Hassium Market Thoughts 27th October 2023
Hope you are well. News flow this month has been dominated by the Israel-Hamas conflict with global equity markets -3% for the month and -10% since the end of July. Despite this decline, US equity markets remain +10% YTD, Europe +10%, UK +2%, and China -1%. Whilst markets have slowly adjusted to the conflict narrative, peak earnings season, stronger than expected US GDP and an ECB rate hike pause have provided some support. The Israel-Hamas conflict will likely continue to escalate and potentially broaden in scope, though oil prices have not traded higher. We are seeing a significant humanitarian crisis and our thoughts go out to all those touched by these recent and sad events. How and if this impacts on financial markets longer term remains unclear.
Despite the conflict, investors remain focused on Q3 earnings season, inflation and rate hike expectations, with the ongoing Russia-Ukraine conflict continuing to be largely ignored. Technology names remain robust with NASDAQ +22% YTD along with Japan +19% YTD. We remain cautious equities and expect a range bound market into Q4 supported by strong earnings, no meaningful change to rate hike expectations, and slowly declining inflation. Despite the Israel-Hamas conflict our focus remains on the US economy in 2024. We are assuming no change in interest rates, GDP growth of +2% and core inflation at +3%. We retain our underweight exposure to equities for now after taking profits earlier this year and again this last month.
In the US a recession has been avoided. The S&P 500 is +10% YTD and -2.5% MTD with the Nasdaq +22% YTD and -4% MTD. Inflation is at +3.7% and is directionally on route to normalisation without rising unemployment at +3.8%. The valuation of US stock markets has adjusted with forward PE multiples at 19x. Q3 earnings of -0.4% and revenue growth +1.8% is already priced, with Q4 earnings +6.7% and revenue growth +3.9% expected. Guidance will be key as seen with Meta and Amazon, and more recent geopolitical events. US interest rate expectations have adjusted to inflation with 3 rate cuts (not hikes) now priced in by 2025. The UST 10 year has risen to 4.9% in recent weeks. Currency markets remain unchanged with USD strength which is +27% overvalued versus EUR and +17% overvalued against the GBP on a PPP basis.
In Europe, equity markets are +10% YTD with forward PE 11.4x. Recent PMI data has been disappointing. Previous estimates of recession in Europe have now passed with European GDP +0.5%. The rate hike pause yesterday on the back of the Israel-Hamas conflict was largely expected. European markets have benefitted from low valuations, defensive sector exposure, and lower energy prices. A weakening EUR has also provided support with the USD +27% overvalued versus EUR. Inflation in Europe has declined and is now +5.2% with markets expecting no further rate hikes and a first cut by the summer 2024. We are constructive European equities which look oversold.
In the UK the FTSE 100 is +2% YTD with forward PE 10.3x. Equity markets seem to be ignoring the domestic picture and have been supported by a weakening GBP to 1.21 which is 17% undervalued versus the USD. The Gilt market has strengthened with the 10-year yielding 4.6%. Inflation has moderated but remains high at 6.7%. UK rate hike expectations have adjusted with no hikes or cuts expected though yields remain high. We are neutral the UK and recently trimmed our overweight position to the GBP.
In China sentiment remains mixed with markets -1% YTD and -4% MTD. The end to the zero covid policy did see an improvement in economic activity and earnings but this firmly behind us. Geopolitical risk remains high with US trade issues escalating, tension regarding Taiwan, and China’s potential alignment with Russia. Domestically, investors remain concerned about debt levels in the real-estate market. Equity markets have been supported by weakening Yuan -6% versus USD YTD. Announced currency intervention measures have clearly helped. GDP growth has declined to +4.9%. We note $17.9 trillion economy growing at +4.9% is still very significant. From a longer-term technical perspective China is circa. 3.2% of MSCI All World, but is the second biggest economy in the world, which should support equity inflows longer term. Short term we remain cautious, longer-term we are positive.
In Japan investor sentiment has improved with markets +22% YTD and forward PE 20x. Japan remains a good way for investors to get indirect exposure to Chinese growth without the geopolitical risks. Japan domestically has also undergone a meaningful change in corporate governance with companies returning cash to shareholders. Japanese inflation (not deflation) is high at 3%, and GDP has been lifted +1.6% by the post covid reopening to tourism and stronger capex. In addition, many investors are underweight Japan supporting equity inflows longer term. We are constructive Japan.
Our outlook for 2024 remains cautious but constructive despite the Israel-Hamas conflict. We remain underweight equities going into year-end and overweight bonds and cash following the ongoing adjustment to higher yields. We continue to take profits where we can with a view to buying equity markets trading at discount over the longer term. We see a weakening USD longer term and stable oil prices. We continue to focus on the US economy, US earnings and the US consumer.