At the Jackson Hole symposium held in August, Fed Chairman Jerome Powell announced his intentions to start scaling back on Fed’s monthly asset purchases sometime this fall. Mr. Powell did not forget to add a few caveats such as necessary pace of economic growth, labor market dynamics and inflation rate (among other factors). The timing of interest rate hikes was also missing. The stock market focused on only one message – the absence of rate hikes in the near future, so the American indices reacted with setting new all-time highs in the last days of August and securing the seventh straight month of gains.
Bad summer for Chinese equity market
Meanwhile, the Chinese market fever continued. We have already mentioned that at the end of July the Chinese government imposed sanctions on private companies working in the education sector. The new rules prohibit these businesses from making profits, attracting foreign capital or conducting operations on the stock market. That, of course, led to a sharp drop in share prices. For example, New Oriental’s stock fell 65%. The new laws have seriously affected such companies as Alibaba and Tencent. Investors, seeing what is happening in one of the fastest growing industries of online services, continued to get rid of the shares of two giants. Since February of this year, the companies’ shares have lost almost 40% of their value.
European and US equity markets
Economic slowdown continues in US and China
For the first time in almost 18 months China’s factory activity contracted, impacted by latest Covid-19 outbreak and lockdown measures, as well as high raw material prices and continuing supply bottlenecks – the Caixin manufacturing purchasing managers index was at 49.2 in August compared to 50.3 in July, below the mark, which separates growth and contraction. Lockdown measures weighted heavily on services activity – official non-manufacturing PMI decreased to 47.5 compared to 53.3 in July. Factory activity also shrank in Vietnam, Indonesia and Malaysia, while slowly expanding in Japan and South Korea.
Business activity in August continued to slow down for the third consecutive month in the United States, impacted by still existing supply shortages and capacity constraints – IHS Markit flash US Composite PMI Output Index, which tracks manufacturing and services sectors, decreased to 55.4 points compared to 59.9 in July. US consumer confidence was negatively impacted by soaring Covid-19 cases and higher inflation expectations – the CB consumer confidence index decreased to 113.8 in August from 125.1 in July and that is the lowest reading since February.
Situation in Europe is more encouraging
In contrast to Asia and US, manufacturing in Eurozone, although slightly slowing down, showed strong performance in August. Economic sentiment eased across the block during August – the European Commission’s economic sentiment index decreased to 117.5 in August compared to 119.0 in July. Optimism decreased in industry sector to 13.7 from 14.5, in services sector to 16.8 from 18.9 and consumer sentiment decreased to -5.3 from -4.4. Inflation in Eurozone exceeded ECB’s 2% target and accelerated to a 10-year high of 3%, driven by higher energy, food and industrial goods costs.
Benchmark 10-year bond yields
Nothing positive in FX and precious metals markets
August was another difficult month for Eurodollar in terms of clear direction and profit possibilities. Euro took a dive instead of trying to regain levels above EUR/USD 1.19 and fell below 1.1750. Unfortunately, we live in market conditions where clear trends are non-existent and all moves are merely a noise. Market has defined EUR/USD at 1.16 as “cheap euro” and 1.23 as “expensive euro” and after a year of staying in this range, it refuses to decide on the direction.
Silver did what we were afraid of, falling through 23.50 dollars per ounce and dipping as low as 22.70 before regaining some ground. Month is ending around XAG/USD 24, which offers some (though precarious) stability. Precious metals are at a very important spot, where a failure to advance soon will definitely mean more losses ahead for already exhausted investors.
Sovereign yields are back to February levels
Central banks are desperately trying to «talk down» inflation risks in order to keep interest rates near zero. Markets are “playing the game” so far – German 10-year yields are back deep in negative territory, French 10-year yield turned negative too, and US yields saw a notable setback. Despite the feeling that Central Banks are omnipotent, US 10-year yields are approaching levels where bonds are considered rather expensive, therefore, we will be looking for a potential correction in the asset class.
High Yield bond Indexes
Natural gas might offer some opportunities on the long end
We got used to the fact that natural gas is cheap and gets gradually cheaper, but some “unusual happenings” on the charts have gained our attention. It appears that long multi-year price downtrend has been broken and the commodity is approaching major resistance level of 5 dollars per MMBtu as we speak. It is highly possible that this resistance will push prices lower to an important support level at USD 3.6 per unit. If price does not respect this 5 dollar resistance level, it can easily move closer to USD/MMBtu 6 mark, which is the last resistance before much higher price levels. One way or another, it might be a good time to have a look at the shares of gas producers as those might offer some good long-term opportunities.
Some self-praise and a few caveats
Last summer, in one of our reviews, we wrote with confidence that within the next two years we will see the S&P 500 at 4000+ points. Following the behavior of Mr. Market after the slight correction in August-October, as well as during and after the presidential elections in the United States, it became quite clear that we are pushing for much higher values of stock indices (though few believed us). At the end of 2020, we already noted that the market structure speaks of the index levels above 5500+ in the next 3 years. We know these levels are not easily imaginable. In fact, with everything being expensive, we ourselves find it hard to believe in these numbers, but, as they say, it is foolish to argue with the market. The S&P 500 reached 4500+ at the end of this month, meaning the US market “doubled” in less than 17 months. Impressive. Of course, there were always explanations for this fact in the media (oh, this selective memory and biased interpretation of events), but let’s be honest, practically none of the market participants we know believed in such a scenario either this spring, or last summer, or all the more so during the nose-dive in February-March of 2020.
Yes, the global trend of slowing economic activity will most probably continue in the fall, so we should see some nervousness creeping into the financial markets. The main concerns now are inflation numbers and market’s reaction to the upcoming Fed tapering. However, we will allow ourselves to assume that the correction / consolidation that everyone has been expecting for many months will be less deep than many would like, and after it ends, the indices will rush to storm the levels that are 10-12% higher than the current ones within the next 2 quarters.