Good morning and Happy New Year! After a robust December for risky assets, particularly following the dovish FED comments and a strong FOMO rally, the momentum has cooled as the expected Santa Claus rally failed to materialize. Positioning in equities is a little stretched as witnessed both from fund flows and investor sentiment surveys and more so in fixed income, I think. The artificial boost to US liquidity (M2 expansion) came mostly from the falling RRR facility and its substitution with newly issued T bills, which mechanically increased bank excess reserves and the amount of money in circulation. We have another 720b to go vs newly created debt of 2.5trn in the US alone, so after H1 2024 one should expect tighter liquidity conditions.
The FED's recent minutes indicate the first discussions about the pace of quantitative tightening (QT) and highlight the loosening of financial conditions over the past quarter. It appears that the FED aims to slow down both the anticipated pace of market cuts and the rising financial speculation. After nine weeks of gains, both equities and credit are expected to consolidate with a downward bias.
The market is responding by slowly rotating from growth to value and from cyclical to defensive assets, following their recent significant lag. However, aside from Energy and large-cap Healthcare, there seems to be little value left in the US market. The thesis of small-cap outperformance has worked well in the past two months, but there are concerns about the presence of names unrelated to value investing in certain ETFs (the MicroStrategy/Carvana like names that have nothing to do with value investing at a decent discount to the market). In Europe, there is a better hunting ground for value, despite a landscape filled with potential value traps and lower active investor participation (the hen and chicken market paradox).
Today's EU CPI harmonized data aligns with expectations at 4.1%, holding steady but on a downward path. PMI data from Germany, France, and Italy indicate continued contraction for almost a year, although they performed better than expected (German services are approaching the 50 mark). Anyway, the macro data so far supports the scenario of growth stabilizing at a low but not recessionary level, with a combination of a labor market turning less tight (JOLTS report) and a slow disinflationary process.
In corporate news, the focus should be on the implications of Suez for supply chains and rising geopolitical risks. The UK sports retailer JD posted a small profit warning(down by a quarter in market value), not totally unexpected after the Nike volume guidance, while Next and Inditex have been bullish, suggesting a gradual consumer recovery and a shift in preferences. A profit warning from Mobileye today puts pressure on other auto-related semiconductor stocks, the worst-performing sector this year after a stellar 2023.