Where Are We Headed?
This weekly is on the early side and I am wary of what Friday brings, especially as the debt ceiling saga gives rise to further bond market volatility.
Welcome to the first Weekly of 2023. In this week’s update the markets have had a strong start to the new year as inflation lowers. There is a growing view that interest rates may start to decline either this year or next and given all that happened last year, equities are also looking undervalued.
Continue reading for the full market update.
Markets are off to a strong start with equities already posting good gains. The main driver is the improving news on the inflation front that has prompted the idea rate hikes will moderate from here. This has resulted in a clear “Risk-On” feel. Looking at the table below, the Volatility Index (VIX) is down to just over 18, a decline of over -42% these past three months. This should come as no surprise – that’s when headline inflation began a turnaround. There is a growing consensus view interest rates might start to decline. I think this is unlikely this year – unless we hit a slow patch – otherwise, rate reductions are more likely to follow next year. This means with declining headline rates and unchanged interest rates, monetary tightening will continue. Key highlights since the start of the year:
For reference, the US, China, Japan, Germany and India account for the top 51% of global GDP. If you throw into the mix the wider European region, plus the UK, it jumps to about 64%. Given all that happened last year, there are a lot of undervalued equities. Look at the map below (courtesy of Invesco):
So any combination of declining geopolitical risk and / or improving inflation / steady rates / rising consumption can easily change valuations quickly at the margin. The “P” (price) in “P/E” (Price to Earnings) will expand very quickly…..and with markets already down some -20% in 2022, it’s not a bad starting point. Investors have already snapped up some $39bn Emerging Market sovereign bonds. There’s a clear sign they are willing to deploy cash for “Risk-On”. Saudi Arabia (investment grade) sold $10bn of 5y, 10y and 30y bonds. Turkey sold $2.75bn Eurobonds at 9.75% (beware Turkey though but, even by Turkey’s standards, this is high).
For w/e 11th January, global equity funds received their first boost in inflows for ten weeks attracting $5.17bn as inflation headlines start to moderate. Europe gained $7.35bn and Asia $1.54bn. The US saw outflows. Industrials, Financials, Consumer Discretionary benefitted; Technology still saw outflows. Global bond funds saw net purchases of $16.92bn while MM funds $13.37bn.
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