Tentative Signs of Optimism
The wobble in equity and the markets we saw in September continued at the start of October, as investors remained anxious that rates would be staying high, even as economic activity seemed to be weakening. But towards the end of the week, the yields on bonds seemed to stabilise and this brought welcome relief to the equity markets, with the US staging a recovery into close on Friday. So much so, that somehow the S&P 500 managed to creep into positive territory for the week, standing alone amongst the major developed markets.
For a while on Friday, it certainly didn’t look as if the US markets were going to scrape into positive territory for the week, as a blowout US Jobs report temporarily sent yields soaring and equity markets tumbling. Non-farm payrolls increased 336,000 last month, the most since the start of the year, after sizable upward revisions to the prior two months. However, the unemployment rate held at 3.8%, and more importantly wages rose at a modest pace.
After digesting the report, investors suddenly decided to view the glass as half full, rather than half empty. Maybe, just maybe, a soft-landing scenario might be possible, went the narrative. Perhaps, employment could remain resilient without causing higher wages? And if you focused on the subdued change in earnings and coupled it with some encouraging recent reports on inflation, maybe the Federal Reserve will not need to raise rates again in November? The hope is that, the over 5% monetary tightening, although harsh, hasn’t caused irreparable damage and that the economy could prove to be robust enough to handle increased borrowing costs.
Let’s see how long this new burst of optimism lasts, but we also had a lot of bullish views circulating that actually there had been significant periods when equities had done well even when rates were high. For instance, according to a team of strategists at Bank of America, “…between 1985 and 2005, inflation-adjusted yields averaged 3.5%, well above the current 2%, with the S&P 500 managing to return 15% per year for the period”.
Despite a poor week for the FTSE 100, largely as a result of a steep drop in the oil price, there is some good news brewing. After briefly losing its position to Paris, London is on the cusp of reclaiming the title of Europe’s largest equity market, as French luxury, a big component of the CAC Index has taken a battering. As at the end of September, the current market capitalisation for primary British listings is $2.90 trillion, closely tailing France’s $2.93 trillion; a significant drop from France’s previous $3.5 trillion.
London’s market does seem to be witnessing renewed investor optimism, a departure from its previous unpopularity, which with hindsight, we can probably put down to Brexit. Factors in the UK’s favour include the recent oil rally (prior to last week), easing inflation, and a potential BoE policy shift that might weaken the pound, which is beneficial for the big component of exporting stocks we have in the FTSE 100. In contrast, Paris faces challenges from China’s economic slowdown, affecting luxury brands that were previously the market drivers. Global investors could finally be waking up to the fact that the UK market is extremely cheap and offers world class global businesses a significant discount to similar businesses listed in the US.
Probably the question we are most frequently posed by our clients is, when is this obvious value differential likely to reverse? I am certainly not brave enough to make a definitive call here, but at least the discount seems to be holding at current levels, and perhaps you could argue that the trend is starting to reverse. Let’s hope so and the recent devaluation in Sterling from over 1.30 to around 1.22 against the USD should help entice foreign investors!
The Chinese market is another that on the surface looks an obvious valuation buy or trap, depending on your perspective. It keeps threatening to stage a meaningful recovery, only to disappoint once more, and despite the authorities taking meaningful steps to enhance the attractiveness of investment, little has worked.
Data in the last week has at least confirmed the major reason. In September global funds continued to reduce their Chinese stock holdings, pushing their average stake in the nation to its lowest since 2020. The month saw a net outflow of $3.2 billion from active managers in China and Hong Kong equities, exceeding $3 billion for the second month in a row. Additionally, September witnessed foreign funds selling off $5.1 billion of mainland stocks through Hong Kong trading links, following the record outflows of $12 billion in August. How much more selling is possible awaits to be seen, but as far as sentiment goes it is probably safe to say we have hit extreme bearish levels. China has been shut all week for one of the ‘Golden Week’ holiday periods, so we shall see if the break has left investors in a better mood when they return on Monday…
Speaking of bearish positioning, finally this week, I thought I would look at how market sentiment is fairing amongst individual investors and show the latest ‘bull/bear’ ratio chart produced by the Association of Individual Investors in the US. Bearish sentiment expectations, that stock prices will fall over the next six months, rose 0.6 percentage points to 41.6%. Though modest, it was still a large enough increase to put pessimism at its highest level since May 4th 2023 (44.9%). This is the fifth time in seven weeks that bearish sentiment is above its historical average of 31.0%. As a rule, this proves to be a good contrarian indicator and suggests to me that perhaps the turn in markets on Friday could have legs…
Quick Guide – AAII Sentiment Survey
The AAII Sentiment Survey is conducted each week, where all AAII members are asked to vote on the direction they think the market will take over the next 6 months. It is strictly aimed at amateurs only, but it does reflect the mood of the market very well. Regardless of how they individually stack up, collectively they typically get it wrong, and since the Sentiment Survey was launched it has garnered a following for its role as a contrarian indicator for market direction. As the data shows, so far in 2023 it has worked well. Peak pessimism in May led to short term gains before peak optimism in July provided advance warning of the imminent sell-off!