysts in the US are divided on if there will be a US recession and its likely depth.

165 companies of the S&P500 have reported earnings. EPS shows a negative growth of -2.4% YoY and companies are warning of weaker outlook through this earning season. The current PE ratio of the index is 18.1 (earnings yield of 5.5%).

Interest rates: The current yield on a 2Y US Treasury is 4.2% which makes the bond more attractive in the near term from a risk-reward perspective. US equity investors are pricing in a Fed "pivot" and are optimistic of a "soft landing" of the economy.

In Europe, 386 companies of the Stoxx 600 index have reported earnings.

EPS has grown 7% YoY. Analysts have estimated earnings to bottom out in Q2 and Q3 this year. The index is currently trading at a forward PE of 12.8 (an earnings yield of 7.8%).

Compare that to the German 2Y bond yield of 2.6%, it makes equities a more attractive investment at this time.

A likely reason for the YTD out performance of the Dax and EuroStoxx 50 indices compared to the Dow30 and S&P500.

With the current uncertainty in corporate earnings as well as global macro, markets appear optimistic. There is even talk of a beginning of a new bull market. Add to this a familiar adage among investors: "as goes January, so goes the year." All considering, it may be better to err on the side of caution.