Market report

War in Israel and parliamentary crisis in the U.S., economic indicators in the U.S. and interest rate development, institutional investor survey

October 23, 2023
6 min.
War in Israel and parliamentary crisis in the U.S., economic indicators in the U.S. and interest rate development, institutional investor survey

Chart of the week

Source: YouTube, Mario Lochner. 21.10.2023, Time stamp 15.01

The chart shows a Bloomberg survey of what economic impact investors expect the war in Israel to have and under what scenario.
A ground invasion is already priced into prices. But if the war escalates, stock markets will continue to fall.
Why this is important
What is currently unsettling the stock market is the following:
U.S. parliamentary dispute:

The nomination of the new Speaker of the House of Representatives has failed three times and the candidate has withdrawn. No immediate solution is on the horizon. As a result, the House cannot make any decisions and is paralyzed. As a result, decisions on the following matters are blocked:

- Military aid to Israel

- Military aid to Ukraine

- Budget compromise.
The current interim budget lasts until November 15. If a new budget is not passed by then, the administration must go into a shot-down. All non-vital facilities will be closed and civil servants put on forced leave.
The psychological effect may also affect Black Friday, the most important day in the Christmas shopping season, which takes place on Nov. 24.

War in Israel:

Wherever you look, immeasurable suffering for the civilian population. The war will leave only losers on both sides.

Economically, the impact of the conflict on the price of oil is crucial. Globally, oil and gas provide 55% of the world's energy needs. Coal another 25%. The war is taking place in, or may spread to, a region where 1/3 of the world's oil production comes from.

The risk of escalation of the war when Israel launches the ground offensive is very high. There is a danger that...

- Hezbollah intervening in the war and forming a second front.

- Direct or indirect Iranian intervention in the war. This can be done by firing missiles into Israel to help its Hamas or Hezbollah partners or by blocking important oil trade routes such as the Strait of Hormuz.

- Israel destroying all the oil production in Iran to deprive Hamas of all the resources that come from Iran.

Everyone, America in particular, is trying very hard to avoid escalation. But we don't think they can stop Israel from a ground offensive.

Real estate crisis in China:

The bad news from the Chinese real estate sector does not stop. The number 1, Evergrande, has stopped paying interest for a long time and the number 2, Country Garden, has also stopped paying interest on foreign bonds. The two are sitting on debts amounting to USD 550 billion. There are increasing signs of an uncontrolled collapse.

The bad news from the Chinese real estate sector does not stop. The number 1, Evergrande, has stopped paying interest for a long time and the number 2, Country Garden, has also stopped paying interest on foreign bonds. The two are sitting on debts amounting to USD 550 billion. There are increasing signs of an uncontrolled collapse.

Good entry points:

The stock market in Europe has already lost 10% since the peak in July. We are close to the lows of the banking crisis in March 2023. This is then also a first possible entry point.

There is also the probability that the stock market drops another 5%, to the level of the beginning of the year. This would then be an ideal entry point.

Economic indicators in the USA and interest rate development
The chart below shows an index of economic indicators that show a change in economic development very early in the past. This index (LEI, Leading Economic Index) is calculated by the American think tank "The Conference Board".

Source: Twitter, Liz Ann Sonders, @LizAnnSonders, 20.09.2023

Since the beginning of the year, the index, and thus the average value of all leading indicators, has been falling sharply. In the past, this always signaled an economic turnaround and an emerging recession.

Source: The Conference Board, LEI for the U.S. Continues to Fall in September, 19.10.2023

The chart shows the individual components of the LEI. In blue is the change compared to the previous month, in gray the change since 6 months. Except for the stock price (S&P 500 Index), almost all components of the index are negative or unchanged since 6 months.

There are three components that do not fit into this picture. The still strong stock market, unemployment, which is not declining (last value in the chart above, Initial Claims) and consumption (not part of the LEI index).

Source: YouTube, Mario Lochner. 21.10.2023, Time stamp 9.31

The chart shows the monthly change in US consumer spending since a year ago. Although many assume a recession or at least a cooling of the economy, consumption has been growing steadily since April.

