Winter is coming, will the bears start to hibernate?

Stocks continued to slide last week, the S&P 500 falling over 5%, taking the index back into bear market territory for the year, and its lows of June. The FTSE 100 continues to hold up benefitting from the weakness in sterling. The pound fell to decades lows against the US dollar and slid further against the euro post some weak retail sales numbers towards the end of the week. Retail sales fell by over 5% year on year. Concerns about the upcoming fuel bills probably keep most people away from the high street. As we wait for the anticipated emergency budget from the new Chancellor, the economic picture in the UK continues to look poor as the latest composite Purchasing Manger Surveys indicated a contraction and inflation rates may have dipped a little last month, back below 10%, but this remains well above the banks target rate.

This is a busy week for central bankers, the focus will be on the Fed later on Wednesday, closely followed by the Bank of England on Thursday. The bond and equity markets are now discounting a 75 basis point hike this month followed by 2 more 50 basis point hikes from the Fed by the year-end, which would take US interest rates to 4%. After the latest fall in bond prices, the yield on 2-year US treasuries now stands at 4%, a pretty attractive alternative for savers to equities. Valuations for US equities, particularly if one strips out the FAANG’s are starting to look more attractive. According to Alpine macro, ex FAANGs the S&P 500 is on just over 12x earnings, which equates to an earnings yield of just under 8%. Ten-year US treasuries currently yield 3.5%. That puts the equity risk premium at between 4.5%and 5%, roughly where it has been for the past 10 years.

Sentiment for equities remains bearish and fund managers, as we noted last week are underweight stocks and overweight cash, according to Merrill Lynch’s latest survey. Ahead of the Fed announcement later on Wednesday, stocks fell again, after a small bounce on Monday. The market has now largely discounted the actions of the Fed, and it is becoming hard to see hard Powell can get much more hawkish. The Fed also does not like to see equity markets declining. As we head to the US midterm elections in November, if the markets start to get a sense that interest rates may be peaking in the US at around 4%, equity markets may start to look forward with a more positive eye.