Weekend Analysis

Given we are still in earnings season with Econ data published regularly, it seems the investors have been largely focused on the on going standoff on the US debt-ceiling talks which continues into this long weekend. We had plenty of positive murmurs in the latter half of the week suggesting the deal was getting close and the the two parties were barely $70bn apart with the sticking points being the work requirements for anti-poverty programs, the funding for the Internal Revenue Service to hire more auditors and target wealthy Americans. But funding for discretionary spending on military and veterans is on.  These leaks from "reliable sources" did rally the Markets but Investors remain on edge over the potential that the US could see a technical default. If this was to happen then we should be aware of the potential implications.  

A technical default will see an increase in volatility in the market. Treasury yields would likely decline, although those maturing shorter-term, around the X-date, could probably rise sharply. Credit spreads will widen and credit default swaps will rise. Equity markets would view any technical default as a risk-off event, and could sell off until there is a clear resolution. Inevitable the USD could take a hit. 

The last time the US found itself in this dilemma was back in 2011 and back then the the S&P 500 slid roughly 18% between July 20, 2011 and October 2, 2011. What is interesting about that decline is that the vast majority of the damage occurred after the 2011 deal was reached. The main factor for markets to consider is likely not to be if a deal is achieved - as a deal is expected at some point - but whether the details materially impact market expectations.

Markets would likely favour looking through any near-term volatility, and instead  focus on longer-term factors impacting relative performance such as Fed policy, or interest rates. 

All the noise around the debt ceiling meant the FOMC minutes released during the week was largely ignored.  The minutes seemed to cement expectations for a pause at next month's meeting with  policymakers in general agreement that the need for further rate increases had become less certain, but some division among officials regarding the path forward appears evident.

However, the Econ data coming out this week suggest the FED has more work to and will be hard pushed not to raise the rates at 14JUN meeting as the inflation still remains too high and is stubborn. The most likely scenario is a rate hike based on Econ data, however if the debt ceiling debate isn't resolved quickly the Fed will most likely not raise rates even if the data suggests it's needed.

A spate of Econ data this week repeated a mantra market participants have memorised by now - the economy's resilient, the consumer is strong, inflation is high, the labour market is tight, and no one wants to sell their house. The week has been a bit of a wake-up call with a realisation that inflation is going to be stickier for a lot longer raising expectations for an imminent rate hike. 

In Econ data, the number of Americans filing new claims for unemployment benefits rose modestly last week, and the prior week's data was revised sharply lower. The four-week moving average, which irons out weekly volatility, moved sideways. The data drives home how tight the labour market remains, with unemployment still hovering near half-century lows and about 1.6 unfilled positions for every jobless worker. It also shows that the growing list of high profile announced layoffs - not to mention tighter credit conditions due to Fed tightening - have yet to put so much as a dent in the labour market. The minutes from this month's FOMC meeting made clear that a more significant loosening of labour market conditions is needed to keep rate hikes permanently off the table

Pending home sales in the US unexpectedly held steady in April amid affordability and inventory challenges.  Annually the contract signings declined nearly 20% in April, though the big picture is that home sales are no longer falling, but a sustained rebound from the current lows remains a fantasy until affordability improves meaningfully.

The US economy grew at a slightly faster pace than previously expected in the first three months of 2023 to show 1.3% quarterly annualized growth. Scratching below the surface, there were upward revisions to business investments, state/local government purchases, consumer spending, imports and exports, and a shallower than previously stated drop in private inventories, which nonetheless remained the largest detractor from the headline number. Stripping out inventories, that headline would be a much more robust 3.4%.

The consumer on whose shoulder sits 70% of the American economy, continues to spend with spending on services bumped a tad higher, adding 1.1 percentage points to the net, but durable goods - which encompasses everything from waffle irons to speed boats - contributed an impressive 1.3 ppts to the upside.

We are nearing the earning season with results from 485 of the S&P500 published. Taking into account the result and estimates of those yet to publish, the Q1 profit estimates are almost positive with a dip of just 0.1% in the first quarter year-over-year against a forecast a 5.1% fall in earnings for the quarter at the start of April.

Further a field, China's yuan slid along with Chinese stocks as the shine comes off expectations of a booming post-pandemic recovery, sending steel prices in the country to a three-year low. The US debt issues are not the only 'ceiling' that Markets are dealing with, as a slowdown in Chinese economic data suggests that a ceiling for growth may be forming as well. 

Germany reported its second consecutive quarterly contraction in GDP, and apprehensions regarding global economic growth have been further fueled and putting additional pressures on the European  Markets. 

And in case you've missed it, the Japan's Nikkei 225 NI225 reached its highest level since 1990. The N225 is up 18%+ year-to-date, while inflows into the most popular Japan ETF began ramping up at the end of the first quarter. Japanese equities are trading at a 5.4% earnings yield (the reciprocal of the P/E ratio), which far exceeds Japan's 10-year, BBB industrial bond yield of 0.84%. In the U.S., the S&P 500 earnings yield and the corporate bond yield consistently trade in tandem. Meanwhile, Japanese earnings are expected to rise 2% over the next four quarters vs a 2-3% decline in S&P 500 earnings. Other factors for this surge are improving corporate governance, the view that US tensions with China have benefited investments in Japan, economic improvement, and a cheap yen.

Nasdaq continued its recent revival, helped largely by Nvidia (NVDA) which dragged other Tech stocks up with it to allow it post a five week bull run and get ever so close to RN13k, a level last breached in AUG22. It has also now dropped out of Bear territory and into the correction zone. S&P scraped in a positive week as well and BO of the RN4200 in the process but remains firmly at this and the CAT Res. DoW posted a Red week to make 3 Bearish weeks out of 4 this month and wipe out all of the gains achieved in April. The Index is still riding its w50MA for support. 

The USD strength continues to affect the CABLE which has posted another Red week to make it 3 in a row and wipe out nearly all of Aprils gains. The pair has week Support with only the w20MA to note and this may not be enough to the halt a further decline to its w50MA/RN1.2 combo. 

In the Sector ETF's we had a very Bearish week with 8 sectors posting a Red week led by Staples (XLP) which also BD its DVI supp. Material (XLB) and HealthCare (XLV) were not far behind. 

Technology (XLK) as would have expected given the NVDA affect was the outperformer and posted its best week since 17MAR. 

Staples (XLP) and Real Estate (XLRE) are now on a four week Bear run. Finance (XLF) and Discretionary (XLY) are now on a 3 week Bull run with the former heading up towards the Improving quadrant and the latter further establishing itself in the Leading quadrant. 

For next week we have the Manufacturing PMI across US and China, the German CPI and US unemployment claims. However the star of the week will be the NFP data on Friday. 

So with the week being book ended by Bank Holiday and the NFP, this will be a very strong stand aside week for us. 

Enjoy the the long holiday weekend and hope it is as sunny wherever you are as it for me in sunny Surrey. 

Anil Dala

Let's go trade!