Pictet North America Advisors

2022 Weekly Views — July 25

Pictet North America Advisors 2022 Weekly Views — July 25
Pictet North America Advisors

2022 Weekly Views — July 25

Pictet North America Advisors 2022 Weekly Views — July 25

Market update

Crucial week for Europe

The S&P 500 closed the week at 3,961.63, +2.55% higher. The Dow Jones closed at 31,899.29, +1.95%, with the Nasdaq higher by +3.33%. The volatility index VIX closed the week at 23.03 down from 24.23. The Euro Stoxx 600 gained +2.88%.

The 10-year UST closed at 2.75% down from 2.92% a week before. The yield curve flattened with the yield spread between
the 3-month and 10-year UST at +30bps. US Corporate Bond spreads: Investment Grade tightened 7bps at 190bps and High
Yield tightened 45bps at 548bps. German 10-year Bunds yield closed at +1.03% down from +1.13% a week before. In
Europe, Corporate Investment Grade spreads tightened 15bps at 208bps and High Yield spreads tightened 61bps at 632bps.

The US Dollar Index (DXY) depreciated -1.23% last week and closed at 106.73. The Euro closed at 1.0213 (+1.32% weekly);
the Yen appreciated +1.77%, closing at 136.12 and the Swiss Franc was up +1.46% at 0.9629. Gold closed at $1,727.64 appreciating +1.14%. Oil was up, Brent closed at $103.20 (+2.02%) and WTI at $94.70 (+0.14%).

Macroeconomy

ECB meeting

Last week, ECB surprised by hiking policy rates by 50bps despite explicit guidance for a 25bps “first cautious step”. This hike takes the ECB Deposit Facility rate back to 0%, after being in negative territory since May 2014. Comments by ECB President Christine Lagarde suggested that the rates decision was the result of a compromise of the Governing Council, in order to reach unanimity on the antifragmentation tool (Transmission Protection Instrument, or TPI). Lagarde also mentioned rising inflation risks, including the increase of “some measures” of inflation expectations. Lagarde insisted that
the larger-than-expected rate hike did not imply a higher terminal rate and markets did not reprice the terminal rate higher which remained at just below 1.5%. Forward guidance was effectively terminated, the ECB is now in full data-dependent mode, and Lagarde refused to commit to anything for the September meeting.


Anti-fragmentation tool

Details about the anti-fragmentation tool were announced.  The program will let it buy bonds from indebted countries such as Italy to cap any excessive rise in their borrowing costs, helping limit financial fragmentation within the Eurozone. In terms of assets, amounts and restrictions are not set, purchases will be “focused on public sector securities with a remaining maturity of between one and ten years”, while purchases of private sector securities “could be considered, if
appropriate”. In terms of eligibility, the ECB will consider a “cumulative list of criteria” which will be “dynamically adjusted”, including (1) compliance with the EU fiscal framework, i.e. no  excessive deficit procedure; (2) no severe macroeconomic imbalances, i.e. no excessive imbalance procedure; (3) fiscal sustainability analysis from the European Commission, the European Stability Mechanism, the International Monetary Fund and other institutions, together with the ECB’s internal analysis; (4) sound and sustainable macroeconomic policies as submitted in the recovery and resilience plans for the Recovery and Resilience Facility and with the European Commission’s recommendations under the European Semester.


Energy in Europe

Natural Gas to Europe through the Nord Stream pipeline returned to 40% of capacity, their level before flows were halted for 10 days of planned maintenance. In Germany, gas-storage facilities are at about 65% capacity, short of the government’s 90% target. Putin indicated that flows could fall to 20% as one of the two working turbines goes for maintenance this month. The European Commission outlined its plan (“Save gas for a safe winter”) for a gas rationing. The plan asked for a
voluntary gas demand reduction target of 15% from August to March 2023 (compared to 5-year average of the same period). It is mainly focused on industries («non-protected customers»), as opposed to households and essential services («protected customers»). The share of Russian gas is not dominant in the whole national energy consumption (all sources combined) of the Eurozone but is still significant in Germany and Italy, where it accounted for 17% and 16%, respectively in 2020. For the Eurozone, the share of Russian gas as total energy consumption amounted to 10%.

Highlights

Earnings season

As of Friday, 21.9% of the S&P 500's market cap reported. Earnings are beating estimates by 3.7%, with 66% of companies topping projections. By the time being, the market response to earnings is quite subdued. Companies beating on both revenues and EPS are outperforming the market by +0.5% vs. an average of +1.7%. Guidance is being largely weak but the sample of companies providing guidance is small. Value is delivering stronger revenue and EPS growth (11.9% and 13.6%) than Growth (9.1% and -2.3%). Value results are surpassing estimates by 3.1% vs. 4.8% for Growth. EAFE is delivering higher revenue and EPS growth (11.6% and 9.7%) vs. the U.S. (11.1% and 6.0%) in 2Q. EAFE results are topping estimates by 7.7% vs. 3.7% for the U.S. More globally oriented S&P 500 companies are delivering faster EPS growth than their more domestically oriented peers: 15.6% vs. 12.3%. Expectations are for revenues and EPS growth of 11.1% and 6.0%. Ex-Financials, these jump to 13.3% and 14.1%. Consensus projections are for EPS growth of +56.5% for Cyclicals, +0.3% for non-Cyclicals, -4.6% for Tech+ and -21.6% for Financials. Estimates for Q2 fell -0.2% since March-end, less than historical trends (negative revisions prior to reporting season followed by positive beats), up 1.2% over the past week.

Italian rates

Despite market participants pricing only partly a 50bps hike, 10-year euro government bond yields ended the day slightly lower with the exception of Italy, where the yield rose to 3.55%. The rise was due to a widening of its spreads vs. the Bund to 232bps in the wake of Mario Draghi’s resignation as Italy’s Prime Minister. The dissolution of parliament means snap elections will take place on 25 September, with the center-right coalition of the Brothers of Italy, the League and Forza Italia well positioned in the polls. In terms of the Transmission Protection Instrument (TPI), the market has focused on the negatives initially. Although the ECB is unlikely to cap BTP spreads should snap elections trigger a political crisis, the fact that the TPI is unlimited, unanimously agreed and at ECB’s full discretion should still provide a backstop.

What to watch

Monday: Q2 reporting season: 183 S&P 500 and 201 STOXX 600 companies will report during the week; German IFO (July)
Tuesday: US conference board consumer confidence (July); US housing price (May) and new home sales (June)
Wednesday: Fed’s monetary policy statement and interest rate decision
Thursday: US GDP (Q2); Euro area consumer and business confidence (July); US initial jobless claims
Friday: Euro area GDP (Q2); Euro area HICP inflation (July)