Note Aug. 18,2023: Not Lazy, Hazy Summer for 2023. It is not a lazy, hazy summer for 2023, neither climatologically from droughts to floods to wild fires and nor for risk premiums versus momentum in capital markets. The war in Ukraine has revived talk about a new cold war but the Soviet system was not an equal. It is currently more apt to recall the long turn of the 19th century rivalries amid the emergence of then new technologies of steam/steel/textile. From military to economic footprints, the existent competition between the United States and China is of quantum difference from the cold war. Then as now with 5G and cloud computing in emergence, new technologies then did not salvage momentum investing amid a lack of risk control. As valuation imbalances are addressed via volatile capital markets, we expect FICCs and equities linkages to rise.
Into their August 25, 2023 Jackson Hole gathering, major central banks face differential challenges. Many governments also did not use the quantitative ease period to strengthen fiscal balance. Unlike its earlier stable locomotive role, deflation and excess credit press in China. Despite recovery, Japan seems espousing minuscule rates. For many OECD countries, inflation seems stubborn at well above 2%. Further Fed Funds rate increases to 6% seem likely as are other major central bank rate increases from differentially lower levels. With more stable exceptions like India, in emerging countries appear high inflation and currency stress. Unlike 2008 to 2021, currency turmoil is likely, among even major economy countries.
Amid technology driven change, war and natural catastrophe, commodities realities contrast with conventional assumptions of being late cycle investments. Scandal in cryptocurrency underscores precious metals as diversifiers. Commodity related events compounded with fiscal deficit pressures appear likely to further sensitize credit quality criteria. Emergent already are signals of “sell what you can” in Fixed Income liquidity.
As 10 year U.S. Treasury note yields approach 5%, the pressures are likely to rise on rationalizing yield tranches, including between the currencies of fixed income denomination.
Exogenous and internal aspects favor quality as capital market criterion, including rebalance in equities between momentum and valuation. About momentum, an alternate reality appears in the S&P 500 actually peaked in late 2021. In 2023 to August in weaker global growth and extended inflation, geographical rotation has been conventional with the U.S. among the lead, a twist of hope of Japan restructuring, lag from Europe and emerging areas tentative pending tangibly stronger global growth.
In equity markets in a hot and cold tryst with momentum, valuation globally is not low. The S&P 500 as benchmark is some 16x a fulsome consensus estimate for 2024 operating earnings. Consensus appears tardy in readjustment to a more challenged period. In the first two quarters of 2023 corporate results, margins appear declined to more sedate levels, companies more circumspect and cutting costs. Financing costs appear rising. For the globally crucial financial services sector, capital strengthening controls appear likely to expand due to inadequate risk control exposed in segments of U.S regional banks and European SIFIs.
In asset mix, we favor for shorter duration in fixed income and for precious metals as diversifier. In equities, facing readjustment expected to encompass markets globally, geographical rotation seems secondary. As primacy, we expect bifurcation of delivery within sectors and favor quality, with balance a priority overall, for instance about Information Technology weightings.
It is not a lazy, hazy summer for 2023, neither from droughts to floods to wild fires climatologically and nor for risk premiums versus momentum in capital markets. Also, requiring attention are geopolitical and political economy stresses. The war in Ukraine has revived talk about a new cold war. The post world war period into 1990 did involve sharp military and political rivalries. However, the Soviet system was not the equal of the political economic world then dominant. While no two eras are the same, it is currently likely more apt to recall the turn of the 19th century rivalries and events that were to dominate for close to a century. In both the military and economic spheres then, the emergence of the steam/steel/textile technologies era also coincided with the rivalries (and collapses) of empires. In that period as well, new technologies did not salvage momentum investing as evidenced in a lack of risk control that raged from Argentinean farmland to the Suez Canal. Hence across FICCs and equities, capital markets were volatile and currently have the potential to require addressing internal valuation imbalances amid external pressures.
Currently, evolution surges of high technology into every facet of personal, business and governmental activity in advanced and emerging countries alike. There can also be little doubt that from military to economic footprints, the existent competition between the United States and China is of quantum difference from the cold war rivalries of the West and the Soviet system. Further currently is the reality that many governments did not use the quantitative ease period to strengthen fiscal balance and instead extended deficits. These aspects mean that rather than ignoring risk as momentum market phases have practiced now for years, more linkages and hence stresses are likely to be driven by valuation, including between FICCs and equities.
