After lifting restrictions in May 2021, South Korea has again banned short selling, this time until June 2024. The measure, which takes effect immediately, should prompt a rally in the short term. However, it could also mean that MSCI holds off on its decision on whether to include South Korea in its developed markets index.
Investors do not appear to be focused on the conflict in the Middle East, but oil prices nevertheless remain extremely volatile and still offer a major geopolitical premium. However, we don’t think demand will rise fast enough in the short term to justify that premium.
Unexpectedly, industrial orders in Germany rose slightly in September after picking up sharply in August. Other key leading indicators, such as the IFO (manufacturing survey) and the ZEW (financial market survey) also improved. This suggests that the German economy may have bottomed out in the third quarter.
Opportunity on US bonds
In the space of just three years, US 10-year yields have risen tenfold. Back in autumn 2020, long-term US dollar yields stood at 0.5%, having been dragged down by concerns about the COVID-19 pandemic and its impact on both the US and the global economies. Since then, yields have risen steadily, peaking at around 5% in October, a level we hadn’t seen since the summer of 2007.
This sharp rise in yields has not been good news for the US bond market. While it’s true that 2022 will no doubt be remembered among investors as the year of the worst-ever bond crash, with prices falling by over 15%, the length of the current correction won’t be easily forgotten either.
The USD fixed income market has now posted losses for three years in a row, which is an extremely rare occurrence.
Luckily, we seem to be nearing the end of the current correction, as the factors that pushed up yields are starting to return to normal. In particular, the surge in inflation that took hold in both the US and around the world in recent years has ended and we’ve now entered a period of disinflation. Falling commodity prices meant that this easing of inflation was initially felt in the prices of goods, although it is now spreading to the prices of services as well. On top of that, the economy has slowed and the labour market has loosened, which has reduced the risk of second-round effects and prevented a wage-price spiral. So, after tightening monetary policy sharply, the US Federal Reserve (Fed) – like other central banks around the world – is now taking a pause. Its next move will be to start cutting rates, probably sometime in 2024.
Given these factors, we think it’s unlikely that 10-year Treasury yields will rise above 5%. The time is therefore right to expand our portfolios’ bond holdings. In our allocation grids, we’re upping our exposure to USD fixed income and reducing our exposure to commodities (energy). Although the yield curve is relatively flat, we think it’s worth investing in longer-dated securities, which will offer more upside when interest rates begin to fall.
USA – a decisive change in tone
The S&P 500 rose by 5.85% last week, making it the best week so far this year for the US index. But how did it manage to gain so much ground in the midst of all the geopolitical uncertainty and now that the earnings season is more or less over?
The rebound can be put down to Jerome Powell’s change in tone at the Fed’s November meeting, when he announced quite a drastic shift in the bank’s monetary policy. As there have been no nasty surprises on the inflation front, the Fed has now finished tightening its monetary policy and the likelihood of further hikes is close to zero.
This will have a major impact on stock markets, especially after the recent correction caused the S&P 500 price/earnings ratio to contract by three points. If interest rates start falling, equity valuations will likely do the same, which bodes well for the traditional year-end rally. Better still, expectations of a rate cut before June 2024 are rising sharply. And while it’s still too early to tell whether these expectations are well founded, the current improvement in forecasts will provide a major boost to the stock markets.
And technically speaking, last week’s rebound suggests that the uptrend could continue over the coming weeks. We’re therefore maintaining our constructive stance on US equities.
Author
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Daniel Varela holds a degree in business administration with a specialisation in finance from the University of Geneva and began his career in 1989 as a fixed income manager. He joined Banque Piguet & Cie in 1999 as head of institutional asset management and with responsibility for bond analysis and management. In 2011, he became head of the investment strategy and Piguet Galland's investment department. In 2012, he joined Piguet Galland's Executive Committee as CIO.
