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July 15th, 2024 - Time to recharge our batteries.


The time has come for the summer break and this will be the last weekly review until the 12th of August. Last year, around the same part of July and days before I left for my vacations, equities registered a short-term peak and corrected almost 10% throughout October. And with the experience of more than 25 years in financial markets, many summer vacations have included turmoil and corrections , which are magnified by the much less volume and fewer participants, compared to other periods of the year. The probability of a similar short-term correction has risen as the powerful rotation out of the US mega caps last Thursday into the more cyclical parts of the market caused havoc to Tech investors who have been betting more and more on the upside. Friday's initial rebound was met with selling again. Memories of 1999 have come back, but we could still be some way from similar extremes.


US inflation surprised positively in June. Even more importantly, we had the first negative inflation change on a monthly basis since 2020 and the pandemic-induced deflation. The yearly change in CPI inflation slipped to 3.0%, vs expectations for 3.1% and compared to 3.3% in May. The good news continued with core CPI inflation falling to 3.3% in June, vs expectations for no change compared to the 3.4% in May. Looking into the details, the report was even more encouraging, as rental growth finally broke below the 0.4% monthly change with an increase of 28bp in June and close to its 27bp pre-pandemic average. Rents is the largest single component in the CPI, and one of the most persistent, so a slowing +was very positive sign for lower inflation.


The possibility of a September cut by the FED is increasing. The recent weak macro data and especially those concerning the labor market have convinced the market that the FED will cut rates for the first time in their September meeting. We should get more color during their July 31st meeting, which could be used to "pre-announce" the forthcoming rate cuts. Chairman Powell in his semi-annual testimony to Congress gave us the first hint, however, ahead of that meeting. He acknowledged the softness in the labor market, he welcomed the progress on inflation and reminded that the central bank has a dual mandate, inflation and employment. All in all and in the context of recent weak jobs reports, the market now believes these words were meant to guide for a September cut, as a start.


China moved deeper in deflation, as its June CPI number was announced at -0.8%. Falling consumer prices probably show still lackluster demand for goods and services and speculation is rising that more rate cuts are coming. There are two critical events coming up this month which could be used as a forum for decisions to boost the economy. The once-every-five-years Third Plenum begins this week which usually sets the longer-term economic agenda and the quarterly Politburo at the end of the month, which could provider some fresh short-term stimulus.


The first major US banks' quarterly results had a common denominator: softening consumer demand. "We are not seeing the same growth in consumer spending that we had in prior quarters", Citigroup's CFO said in the conference call, as the bank reported a 70% drop in consumer lending vs last year. Wells Fargo said that "demand for loans is tepid" both for the consumer and the corporates and lowered its guidance for net interest income for the year. JPMorgan's profits (excluding extraordinary items) were just 1% higher than last year and also cited the fact that "lower income families have started feeling the pain of high interest rates and high prices". Overall, it was another confirmation of the view that inflation will eventually come further down due to consumer weakness, which has of course implications on economic growth (GDP) and eventually revenues of economically-sensitive companies.


Equities moved higher, especially in the so-called Value part of the markets, or in other words cheap stocks belonging primarily in sectors like Energy, Materials, Utilities, Financials. In a week where Technology gained only 0.9%, Materials rallied by 4% and small capitalization companies exploded by 6% (Russell 2000). Europe managed to stage a 1.5% rally on average as the rotation into Value/cyclicals is helping the region and Hang Seng posted a solid gain of 3% in Asia.


Bonds had another positive week, as the "weaker consumer" theme is bringing rate cuts in the next two months. The 10-year US treasury yield fell to a low of 4.20%, which is 50bp below the 4.70% peak a couple of months ago. And if this looks small, in terms of actual price impact on the bond it translates to about 3.5% capital gain in such a short period of time (on top of the income from the coupon). The German 10-year dropped to a low of 2.45%, but with the ECB meeting coming up on Thursday things could get volatile. Will Mrs. Lagarde and Co put on their "dove costume" (i.e. hint for lower rates in September) or would they stay with the slightly hawkish style of late ?


Chart of the Week : Low volatility in US markets shows complacency.

The S&P500 has fallen more than 1% only 6 times in the approximately 150 trading days of the current year and the Volatility index (VIX) is at a multi-year low, which are clear signs of any lack of fear or stress by investors and traders. Interestingly, the 1% daily drops of the S&P500 this year have primarily been concentrated in a period of just one month (April) which means that if something cracks then the downward pressure is significant given the valuations and extreme positioning in the market. And if history is to repeat itself, the S&P500 last year peaked in mid July and corrected by (a typical) 10% until end of October, providing an excellent buying opportunity. This period (mid July - mid October) is always tricky and hence we have advised extreme caution in building new positions or adding to risk. On a sectorial basis, we could see a further rotation out of Tech-related companies into the more cyclical/Value aspects of the market.


Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : FactSet/KSH , Photo : https://www.cntraveler.com/story/should-we-cancel-summer-vacation


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