Into their August 25, 2023 Jackson Hole gathering also present are the differences in the challenges faced by central banks. Far from being the stable locomotive of the first decade of the 2000s, deflation and excess credit now appear as challenges for China and it has been signaling ease. Even as Q2/2023 economic recovery in Japan seems expanding at upper G-7 levels with inflation at several decade highs, Japan has been espousing minuscule rates, resisting change. With varying shades of grey, many OECD countries and certainly within the G-7, inflation seems likely to be stubborn at well above their benchmark 2% levels. It follows for the Federal Reserve to contemplate further Fed Funds rate increases to 6%. From well below those levels, also likely are other major central bank rate increases. Meanwhile, with more stable exceptions like India, in emerging countries from Argentina to Russia to Turkey appear high inflation and currency stress. More than was the case from 2008 to 2021, currency turmoil is likely among even major economy countries and not just in the emerging lands already demonstrating such.
Currently in capital markets, linkages appear overdue for expansion between currencies, commodities and fixed income (FICCs) with equities. As a result of ongoing events ranged from wars to economic rivalries and from natural catastrophes of floods, wildfires and droughts, commodities have the propensity to behave quite unlike the conventional assumptions of being late cycle investments. The emergence of security, clean energy, cloud and 5G technology requirements extends this propensity. Meanwhile, scandal in cryptocurrency underscores the role of precious metals as diversifiers in portfolios. Commodity related events compounded with fiscal deficit pressures appear likely to further sensitize credit quality criteria that have already appeared in Chinese real estate and junk corporate U.S. bonds. Some signals appear of “sell what you can” in Fixed Income liquidity, for instance with 30 year U.S. Treasury Bond and 10 year Note and BBB corporate fixed income yields at 12 month highs. By contrast, despite facing increased debt service pressures and poorer credit quality, CCC corporate and aggregate emerging country fixed income market yields are up but still at closer to 12 month lows. With lessened quantitative ease and increased administered rates as being core factors, there appears room for increases in fixed income rates and even for sovereign bond rate turmoil within the G-7. As 10 year U.S. Treasury note yields now approach our long held target of 5%, the pressures are likely to rise on rationalizing yield tranches, including those between the major currencies of fixed income denominations.
Numerous exogenous and internal events favor quality as criterion within capital markets. It includes exerting pressures for rebalance in equities between momentum and valuation. During unfettered quantitative ease, momentum activity was dominant in equities and flared well into early Q3/2023. An alternate reality appears in that equity indices such as the S&P 500 actually peaked out in late 2021. In 2023 into August during a period of weaker global growth and extended inflation, geographical rotation has been conventional with the U.S. among the lead, with an added twist of Japan restructuring expectations, lag from Europe and emerging areas being conventionally tentative pending tangibly stronger global growth stability.
In equity markets in a hot and cold tryst with momentum, valuation globally is not low when considering the S&P 500 as benchmark is at some 16x a fulsome consensus estimate for 2024 operating earnings. The first two quarters of 2023 corporate results have been released. We see corporations as being much more circumspect than consensus and to be cutting costs, even in such momentum favorites as media and information technology. From the new peaks of operating margins of late 2021, more recent actual operating margins appear back down to more sedate levels. Meanwhile, financing costs appear likely to rise alongside central bank tightening from the Federal Reserve and beyond. Yet from what has been a boilerplate annual expectation of 10% growth for S&P 500 earnings and at odds with events, consensus earnings estimates appear tardy in downward readjustment for 2023 and 2024.
For the globally crucial financial services sector, more capital strengthening controls appear likely in reaction to potential Basel 3 strictures and for cohort expansion after the tumult earlier in 2023 exposed of inadequate risk control in segments of U.S regional banks and European SIFIs. Sovereign debt weaknesses also appear latent but are present as a result of unusually, fiscal structures not being strengthened during prior times.
In the asset mix context, we see favor for shorter duration in fixed income and for precious metals as diversifier. In equities, facing readjustment to a change of reduced overall circumstances, we expect such redress to encompass markets globally and hence for geographical rotation to be secondary. As primacy, we expect bifurcation of delivery within sectors and favor quality overall as well as balance. For instance for balance within growth, from such momentum favorites as media and information technology at cap, we would favor Consumer Staples at market and Healthcare at overweight. Restructuring financial services are likely to be a crucial benchmark as well. E.o.e.