OVERVIEW
US EQUITY STRATEGY
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There has been no shortage of market-sensitive events in 2022. War, jumbo Fed hikes, oil, rates… all have led sentiment and positioning down to extreme lows, financial conditions to tighten and US equities to rapidly derate. Global cycle indicators continue to drop, and our analysts believe the US dollar and oil will pave the way for negative profit growth in 1H23. Furthermore, our analysts expect market and macro conditions to worsen from here via bond market liquidity, credit conditions and long-duration real assets such as housing. The real fed funds rate is still negative, which continues to suggest unfinished business on Fed tightening.
Paradigm shift – Focus on secular investing
Fundamentals remain solid
The first part of the year has been very challenging for European equities: low growth, high inflation, a strong rise in bond yield and low support from Chinese credit. Also, these headwinds may soften or even turn into tailwinds by the end of the year.
Bright spot despite new lows
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This page contains opinion of the Cross-Asset Research department of Societe Generale. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for informational purposes only and is not a recommendation or an offer or solicitation for the purchase of sale of any security or financial instrument. Investors should not take any investment decision based on the summary material provided here, which should be read in the context of the underlying research report made available to subscribers. Please click on the full report for risks and disclosures.
Fed – Unfinished business on tightening
If the Fed pivots before the base fed rate surpasses core inflation, our analysts think this will equate to unfinished business as historically it has paused only when real fed rates reach positive levels.
All lights are green for Eurozone small caps, and they may benefit from several tailwinds:
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This page contains opinion of the Cross-Asset Research department of Societe Generale. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for informational purposes only and is not a recommendation or an offer or solicitation for the purchase of sale of any security or financial instrument. Investors should not take any investment decision based on the summary material provided here, which should be read in the context of the underlying research report made available to subscribers. Please click on the full report for risks and disclosures.
1) a COVID vaccine - Europe is the epicentre of the second wave and thus COVID continues to weight on its economy. Except Utilities, all the European sectors have underperformed their global peers. Most of them are trading with a discount. A vaccine would therefore be a catalyst for European equities.
With the top-line decline seen in 2020, companies have also logically reduced investment. However, the capex-to-sales ratio has slightly increased. The energy transition, as well as the digitalisation of the economy, are likely to support further corporate investment in the future.
In crypto, our equity analysts see a ‘crypto divide’ which largely excludes banks from crypto innovation on the one side, with crypto fintechs and DeFi (decentralised finance) on the other. Banks are dissuaded from holding crypto on their balance sheets (for trading or lending purposes) due to penal regulatory rules. Banks are also wary of offering their clients crypto-based transaction services (like current accounts or credit/debit cards) because of the treatment of crypto as a taxable asset rather than a currency.
We live in a digital age where most of our interaction with the banking system is already in digital rather than physical form. That is just as true for central banks as for the rest of the financial system. What is not widely understood is that central banks are already issuing digital currencies. When a commercial bank places deposits at a central bank, it holds a liability of the central bank in digital form.
From slowing to negative EPS growth: based on our strategists' top-down EPS framework, EPS growth continues to slow and our strategists do not see it finding a floor over the coming year. The key reasons for this are the slowdown in oil, a negative yield curve and cyclical data globally not having bottomed out yet. Combined with their view that the Fed has unfinished business with regard to tightening, they see this mix of factors as being not conducive to risk-taking within equity investing.
Paradigm shift – Focus on secular investing
Paradigm shift in policies points to long secular themes. Two big initiatives adopted in 3Q this year in the US are: the Inflation Reduction Act, which focusses on climate spending, and the CHIPS and Science Act, which focusses on reshoring and new investment in the technology sector. Both initiatives are secular in nature and should have a profound impact on the US economy, creating an estimated one million new jobs every year until 2030.
Unlike prior efforts at climate change legislation or regulation, the Inflation Reduction Act should inject at least $369bn in direct support for renewable and nuclear energy, and electric vehicles. The Act also incentivises newer technologies, such as hydrogen, and carbon capture, utilisation & storage (CCUS), putting the US far closer to the administration’s goal of halving economy-wide CO2 emissions by 2030.
European equities are currently trading on a 30% discount to US equities, in line with the discount seen during the Great Financial Crisis in 2009 (it even reached 35% in early March). Among other factors, the discount is attributable to the fact that the European market’s sector composition is different than that of the US market.
All European sectors are trading at a discount to US peers, except for Healthcare. And for most sectors, the discount is bigger today than it has been for the last ten years, with the exception of Healthcare, Communication Services and Energy.
S&P 500 VS Russell 2022: the profit margin for the S&P 500 has just reached an all-time high while margins for Small Caps are just above break-even levels
US household savings rate (% of disposable income)
S&P 500 – Negative EPS vs negative sentiment
Extreme negative sentiment, but too early to call a renewed bull market: however, our analysts acknowledge that the sentiment data for the bearish reading by the American Association of Individual Investors (AAII) reached cycle highs at the end of April, and that now the speculative positions are reaching cycle lows. Typically, it takes six weeks for the positioning to achieve a neutralised reading, and they do not view the recent rally in equities as the start of a new cycle.
Key impact of Fed hikes: now, the impact of tightening is felt in markets through the following factors:
Moreover, the Fed is accelerating the pace of withdrawal from USD48bn/mo to USD95bn/mo, starting this month, doubling the pace of Quantitative Tightening (QT). The withdrawal of liquidity will make markets adjust for additional supply. This means that liquidity conditions will continue to be poor for the Treasury and that most markets will remain in a volatile phase. With the upcoming QT of USD1.5tn, the Fed is again far from finishing its business.
a) Inversion of the yield curve, expected to move even further in negative territory,
b) Mortgage rates in the US rising along with the base rate. Hence, along with financial assets, long-duration real assets are likely to come under pressure.
US lawmakers passed the $280bn CHIPS and Science Act, which aims to stimulate research and innovation in the semiconductor field as well as to encourage US companies to invest in onshore production of chips.
Real fed funds rate (fed rate minus core PCE)
Real fed funds rate computed as fed funds rate – US Core PCE (yoy%)
Source: Bloomberg, SG Cross Asset Research/Global Asset Allocation
Source: Factset, SG Cross Asset Research/Quant Strategy