Chief Investment Strategist
Summary: The strong equity rally this year has faded fast in February as bond markets are beginning to second-guess their initial rosy outlook on inflation and policy rates. A significant shift higher in US long-term bond yields has finally spilled into equity sentiment sending S&P 500 futures 2% lower yesterday. High equity valuation themes were leading the declines while commodity related and defence stocks were among the best performing themes. Home Depot and Walmart earnings releases underpinned once again that operating margins are under pressure from higher wages setting equity markets up for more hiccups in 2023.
Equities tumble as long-term bond yields climb to almost 4%
S&P 500 futures declined 2% yesterday closing just above the important 4,000 level as a higher US 10-year yield closing at 3.95%, the highest since mid-November, put downward pressure and breathed new life into the structural inflation and margin compression themes. As we recently argued, the interest rate sensitivity has fallen for the general market compared to a year ago as equity valuations have come lower, but in the various growth segments such as our theme baskets NextGen Medicine, E-commerce, and Bubble Stocks, the interest rate sensitivity was very well alive yesterday down between 3.5% and 5.5%.
The best performing equity theme basket was defence, which we highlighted on Monday on the back of a nervous Munich Security Conference and the upcoming 1-year mark of Russia’s invasion of Ukraine. In the coming weeks geopolitical risks will be on the rise and the key geopolitical risk to consider is whether China increases their commitment to Russia and maybe even supporting Russia with weapons in Ukraine. This is a ‘red line’ for the US and Europe and could cause severe disruptions and mark the end of globalisation. The probability of this scenario is still low, but adding defence stocks to the portfolio would add some hedging against geopolitical risks.
Home Depot and Walmart confirms wage pressures and margin compression
Yesterday’s results from Home Depot and Walmart confirmed that wage pressures are still high with Home Depot setting aside an extra $1bn to their hourly frontline staff. Home Depot’s guidance on operating margin at around 14.5% is lower than the estimated 14.8%. Home Depot is one of the biggest winning stocks of the past three decades in the US equity market and in theory a Berkshire Hathaway acquisition target. While yesterday’s earnings release is a setback for the company and the strong pandemic boom narrative is seeing cracks it will likely be too early for value investors to get into Home Depot shares as the company is still valued significantly above the general equity market and its own long-term average valuation since 2003.
The margin compression theme we have written extensively about for several quarters picked up during the Q4 but overall companies still managed their margins a bit better than feared. However, despite energy and general commodity prices have eased over the past six months, the pressures from wages will begin eating into margins. The equity market’s sensitivity has moved from interest rates to that of operating margin because companies’ margins are rolling over from historically high levels.
The worst-case scenario this year for equities is if the bond market wakes up to the realisation that inflation is becoming more structural and less temporary. That could cause long-term bond yields to push higher and increase the equity risk premium at the same time. If that happens while earnings face an operating margin headwind then the equity market could faces significant trouble. We continue to maintain that under higher structural inflation equities will do better than bonds, but it is important for investors to be overweight companies operating in the physical world and also consider being overweight Europe vs US equities.
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Head of Fixed Income Strategy
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Head of Commodity Strategy
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Chief Investment Strategist
Quarterly Outlook
Head of Fixed Income Strategy
Quarterly Outlook
Head of Commodity Strategy
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)