Delano attended the “At the heart of the financial markets” presentation by David Kruk, head of trading desk, and Pierre Puybasset, spokesman for the portfolio management team, at La Financière de L’Echiquier (LFDE) on 25 October 2023 in Luxembourg. Photos: La Financière de L’Echiquier/ Montage Maison Moderne

Delano attended the “At the heart of the financial markets” presentation by David Kruk, head of trading desk, and Pierre Puybasset, spokesman for the portfolio management team, at La Financière de L’Echiquier (LFDE) on 25 October 2023 in Luxembourg. Photos: La Financière de L’Echiquier/ Montage Maison Moderne

David Kruk and Pierre Puybasset from La Financière de L’Echiquier reviewed recent market developments and outlined their capital market views for the coming months.

“September has been a confusing month for the market…when it comes to economic data…and central bank actions,” David Kruk, head of trading desk at La Financière de L’Echiquier, said during a recent investor presentation. Interest rates stayed unchanged at the Bank of England despite a rate hike expected by the market. The interest rates at the Fed stayed unchanged while the . at the last meeting of all three central banks.

In October, the market started to talk about a “moderation or goldilocks” situation, where moderate inflation and growth are now expected. That should result in no further rate hikes in the US and the eurozone. Indeed, the Fed was understood to believe that long rates were high enough to slowdown the economy.

Kruk explained that October had been challenging in the US because strong retail sales started to be seen in September (0.7%, compared to an expected 0.3%), and higher than expected industrial production and inflation, all pointing toward a stronger economy than anticipated.

Yet Kruk thinks the inflation trajectory is downward in the US. It should end the year at around 3.5% with further gentle deceleration. Without giving levels, he expects further decline in Europe.

Lack of strong Chinese growth: a blessing in disguise?

Kruk wondered whether a stronger Chinese economy, growing in the 6%-7% level, earlier this year would not have resulted in higher global inflation and even higher interest rates on the back end of the curve. “If the Chinese economy restarts only in six months or a year, that could be an ideal outcome given the expected lower global inflation.”

10-year US treasuries breaking its range

The 4.35% benchmark rate was finally breached in the US in October, moving near 5.00%. Visibly taken by surprise, Kruk thought that the market perceived the rate as sufficiently elevated at 4.35% to slow down the economy.

He concluded that the market decided that the flattening (it is not yet completely flat) should come from the long end as a curve inversion of 80 bps (between the two years at 5.10% and the 10 years at around 4.30%) was probably not making sense for such a performing economy.

We lost one major category of buyers, the central banks… resulting in a loss of $1.4trn of purchases from the central bank in the last three months
David Kruk

David Krukhead of trading desk La Financière de L’Echiquier

“No one is considering nowadays that the US economy is heading towards a recession,” said Kruk. He thinks that we may have a “soft landing or no landing,” an outcome that may not justify such a strong inversion.

He commented that the break of the upper range (4.35%) for 10-year treasuries contributed to the recent decline in the stock market by breaking its own lower range.

Loss of buyers for 10-year US treasuries not helping either

Kruk thinks that the financing of the large deficits reaching 6%-7% have contributed to the recent moves. Moreover, he believes that governments are not about to reduce spending and their stimulus because 40% of the world population, 60% of the world market capitalisation, will cast their vote in 2024.

“We lost one major category of buyers, the central banks… resulting in a loss of $1.4trn of purchases from the central bank in the last three months,” said Kruk. In the primary market, the largest buyers of treasuries, the Japanese insurers, have redirected their focus to domestic bonds despite their relatively low rates (around 0.80%) on the back of the end of the “yield curve control” by the Bank of Japan.

Kruk observed that the frequent debt issuances have moved rates higher. He takes comfort that debt issuance went well without a lack of buyers with decent bid-to-cover ratios. As an aside, he noted a high historical correlation between the 10-year US treasuries and oil prices. He is therefore concerned about the geopolitics effects and their impact on oil prices and beyond.

Company earnings in 3Q

Earnings in Europe are expected to show a decline of 15% in the third quarter, year-on-year (-11% in Q2) whereas the US should be around flat. “The positive is that we may have reached the bottom in Q3 in Europe and in the US.”

On the other hand, he noted that “price actions” (moves upon earning announcement) resulted in +0.2% in stock appreciation for companies displaying good earnings and -3.4% when companies missed their expectations in the current earnings season. Without providing figures, Puybasset observed similar reactions on European equities. Both speakers think that the increasing influence of retail investors over institutional players may explain part of these erratic developments.

In addition, Kruk thinks that this market behavior reflects concerns related to high interest rate, high public debt, default risks on private debt, stress on consumers (very high default on auto loans--6.1% in the US) and deteriorating geopolitics.

Yet, high interest rates may not only be negative for companies. Kruk noted the large cash position (€1.5trn) on the balance sheet of European companies is remunerated. He commented that companies in the UK enjoy net interest revenues.

Questioned by Delano on mood in the company guidance, Kruk replied they are not so negative on the back of his discussion with brokers. He reported that they think that consumers will continue to spend, an important consideration as it “weights 60% in the GDP.” According to Goldman Sachs, increasing disposable income coupled with high consumer confidence will outweigh the low levels of cash position in the bank accounts of consumers.

What about the market mood?

The recent bull-bear sentiment indicators from Bank of America, an indicator for contrarian signals that goes from 0 to 10, reached the level of 1.9 in October, down from in 3.0 in July. Kruk reported that Michael Hartnett, chief investment strategist at BoA, considers a level below 2.0 as a major pessimistic level. The latter also observed that the cash position in portfolio have reached 5.3%. A level above 5% signals that “there is too much cash in the portfolios,” another contrarian signal. It worth noting that similar levels were observed in October 2022 before the rally in the markets.

Kruk also reported that a large US broker observed that when the dollar increases, US equities decline. It’s a situation that manifested itself again in October 2023 (the highest point for the dollar was the weakest point for the market). The broker expects the dollar advance further to parity. Kruk wondered whether parity will not be another signal to enter the market.

He concluded companies will revert back with their share buyback after the “blackout” period in September. He reminded the audience that run rate of share buyback is $5bn per day in the US, the “largest equity investor.”

What to do should we see that equity recovery in the next 2-3 months?

“Sell everything… higher rates always break something,” said Hartnett, according to Kruk. His view reflected the tight monetary conditions (quantitative tightening), higher corporate spreads and higher default rates for non-investment grade companies.

This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .