The start of the summer for stock markets coincided with a phase of technical distribution on the primary indices, culminating in a modest correction that affected the entire month of July, quantifiable in a general correction of stocks in the order of about 5%.
The elements that fueled the selling pressure on the stock market are multiple, from the disappointment that the central banks had not yet reduced the cost of money, except for the ECB, with a consequent reduction in systemic liquidity, to the uncertainty linked to the various electoral deadlines, to the mounting geopolitical crises and to the technical overbought levels that had been reached in the first months of the year. Now the summer is coming to life with some constructive fundamental elements, in the sense that the economic situation is holding up, especially in the USA where the preliminary GDP data for the second quarter exceeded estimates, inflation continues to slowly fall thanks to the deflation imported from China, the central banks, FED and PBOC in the lead for a few weeks, after a semester of neutral monetary policy, have started to reinject liquidity into their credit systems. As for the short-term trend of the markets, the statements following the meeting of the FED Board of Directors would confirm the hypothesis made at the time, of a reduction in the key rate between 0.25 and 0.50% during the September meeting. This explains the subsequent marked technical rebound of the indices the day after the statement, which however immediately gave way to a sudden retracement meaning that the decision was already largely discounted by the market. For the S&P 500, holding support at 5380 would indicate the start of an accumulation phase aimed at testing the recent high just below 5700, with a similar dynamic for the Euro Stoxx 50, which has support at the 4695 level.
The short-term violation of these levels would imply the continuation of the correction onto the subsequent supports. Analyzing the internal dynamics of Western stock markets, a gradual rotation of demand from growth stocks to value stocks has been noted, as confirmed by the improved performance of the US DJI and Russel 2000 indices compared to the Nasdaq and partly also to the S&P 500. Therefore, the current stock market correction would lend itself to investments in sectors that benefit from the reduction in short-term rates, such as energy services companies and in general large-cap stocks that offer high dividends, underweighting technology in the field of artificial intelligence and cyber security, in defensive sectors such as pharmaceuticals and food, without neglecting cyclicals that continue to benefit from the satisfactory economic stability.
As for fixed income investments, it is imperative to continue accumulating medium-term bonds, from 3 to 5 years maturity, preferring high-quality corporate issues, rather than sovereign bonds for which, in the medium term, it may be necessary to offer higher yields to attract a demand increasingly concerned about the growing government deficits to finance. What is happening in Japan is emblematic in this regard, in the sense that the BOJ has undertaken a strategy of creating monetary inflation, devaluing the yen that recently declined to a minimum against the dollar dating back to 1986, to reduce public debt in real terms, which has largely exceeded the threshold of 200% of GDP. The natural consequence of this action is the distrust of investors towards Japanese government debt, which is already translating into an increase in the yields offered by the ten-year JGB, now 1.0%, after years of zero yields, with the prospect of increasing to 2-2.5% in a fairly short period of time. The upsurge in the consolidated yield is favoring a recovery of the YEN, but at the cost of a sharp fall in the stock market. So, what could be expected in the coming year, also on ten-year bonds denominated in dollars and euros, is a return to a positive yield curve, albeit via an increase in long-term rates, rather than a sharp fall in key rates, as is commonly expected.
Nicola Bravetti Data Source: Bloomberg
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