• The main drivers of market performance were somewhat weaker macro data and rising bond yields. In addition to quickly declining leading indicators, some notable cracks in otherwise healthy labour markets seem to be appearing in several countries, fuelling previously allayed concerns of rising recessionary risks. However, much depends on whether the current weaker macro-economic trends translate into a deeper recession and how this will affect central bank policies.

 

• Leading indicators have been pointing to weakness since early last year and throughout 2023. Initially, markets corrected accordingly but then rebounded following the regional banking crisis earlier this year as policymakers moved to shore up markets. However, the underlying weakening trends have not subsided and have only gained momentum recently.

• US payroll revisions continue to disappoint on the downside with June putting in a new record with 104k jobs revised downwards from the initial announcement. Other related indicators also point to weakness; the quits rate and labour force participation rate are all consistent with less bargaining power for workers going forward, which is likely to moderate wage growth.

• The US job openings data, which is a good barometer for labour demand in the US economy, continues to normalise from it pandemic-induced peak; a declining trend has historically been accompanied by weakness in the equity markets.

• Growth in the Eurozone remains stagnant, with quarter-on-quarter GDP growth at 0.1% in Q2, the same pace as Q1 and following a 0.1% contraction in Q4 last year. Early indications for Q3 imply that growth might turn negative again as leading indicators are pointing downwards. The good news is that inflation should fall further, especially as input price inflation is decelerating quickly. Consequently, the rate hike cycle in the eurozone is coming to an end.

 

• In the US, delinquency rates are rising and banks are tightening lending standards for consumer borrowing at a time when excess pandemic savings are almost exhausted, certainly so for the lower and middle income households.

• Industrial activity appears to be slowing down which can be seen in declining manufacturing PMI surveys while earnings revisions for the sector are also negative.

• Finally, the sizeable boost from Biden’s fiscal spending packages will top out over the next few months, removing another source of impulse to the economy.

• Taken together with rising yields, a strong dollar, and a potential oil price shock, the macro risks are currently clearly tilted to the downside as we enter the fourth quarter.

• As discussed last month, the most important development in Q3 has been the continued tightening of long-term yields. This is by no means a US phenomenon. We also find 10-year yields near long-term records in Germany, Sweden, Italy, Australia and also in several emerging countries – even Chinese government bond yields are trading off their lows despite the current economic weakness in China.

 

• As long-bond yields have pushed higher relative to the short-end, a process called bear-steepening, we have also witnessed yield curve inversions become less pronounced, with the US 3-month minus US 10-year Treasury bond yields reducing by half, from approximately 185 basis points inverted to less than 90 basis points at the end of September.

• In summary, macro-economic trends as well as low frequency/high impact indicators such as the yield curve point towards a further slowing of the economy over the next few months and quarters. Whether it will turn out to be a soft or hard landing is of secondary importance for as long as precautions are in place to hedge the potential negative outcomes of it occurring.

• Looking ahead towards the end of the year, we believe that the current earnings season will provide some important clues about the risk of a deeper economic slowdown and its effect on earnings. The dollar and oil price tightening effects might be somewhat more temporary which leaves rising long-term yields as probably the most challenging factor to watch. In our view, the long end of the yield curve has potential to tighten further, reflecting rising term premia driven by inflation floor levels that appear to be higher in the future than in the past. At the same time, at some stage, we expect central banks to become more vocal about the path to rate cuts in the future, but deep cuts that markets have become accustomed to in previous rate cycles may prove elusive in this one if higher levels of structural inflation are indeed perceived to be transpiring. Both of these trends will un-invert, and thus normalise, the yield curve.

• Technically, markets are somewhat oversold at the moment. Similarly, sentiment is bearish but short of being at extreme levels. Therefore, a meaningful amount of short-term potential downside has been realised over the last weeks whilst we are heading into a seasonally stronger period for equity returns, which could provide some support to a weakening equity market.

• Discrepancies in equity valuations have been increasing between inexpensive and overvalued stocks and on a regional as well as sectorial level, there are many potential investment candidates that appear to offer value. Overall, we believe markets are not universally expensive, neither are they at risk of a major meltdown. Looking at bottom-up fundamentals, we don’t find it very difficult to identify attractively priced long-term investment targets with strong balance sheets and competitive positioning, trading at a valuation that is substantially lower than it was only a year ago.

• Similarly, in the world of fixed income, we find nearly generational buying opportunities in many issuers that are fundamentally sound and where yields are now substantial – something not seen since the end of the 2008 financial crisis.

• As a result, there is no shortage of investment ideas and great potential on the horizon to diversify capital out of cash and cash equivalents, and into fixed income and equity markets. Yes, prepare to wrap up warm because winter is coming (if you’re in the northern hemisphere), but you may want to forego the hibernation this year as the opportunity to pick up some names at near bargain prices may well present itself, perhaps even ahead of Christmas, should the chill in markets continue into year end!