The Weekend Edition # 110 - Where is the Euro going?

Welcome to another issue of the Weekend Edition.

Thank you to all who’ve read and welcome to all the new subscribers this week!

Here’s what we cover:

• Market Recap - Are we in Correction?

• Macro - Where is the Euro going?

• Earnings Season Q3 - Downside favored

• The Week Ahead - Economic & Earnings Calendars

• Closing Thoughts - Super busy week ahead

Let’s dive in ⬇️

Market Recap - Oct 23 - Oct 27, 2023

The week opened positive with the first two days closing green for most of the broad market indices but then things started to take a turn for the worse and we closed red across the board. Even Friday’s weekly options expiry and the positive impulse from that didn’t help much.

War continues to rage on in the Middle East with fighting becoming more intense and possibly spreading with the US actively participating in some of the attacks.

Yields are higher and volatility on the S&P 500 remains above 20, which keeps equities under pressure. As you can see from the highlighted box above, almost all the indices are now over 10% below their 52-week high, with the Russell 2000 small cap index close to -20%. By this measure, we are officially in correction territory with the small cap index threatening bear market territory.

We had major earnings this week and as I’ve highlighted in the section on Earnings below, the market is being seriously harsh on even the slightest of negative news.

Commodities

With the war escalating in the Middle East, commodities continue to get bid up. Gold crossed the $2000/oz mark as we had suspected last week. So far, the impact on oil supplies has been quantified as low to medium and therefore, that initial spike we saw in oil has be normalized to some extent.

I’d posted this chart earlier in the week in one of my Breakfast Bites and it clearly shows that this time around the spike is not as dire as it had been during the Russia-Ukraine war.

Some of the charts in the recap section have been sponsored by Koyfin. We have a special discount of 15% for MacroVisor readers for any new sign-ups to Koyfin. To take advantage of this promo please sign up here - Koyfin MacroVisor Discount

Macro - Where is the Euro going?

There are conflicting ideas about Europe at this stage. There's one camp that seems to be of the view that the ECB has come to the end of their tightening cycle with the pause at the meeting last week.

Most developed market Central Banks have already paused hiking and the Fed is expected to pause as well given inflation is now below 4%. That seems to be a threshold that many are watching for the US.

But, then we see a few headwinds for the Euro Area even if the ECB decides to hold here, particularly against the US Dollar, which we think we will continue to display strength.

There were two very interesting observations concerning the last ECB meeting:

• Firstly, ECB President Lagarde didn't really acknowledge the increase in energy prices. She just maintained her more generic statement that “Inflation is still expected to stay too high for too long, and domestic price pressures remain strong”, rather choosing to focus on base effects for the decline in inflation during September.

• Secondly, they didn't discuss any changes to their balance sheet program and left the PEPP (Pandemic Emergency Purchase Programme) as is, i.e., principal amounts to be reinvested until 2024. One would think balance sheet tightening would be one way to lend support to the EUR against other currencies, particularly the USD.

In fact, we think the EUR / USD could move closer to parity once again, given the strength of the US and the Fed's resolve to keep rates higher-for-longer. The following are factors we are considering:

1 - The US is stronger than Europe - The US Economy continues to remain more robust than the Euro Area. GDP growth and activity data shows that the US still continues to maintain significant positive momentum. The Euro Area on the other hand, shows signs of weakening with GDP growth close to 0%, on the brink of recession. Even the US labor market continues to remain tighter with a lower level of unemployment.

2 - China - The decline in Chinese GDP growth is a far stronger headwind for Europe than for the US. Chinese business accounts for almost 20% of revenues for European companies and this has been having a significant impact on European equities.

3 - Commodities - Europe is more sensitive to a rise in commodity prices. With war on the continent, and the war now in the Middle East, commodity prices and in particular, energy prices will continue to remain elevated. This not only leads to higher inflation but, a slowdown in growth as businesses are affected by cost pressures.

4 - Rise in yields are limited - While we are seeing a rise in yields across Europe, largely in sync with the rise in yields in the US, we are also of the view that the yields have not gone up a much as they should. In relative terms, we see rates remaining more subdued compared to the US, pushing down the EUR vs. USD.

5 - Cutting rates - While the Euro Area still remains far from their inflation target of 2%, the slowdown in growth and a possible recession could force the ECB to cut rates much sooner than expected, and far sooner than the US. As it stands at the moment, the higher for longer mantra seems to have more support in the US, than in the Euro Area.

As for European equities, forward P/E ratios suggest that the market is undervalued compared to their longer term median value of just above 13x.

However, Morgan Stanley's combined market timing indicator continues to suggest that we're in no man's land. The markets have sold off quite a bit since the summer but, not enough to hit the "buy" zone.

Earnings Season - Downside favored

FactSet Earnings Recap:

It was the busiest week of earnings. All four major tech companies delivered double beats but the reactions were very different. The slightest hint of bad news sent the stock spiraling lower. And yes we do have to say they spiraled. Google was down -9.5%, Meta was down -3.7%. Amazon and Microsoft held up but, with milder increases. Amazon was +6.8% after earnings and Microsoft was up +3.1%.

It's clear that the market is punishing bad news more harshly than they are rewarding good news. The percentage of companies that have had negative price impact after reporting now stands at 64.37% vs. 35.63% with a positive price impact.

Earnings growth however, has improved and the blended EPS growth now stands at +2.7% vs. -0.4% as of last week. In terms of performance vs. estimates though, we have to note that Revenues are missing estimates far more than Earnings have been.

The chart below is from FactSet and shows by S&P 500 sector, the performance against estimates for Earnings (in the top chart) and Revenues (in the bottom chart). Even if the writing is not very clear, the color coding clearly shows revenues are not as expected. This is exactly what we said at the beginning of earnings season. It was going to be a "revenue story" this quarter.

Adding to that though, some of the biggest EPS misses from the table above has been in the Energy sector. Chevron and their potential target Hess, sold off hard on Friday in the wake of Chevron and Exxon both missing EPS estimates. A comparison of earnings growth thus far suggests that integrated oil and gas such Exxon and Chevron have been the most under pressure when compared to other companies in the industry. This presents a potential entry for those who are interested in a longer term position.

The Week Ahead - Calendars

US Earnings Calendar

US Economic Calendar in Eastern Time (Source: Trading Economics)

Closing Thoughts - Central Banks, Employment Data and Apple

We have an extremely busy week ahead of us. Globally, we have four central bank meetings and rate decisions next week. We have the Bank of Japan on Tuesday, the Fed on Wednesday, the Bank of England and Norges Bank (Norway) on Thursday.

Prior to the Fed meeting we have the quarterly Employment Cost Index number coming out. This is an important number that the Fed watches quite closely. While we've seen the levels declining, i.e., wages are decreasing, they continue to remain too high in a historical context.

We also have the non-farm payrolls and employment data coming out on Friday. Since the market has now decided that the Fed's next possible hike could be in mid-December, this is a data point that will be important for the following Fed meeting.

Most of the Central Banks are expected to keep their policies steady without any changes but, we never say never, and there are particular tweaks that each of these banks could make that could move the market.

To top it all off, we continue to have a host of big companies reporting next week including McDonald's, Starbucks, Caterpillar, AMD and the one to top them all - Apple reports on Thursday after the close.

Here’s wishing you safe investing.

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.