Chart of the week
The chart shows the probability with which investors in the U.S. expect an interest rate hike by the Federal Reserve in February 2023. The probability with which investors expect an interest rate hike by the U.S. Federal Reserve in February 2023 has declined massively.
Why this is important
The chart illustrates very well what has happened in the markets in the last 1-2 weeks. Investors are increasingly convinced that less aggressive rate hikes are needed to get inflation under control. The first time one sees such a change in sentiment is when interest rate expectations are reduced 6-12 months from now. That is exactly what is currently happening. Less sharply rising interest rates are good for the equity markets. For us, a good indication that a relief rally can now start.
Best investments when interest rates rise
Even though expectations for sharply higher interest rates are declining, almost 100% of investors expect higher interest rates in the next 2-3 years. Where is the best place to invest in such an environment.
The bank JP Morgan has analyzed which asset classes have performed best in the past with rising interest rates.
The chart shows which asset classes have outperformed the broad market in rising interest rates since 1950. Small caps and value are at the top of the list.
The chart shows how strongly growth stocks have outperformed value stocks since 1975. After the outperformance of growth in 2000 and 2008, there was a major counter-reaction from value stocks in each case. This is also expected now. The movement that has been going on since last November is just beginning. In 2000, the same position outperformed by more than 30%.
More surprising is to see on the list of best asset classes small-cap stocks (small caps). Currently, this has not benefited at all. In fact, the opposite has been true. Small caps have under-performed strongly in 2022. However, research shows that the out-performance only happens after the second or third interest rate hike by the central bank. That would be around July or the end of the summer vacations.
The chart shows a Bank of America survey of how much small businesses expect costs and inflation to rise. Since 1973, this is as high as it has ever been. It seems that currently even the small companies themselves do not believe in better times. In fact, it seems to be too early to bet on this asset class.
Bank JP Morgan has also analyzed which sectors have historically performed best when interest rates rise in the US. The chart shows which sectors have outperformed the broad market in rising interest rates since 1950. Here, not surprisingly, the typical value sectors such as financials, energy and industrials are at the top.
The chart shows the return of the individual main sectors compared to the return of the broad market (S&P 500) since the beginning of the year. Here, too, the Ukraine war seems to have overridden the long-term correlations. While the energy sector is at the top of the returns list, sectors such as healthcare, consumer discretionary and utilities have done well. None of this fits into the long-term picture yet. If concerns about the war in Ukraine do not materialize, we expect financials and industrials to rebound.
Oil and sanctions
Since the start of Putin's war of aggression on Ukraine (and even a few weeks before), the oil price has risen sharply and fueled inflation.
The chart shows the oil price since July 2019. Since the low during the Corona crisis, the price has increased more than six-fold at times. Since the war in Ukraine, sanctions against Russia in particular have driven the price.
New figures now show the obvious picture. The sanctions are not working and are hitting the wrong people. It was previously assumed that the sanctions would lead to lower oil volumes worldwide. However, this is not the case. Russia has managed to find new customers in China and India. Last week, India called on all companies in the country to buy more Russian oil. Due to the high oil price and the new sales markets, Russia has earned even more from oil than before. But at the same time, inflation is skyrocketing in the U.S. and Europe.
The focus of the sanctions must urgently change. Only a low oil price hurts Putin.
Last weekend and these days EU, G7 and NATO summits took place. The U.S. has a plan to change the sanctions so that the oil price falls and harms Putin. Whether that succeeds will be seen, but the very possibility of lower oil prices should help the stock markets.
Recovery of the stock markets
The chart shows how the current correction can be classified historically. The gray area shows the course of all 20% corrections in the S&P 500 since 1950. The light blue line is the average of all recoveries in which there was a recession afterwards, in dark blue without recession.
In orange is the current correction. Even if there is a recession now, prices have overshot too much to the downside. A countercorrection seems likely.
The storm is not over yet
Even if a recovery, a so-called bear rally, could occur in the next few weeks, the crisis is not yet over.
The chart shows in blue the global actions of the central banks. As can be easily seen, this is a very good leading indicator of the development of the PMI. The Purchasing Managers Index, also known as the "ISM Manufacturing Index" or "ISM - Purchasing Managers Index", is in turn the most important and reliable leading indicator of economic activity in the USA. A value below 50 indicates a shrinking economy. So we could see values at 45 in the next few months. This means recession.
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