Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Equity update: US banks, European earnings, and Apple earnings
Peter Garnry
Chief Investment Strategist
Summary: Fed Chair Powell did not imply that US banks had a problem, but the facts are that US regional banks are in trouble and US banks have in general underperformed European banks by 41% since mid-2021. The market is pricing in three rate cuts by the Fed December meeting, but the economy is nowhere weak enough to justify this so the only catalyst that can trigger this is if the US banking crisis spins into something bigger. In today's equity note we also take a look at European earnings this morning that all point to strong performance and solid outlook for the year. Apple is reporting earnings tonight with weak figures expected compared to a year ago and Qualcomm's horrible outlook for the current quarter yesterday is a bad sign.
Implied Fed rate cuts require a crisis
The Fed delivered the expected 25 basis points yesterday and hinted of a rate hike pause committing to be data-driven. The market immediately priced the Fed Funds Rate lower with the current pricing at three rate hikes (or 75 basis points) by the December meeting. As Fed Chair Powell indicated if the US economy slips into a recession it will be mild, and the nominal economy will likely remain strong (US nominal GDP growth is currently 7%) which limits the Fed’s ability to cut the policy rate. So what is the market pricing then?
In our view it is only the banking crisis in US regional banks that can explain the forward curve on the US policy rate with the message we got last night from the Fed. Although Jerome Powell did everything to say there was no banking crisis the facts are instead leaning that way. PacWest and Western Alliance were down heavily in extended trading last night and PacWest said that is weighing strategic options including a sale. JPMorgan Chase has for now been the vehicle by regulators to absorb failing banks with the latest example being First Republic Bank, but the largest US bank is now past the limit of how much deposit they can have; a bank in the US is not allowed to control more than 10% of total deposits. So the three other major banks Wells Fargo, Bank of America, and Citigroup must step up now. The iShares US Regional Banks ETF was down another 2.2% yesterday and this segment will clearly be in focus again today. In the bigger picture something remarkable has happened. The long time narrative in the market has gone like this. US structural growth was better than in Europe, the Fed’s policy was more positive for banks than the ECB’s negative rates, and loan growth was better in the US. From this narrative, which was right, investors bought into US banks leading to a significant outperformance relative to European banks from mid-2010 to mid-2021. Since then, US banks have underperformed by 41% relative to European banks in that looks like a stunning reversal of past dynamics. While the US is dealing with a banking crisis that will not die off, Europe has moved past Credit Suisse troubles although funding costs are still on the rise and the risk premium in AT1 bonds past the Credit Suisse shotgun wedding with UBS has not disappeared.
The overall point to understand today is that three rate hikes this year in the US are not coming if we not getting an escalation of the banking crisis. The nominal economy does not warrant rate cuts in 2023.
Strong European earnings persist into Q1
A consistent theme since Q1 2022 has been the physical world outperforming the digital world and in that process European companies have done better than US companies. Over the past year EBITDA has fallen 7.2% for the S&P 500 while rising 10.5% for the STOXX 600 suggesting very different dynamics between the two regions.
This morning we have got Q1 earnings results from European companies such as Equinor, AB InBev, VW, BMW, Novo Nordisk, ArcelorMittal, Infineon Technologies, Shell, Maersk, and Ferrari. The red thread among these earnings results is that revenue and operating profits are above estimates, and all the companies are reaffirming their outlooks suggesting the economy is still looking resilient.
Qualcomm earnings was a bad rehearsal for Apple earnings
The next big earnings release is tonight with Apple reporting FY23 Q2 (ending 31 March) results after the US market close. Analyst estimates indicated revenue of $92.6bn down 5% y/y and EBITDA of $30.2bn down from $32.7bn a year ago. High inflation has negative impacted demand for high-end consumer electronics including iPhone and Mac sales. While Intel, Samsung, and AMD are indicating that consumer electronics demand will revert back to growth in the second half of the year, the growth rates are expected to be low. The question for Apple investors is whether the services segment can offset the weakness in device sales.
Qualcomm’s results after the close yesterday were not a good lead into tonight’s Apple earnings as the company is a big supplier to Apple and disappointed the market with its revenue guidance for the current quarter at $8.1-8.9bn vs est. $9.3bn. The driver behind the weak guidance was that the company is seeing no evidence of a meaningful recovery in China leading to expectations that the phone market will be down high-single digit this year. Qualcomm shares are down 7% in pre-market trading. Latest Market Insights
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