Stocks inched up in Europe in early trading on Wednesday after more positive session on Wall Street. The FTSE 100 regained 7,700 after snapping a 5-day win streak in the previous session. The Nasdaq led gains on Wall Street, rising 1 per cent as tech continued to fetch a bid, whilst the S&P 500 rallied 0.7 per cent as Jay Powell, the Fed chair, shied away from laying down too hawkish a message. Not a lot on the slate today – US 10yr bond auction perhaps of note. Key US CPI is tomorrow. Dollar holding lows at 103 but not making fresh lows yet. Gold continues to move up, crude oil firming a touch, copper making fresh cycle highs.
Why markets could be wrong about rates
Going back to the old topic of inflation, the early 2023 data (weak ISM, slowing wage growth) supports the ‘peak inflation’ narrative. The worry seems to be more about growth now, but, if an inflation peak has been discounted by the market then there is room for a shock should it linger for longer. This narrative will be tested tomorrow with the CPI inflation report.
Markets still underprice the terminal rate at 4.75-5 per cent vs the 5-5.25 per cent indicated by the dot plot, whilst fed funds futures trading indicates cuts towards the end of the year – even as no Fed policymakers thinks they will cut this year. I think the market is underestimating it and we get closer to 6 per cent than 5 per cent by the middle of the year.
JPMorgan CEO Jamie Dimon believes there’s an evens shot of US rate topping 6 per cent. I put the odds on 6 per cent at shorter than that. As repeatedly talked about in this newsletter, the persistence of inflation and the resilience of the labour market will see the Fed squeeze rates higher than the market expects. Markets seem to be taking the peak inflation narrative as a signal to buy. However a plateau is not the same as a peak and they will find it lingers higher for longer, and the labour market will remain tight = more hikes.
Terry Smith on Unilever
Some choice words from Terry Smith, head of Fundsmith, with the choicest reserved for Unilever (ULVR). Smith has been a long-time critic of management, particularly some value-destroying acquisitions that he points out management don’t really like talking about, or disclosing how much they paid, such as Dollar Shave Club.
There was also a swipe at share-based compensation. Or at least, a swipe at the way some companies use this to distract from their actual earnings per share. In the case of Intuit, he says, it would imply that the company is not in fact trading at a trailing twelve-month free cash flow yield of 3.5 per cent. “Removing $1.5bn of share-based compensation from the $4.1bn of operating cash flow reported in the cash flow statement would leave Intuit’s free cash flow yield much lower, at 2.2 per cent. This example gives a sense of the magnitude of distortion that the accounting for share-based compensation could inflict on free cash flow yields,” Smith said.
Finally, Smith attributes the fund’s underperformance on the “painful” end of easy money. This could be seen as too easy an excuse, but it’s hard to disagree. Click here to read more.
Charts
Gold moves higher
Gold has risen to its highest since April last year as a combination of slower Fed rate hikes and persistent inflation have left traders backing the metal, which is up about 16 per cent from its Sep-Oct-Nov bottom. A weaker dollar, which is about 10 per cent off the multi-year highs hit in September, has also underpinned the rally. Golden cross forming with the next big test at the 38.2 per cent retracement round number resistance around the $1,900 level. If that goes then the April 2022 swing high at $2,000 becomes possible.
Neil Wilson is the Chief Market Analyst at Finalto
