Macro Outlook H2 2023: Equities Muddled, Bonds Rising

The equity markets of Developed Markets (DM) economies are going through a slow roll in the year so far as recessionary indicators continue to be prevalent while not enough are flashing red to call for a recession in the biggest DM of all: the United States. This colours how the markets can be expected to perform in the next six months.

JPMorgan estimates that while core inflation is likely to cool, the inflation slide is likely to prove incomplete. An actual recession would go a long way in cooling high valuations and increasing affordability. There, in the absence of a recession, the bank forecasts that global core inflation will remain well above 3% through the end of 2024. Of all possible scenarios, the dominant one indicates a 36% probability of a synchronized recession sometime in 2024 due to inflation being persistent and becoming more embedded, thus necessitating policy rates to rise materially further causing sustained tightening. The second largest probability – at 32% – indicates that the US will slip into a “mild” recession by the end of the year, with the rest of the world growing at a sub-par positive pace.

Over in US markets, there has been a flight of capital (of sorts). Bank of America notes that the percentage of S&P 500 constituent stocks outperforming has been drastically falling and is increasingly concentrated to a select few names over the course of the year.

On a historical basis, the likes of tech (both hardware and software) and consumer services stocks have seen the least bit of intra-sector correlation while the likes of banks and REITs have shown the highest level of correlation.

Of course, there’s a very strong empirical basis for the idiosyncrasy of US equity markets: since the 1960s, the peaks of select sectors have been lifting up markets for periods of time. The greatest peak ever seen was in the late nineties during the “Tech” bubble. Since then every peak and drop has seen “Tech” being involved.

The S&P 500 ($S&P 500(.SPX)$ and $SPDR S&P 500 ETF Trust(SPY)$) shows enormous amount of dysfunction in that 5 companies have an unduly significant effect on the index – significantly more so than in the heyday of the “Tech Bubble”. Apple ( $Apple(AAPL)$) alone is now bigger than the small cap Russell 2000. 

In fact, when considering the fact that forward-looking Price-to-Earnings (PE) Ratio is trending downwards, individual stock valuations should ideally reflect the same sentiment. As it turns out, there is very little relationship between forward estimates and current valuations.

The net consensus of forward earnings estimates also determines that net earnings per share growth will be nearly flat over the next two years, with “globalization”-related factors, such as lowered taxes in wake of global competition, lowered cost of goods sold due to outsourcing, etc. being key factors for the net margin growth seen in recent years.

With the onset of a recession likely in Q4 2023/Q1 2024, JPMorgan contends that there is an “unattractive” risk-reward for equities while investors are complacent despite bankers’ expectations that the business cycle will decelerate in H2. Bank of America highlights this complacency that the likes of tech continue to show high beta on account of overvaluation while energy stocks’ high beta ignores the risk in expecting high returns.

At least part of the reason why certain stocks enjoy relatively higher valuations is because they’re (again) relatively more liquid. At least some of this is attributable to the fact that buybacks have been very common among leading names in each sector for about a year now.

For more than a decade now, companies – on average – have been spending a higher proportion of their earnings on share buybacks than on traditional capital expenditure (CapEx) that would improve and scale up their operations.

Overall, JPMorgan is treading lightly on DM equities, given the more challenging macro backdrop for stocks in H2 with softening consumer trends at a time when equities are re-rating sharply with lower multiples. Bank of America indicates that sentiment in U.S. equity markets indicates an overall tendency towards a slight bullishness.

Bank of America also notes that the Equally-Weighted S&P500 has an upward trajectory in its forward performance, which implies that tech valuations will begin to drop and the resulting sector rotation will prop up other sectors.

JPMorgan estimates that Emerging Markets (EM) equities will return another 6% up to 2023, driven primarily by 2024 earnings growth or convergence of valuation multiples. Among EM, India is upgraded to “Neutral”, Saudi Arabia is downgraded to Neutral (given the high risk of Energy prices being unsustainable) and China remained at “Overweight”, i.e. there’s far too much expectation that it will perform at highs.

JPMorgan forecasts a decline in yields in H2 2023. Given that inflation continues to remain uncomfortably high, the bank expects that the Federal Reserve is likely to hold off on rate hikes after one round of hikes in July. However, other DM central banks are likely to continue tightening throughout the rest of the year. Overall demand for US Treasuries is expected to remain weak.

Bank of America, on the other hand, states Wall Street strategists’ average recommended weight for bond have been increasing in the YTD and will likely continue. Simultaneously, its private investor clients have been decreasing their long-term exposure to equities.

Earlier this year saw the closure of Buzzfeed News and Vice News while it’s estimated that Disney has lost nearly $900 million in opportunities in their last eight movie releases. Unsurprisingly, Bank of America thus asserts that cable service providers and media companies are now at the highest levels of default risk while gaming, metals and services have the least.

JPMorgan too remains structurally long-term bullish both gold and silver prices and estimates a 11% recovery in the BCOM Industrial Metals sub-index over the course of the year on account of stable demand worldwide.

In summary, while H1 2023 showcased a lot of conflicting signals despite the forward outlook, a strong consensus indicates that market trajectories will be more holistic across sectors in the latter half of the year. This implies the strong likelihood of a number of crests of troughs in the prices of a number of high-conviction stocks and themes. In such conditions, Exchange-Traded Products are ideal tools of choice for the sophisticated investor. For instance:

• $QQQ5 gives a 5X exposure to the upside of the Nasdaq-100 while $LS -3X SHORT QQQ ETP(QQ3S.UK)$ gives a 3X exposure to the downside

• $SP5Y gives a 5X exposure to the upside of the S&P 500while $LS -3X SHORT SPY ETP(SPYS.UK)$ gives a 3X exposure to the downside

• $CHI3 gives a 3X exposure to the upside of the Chinese market while $LS -3X SHORT CHINA ETP(CHNS.UK)$ gives a 3X exposure to the downside

• $LS 3X LONG GOLD ETP(GLD3.UK)$ gives a 3X exposure to the upside of Gold prices while $GL3S gives a 3X exposure to the downside

For broader articles that deep-dives in business and culture in Asia, visit asianomics.substack.com. Latest articles was all about “New India” in macro trends (a shorter version of which was published here), AI startups, jet engines and an ongoing challenge being mounted against global e-commerce giants Amazon and Walmart.