Source: YouTube, Markus Koch. 17.10.2023, Time stamp 3.37

Since 1960, one of the reliable indicators of an emerging recession has been an inverted yield curve. This refers to a situation in which short-term interest rates are higher than long-term interest rates. Normally, it is the other way around, as the longer you lend money, the higher the risks.

The chart shows how many days we have now seen an inverted yield curve in the markets. At 232 days, it's the highest since 1960, so a recession is already overdue.
Interest rates continued to rise last week as well. An interesting chart shows the impact on the real estate market:

Source: YouTube, Mario Lochner. 21.10.2023, Time stamp 4.36

The graph shows in red the return that investors achieve with rental properties. This currently averages 4.6%. The blue line shows the yield on 10-year US government bonds. The chart shows a value of 4.6%, in the last week this has risen above the magic limit of 5%. Magical because in the past, when the yield on US government bonds was above 5%, there were major shifts from equities and real estate to government bonds.

With a yield of "only" 4.6%, it no longer makes sense for investors to buy residential real estate. With a risk-free investment in government bonds, one earns more. The market for residential real estate has then also collapsed sharply.
But what does not fit into the current picture at all is the net interest burden on companies:

Source: YouTube, Markus Koch Wall Street, 06.10.2023, Time stamp 10.58

We have seen in recent years it fastest and strongest increase of the key interest rates by the U.S. Federal Reserve since 1970. Therefore, the chart above is logical, as it shows that the interest burden on retail investors has risen sharply.

What is illogical, however, is that the net interest burden on businesses has decreased. The explanation for this is relatively simple. Many companies, when interest rates were at 0%, took on as much debt as they could, but did not invest the money in productive assets. The money stayed in cash accounts, and is now invested in government bonds at high interest rates. So many companies are currently making financial profits in addition to their core business.

This may be one of the important reasons why corporate profits are not falling and why there is no recession.
After the many negative reports about wars, political disputes and negative leading indicators, I would like to end on a positive note:

Source: YouTube, Mario Lochner. 21.10.2023, Time stamp 14.27

The chart shows the average return on the U.S. stock market since 1960 when private investors were extremely negative (AAII, American Associtation of Individual Investors) and a record number of investors were hedged (U.S. call/put ratio). Both indicators have current values close to their historical maximum.

The chart shows the return an investor has made over the past 60 years if they were brave and bought when sentiment indicators were this negative. Just 3 months after the investment date, his investments showed a gain of 3%, after 6 months 10% and after 12 months almost 20%.

With all the negative news, this leads to the conclusion that good entry points are approaching.

Survey of institutional investors
In the US, over 70% of all financial instruments (stocks and bonds) are held by institutional investors. Their opinion is important because they also account for most of the trading volume.

If, as we see in the chart below, institutional investors think technology stocks are overvalued, they will stop buying them. It is then only the private investors who drive the prices up, but volumes can soon be expected to fall.

Source: Isabelnet, 20.10.2023

The chart comes from a Bank of America survey of the largest institutional investors. The question was where they see the biggest crowded trade. In other words, the greatest danger of a bubble, because all investors are running in the same direction.

The first correction in technology stocks is having its effect. A month ago (light blue), over 50% of institutional investors were convinced that technology stocks were massively overvalued. Now that percentage has dropped to 37%. But with over 1/3 of investors still very high. It still seems too early to get into technology stocks.

Last week was the first week in a long time in which net, money flowed out of the technology sector.

Source: Isabelnet, 20.10.2023

Here, institutional investors were asked where they see the highest risk on the stock markets. The change in the values from September to October is an excellent indication of the change in sentiment.

Fears of continued high inflation are fading, but fears of geopolitical crises and a subsequent recession are on the rise.

Source: Isabelnet, 20.10.2023

Here, investors were asked how they assess future economic development. At almost 60%, investors believe that the central banks have cooled the economy just right so that there will be no recession (soft landing).

However, almost 30% believe that we are facing a recession (hard landing). However, the number of investors expecting a recession has nearly doubled since last month.
Even if good entry points are now forming soon in the markets, as described above, the overriding investment strategy should still be very cautious. That is, a focus on large-cap quality stocks and value stocks is appropriate.

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