Market insights – October 17, 2023

Written by Daniel Varela, Chief Investment Officer | Oct 17, 2023 10:00:00 PM

US headline inflation took a pause in its downward trajectory in September, even though energy prices rebounded amid a tense geopolitical climate. But core inflation – the US Federal Reserve’s (Fed’s) preferred metric – continued to ease back to normal levels. This makes it unlikely that the Fed will raise its policy rate at its November meeting.

LVMH was the first luxury goods company to report its Q3 earnings, which included a 9% increase in revenue. Its share price fell on the news, suggesting that investors hadn’t fully priced in management’s earlier conservative guidance. The luxury goods sector as a whole has shed over 20% since May, which in our view is creating opportunities.

Gold rallied to USD 1,940 per ounce last week on the back of fresh geopolitical concerns in the Middle East. But despite this upswing, we believe gold is still in a consolidation phase and that any lasting trend reversal will depend on movements in interest rates.

US – consumer spending is holding up well

The US economy continues to defy extremely bearish forecasts. But although consensus estimates have improved in recent months, most economists still think the US is on the brink of a recession. We, however, believe that, barring any unforeseen financial mishaps, US growth will slow but a recession will be avoided. With the current round of rate hikes likely at an end, the Fed has managed to steer the economy to a soft landing. It’s largely thanks to consumer spending that the slowdown was not more abrupt. Unemployment is very low and wages are rising, which has prompted consumers to keep spending despite the gloomy international environment and the sharp rise in borrowing costs. The services sector has done well out of this trend and continues to drive growth. That said, the manufacturing sector seems to have moved past its rough patch – the ISM’s PMI has bottomed out and is now heading upwards. In the past, stock markets have gained ground in this kind of environment, so the US stock market should start moving upwards again after its summer slump. The S&P 500, Wall Street’s flagship index, is up by more than 20% on last autumn’s lows, confirming that the 2022 bear market is well and truly over and another bull market has probably begun. If we look back over the period since the 1950s, bull markets have tended to last for five years on average and to deliver a total return of around 180%. The current market rally in the US is still in its early stages, so there’s likely to be plenty more upside potential. In the near term, concerns about a potential US government shutdown in November have sparked volatility in the stock markets. But the prospect of this risk materialising will likely prevent the Fed from hiking rates in November, despite the slight uptick in inflation caused by the strong rise in oil prices.

Bond yields should soon peak

Disinflation is under way pretty much around the world. Consumer price indexes in developed countries are still a little high, but they should drop back to their pre-Ukraine war levels in 2024 or, at the latest, in 2025. Slowing price growth was first observed in manufactured goods and is now reaching the services sector. In the US, for example, rents are finally starting to decline after rising sharply in recent months. This will have an immediate knock-on effect on core inflation, as rents are the main component of that indicator.

Central banks appear to be on the cusp of winning the war on inflation, which means the rate hikes enacted in recent weeks are likely to be their last ones for the time being. That should provide a boost to the bond market, which again struggled over the summer. Yields were sharply up everywhere but Switzerland. US 10-year yields, for example, reached their highest levels since October 2007. At their current level (4.7%), they’re easily making up for inflation expectations over the next decade (2.5% per year). High real yields seem to suggest that nominal yields are close to topping out. As a result, sovereign bonds should once again become an attractive investment, after several years of low or even negative yields. In the lower-quality bond segment, hard-currency emerging-market debt looks like an attractive source of diversification. Their current risk premium (the yield pickup versus investment-grade paper) is quite significant. With a few exceptions, emerging markets have weathered the global slowdown quite well and appear poised for a steeper and stronger recovery than developed countries.

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