Continued negative sentiment among investors, how long will interest rates continue to rise in the U.S.?
Chart of the week
he chart shows the positions of all market participants with forward contracts on all major American stock markets. With futures, you can profit with little money on rising markets (calls), but also hedge your portfolio if the stock market falls (puts). The premium paid for a put is then like an insurance premium against falling stock markets. But if the stock market then rises, you have paid the insurance premium for nothing.
Currently, investors hold a lot of put options.
Why this is important
In the history of the U.S. stock markets, there has never been a case where the number of investors holding puts has been so large.
The stock market goes down when more investors sell than buy. But if everyone is hedged or uninvested, it only takes a few positive reports and the stock market goes up 2-3% in a day. This happened twice last week. When at the beginning of the week rumors arose that China would turn away from the zero COVID policy or at the end of the week when rumors arose that Putin was ready to talk to the Americans about the war in Ukraine.
The risk for more big drops in the stock market is less than the risk of missing these massive moves to the upside.
Interest rates in the USA
Also last week, the Federal Reserve (FED) raised interest rates by another 0.75%.
The chart shows how the central banks in the USA, England and Europe have already raised interest rates. Important for the investment policy is the big difference between the USA and Europe. In 2021, the US was about 1% higher, now it is 2.5%. This interest rate difference makes the USD stronger, because more investors lend their money in the USA than in Europe. Only when this interest rate difference becomes smaller again will the USD lose value against the EUR.
The chart shows investors' expectations about further interest rate steps by the U.S. Federal Reserve. In dark blue the expectations on Wednesday before the announcement and in light blue after the press conference. After the press conference and the statements by Federal Reserve Chairman Jerome Powell, expectations rose again slightly. Many had hoped that the central bank could now raise interest rates less sharply, but the hopes were not fulfilled.
The chart shows the terminal rate in the USA. The terminal rate shows the level at which the FED is expected to stop raising interest rates. With Wednesday's rate hike, the FED's target rate is now between 3.75% and 4%.
Every time the terminal rate goes down, there is a rally in the stock markets. Therefore, to forecast the stock markets, looking at the interest rate forecasts is key.
A somewhat negative picture is shown in the following chart.
The graph shows in red the phases of an inverse yield curve. Normally, one pays a lower interest rate for short-term loans than for long-term loans. The future is uncertain and therefore the risks for long-term loans are higher.
Currently, we are in a rare phase where long-term loans (10 years) have a lower interest rate than short-term loans (2 years).
In the last 30 years, after such a situation, there has always been a recession.
A recession does not necessarily mean sharply lower stock prices. But in all these phases, value stocks have performed better than growth stocks.
A lot of data shows that the economy is already slowing down:
The chart shows inflation (white) and the ISM index (green). The ISM manufacturing index, also known as the Purchasing Managers' Index (PMI), is a monthly indicator of economic activity in the US based on a survey of purchasing managers at more than 300 manufacturing companies. Many firms are cutting back on purchases, suggesting reduced production in the future. The ISM is one of the best-known early indicators of economic performance. Therefore, its forecasting power for inflation has been very good in the past.
The current large deviation is based on the war in Ukraine and the strongly rising energy costs as well as still supply difficulties from Asia based on the zero-COVID policy of the Chinese government.
The strongly rising interest rates also have an impact on the gold price. Gold is a safe investment and appreciated in times of crisis. However, gold does not pay interest. That is why gold's natural competitor is safe government bonds. Since government bonds now pay much higher interest, this motivates investors to shift from gold to government bonds. Also, a strong USD is usually negative for the gold price.
The chart shows a phase of unusually long negative money flows from gold. However, due to additional covid waves and the war in Ukraine, which could still escalate, there are major geopolitical risks, we maintain a (small) gold position in the portfolios.
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