September 2023 unfolded as a month best left unremembered, characterized by lacklustre performance in equities markets as investors took a defensive approach by reducing their exposure to stocks. Despite the Fed's decision to pause rate hikes in September 2023, their path remained data-dependent, marked by a consciousness of inherent uncertainties, as detailed in their press conference. The Fed's resolute stance on interest rates, emphasizing their unwavering commitment to bringing inflation down to the targeted 2% further fuelled caution[1]. Additionally, long-term U.S. Treasury yields surged to a 16-year peak, triggering concerns about tightened financial conditions, which in turn bolstered the U.S. dollar's performance. [2]

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Across the Atlantic, the European Central Bank (ECB) raised rates by 25 basis points but hinted at nearing its terminal rate, while the Bank of England (BOE) and the Swiss National Bank (SNB) surprised markets by holding steady, with the latter adopting a wait-and-see approach. The Bank of Japan (BOJ) maintained its rates, with the BOJ's chief expressing reservations about the uncertain wage and price outlook[3]. In Asia, China's property market turmoil persisted, exemplified by Evergrande's missed payments on onshore bonds.

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Lastly, oil prices experienced a sudden surge to $95 on 20 September, 2023, contributing to supply concerns as OPEC+ members Saudi Arabia and Russia extended combined supply cuts of 1.3 million barrels per day (bpd) through year-end.[4]

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Fixed Income Strategy

 

Our steadfast strategy remains centered on the concentration of short-duration investment-grade instruments, a choice that continues to prove its mettle. September 2023 witnessed a resurgence of U.S. Treasury Yields, surging to multi-year highs. While the allure of longer-term yields may be tempting, we advocate for investor patience, as we anticipate further potential upward movement in Treasury Yields. Concurrently, there is a risk that credit spreads may widen as market participants grow complacent regarding recessionary concerns. While there are some minor positive signs indicating potential relief in the China property bond market, we believe it would be premature to re-enter until we see more substantial stimulus policies being implemented by Beijing.

 

Equities Strategy

 

Following the September FOMC meeting, S&P 500 fell 2.6% over the next two trading sessions, with growth-related stocks underperforming. As of writing (27 September, 23) the VIX volatility index is trading at 18.3 a level unseen since May this year. The strategy of buying put options on S&P 500 has definitely paid off over the last 2 months. We see this sharp pull back in September as a good opportunity to acquire some names with stable outlook and good free cash flow growth potential. With the heightened volatility, yield hungry investors can consider selling put options on such selected names.

 

Investors are increasingly attentive to the recent surge in oil prices. With Brent crude rallying by approximately 30% from its June lows to exceed $90, Goldman Sachs' research [5]indicates that a substantial portion of the oil price upswing has already materialized. This upward trajectory in oil prices has closely mirrored the performance of the Energy sector throughout the year. Drawing from historical patterns dating back to 2015, it is anticipated that the Energy sector could yield a 4% return if Brent oil prices reach the $100 mark, which aligns with Goldman Sachs' new 12-month target.

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Remarkably, the Energy sector presently trades at an exceptionally low valuation of 0.7 times its price-to-FY2 earnings, placing it in the 5th percentile when compared to the past three decades. Additionally, the sector offers a compelling total cash yield, encompassing dividends and buybacks, at 8.5%, notably surpassing the S&P 500's 3.7%.

 

While the combination of attractive valuations, high yields, and robust oil prices suggests that Energy stocks are poised to outperform, we agree with Goldman Sachs which advises [6]caution regarding the immediate upside potential. Investors are now weighing the potential benefits of Energy investments against the growing risk of a recession stemming from the inflationary pressures induced by elevated oil prices. It's also essential to recognize that high oil prices effectively act as a tax on consumers, leading to reduced discretionary spending. Historical data reveals that when oil prices rise by 5% in a single month, as was observed in both July and September, the equal-weighted Consumer Discretionary and Staples sectors tend to underperform the broader S&P 500 index. Industries such as airlines, construction materials, and logistics have historically exhibited the most significant lag in such scenarios.

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FX Strategy

 

With the Federal Reserve adopting a more hawkish stance, signalling a potential rate hike this year and reduced easing plans for 2024, it has eliminated hopes of an earlier rate cut that some in the market were anticipating. Coupled with rising oil prices, a downgraded economic outlook from the European Central Bank, unexpected rate holds by the Bank of England and the Swiss National Bank, and inaction by the Bank of Japan, U.S. Treasury yields have climbed higher, giving the U.S. dollar the impetus for a sustained rally.

 

As the U.S. Dollar Index (DXY) continues to climb higher to 106.50 (as at 28 September, 23) traders are re-evaluating their short USD positions. It looks like the foreign exchange markets are tilting towards a stronger dollar trend, although this will always hinge on economic data and it will not be linear with bouts of weakness.

 

It's noteworthy that volatility has also dropped significantly towards the end of September, making options more affordable, especially with Gold volatility trading at 13Vol (as of September 26, 2023). Meanwhile, investors looking for funding currencies may considerthe Swiss Franc (CHF) and the Chinese Yuan (CNH). Both CHF and CNH have been weakening since August and are likely to continue. They are more cost-effective alternatives to the Japanese Yen (JPY), which has been under scrutiny, especially now that it is trading close to the 150 level due to frequent verbal warnings from Japanese authorities Looking ahead, our focus remain on yields, which we believe will be pivotal in shaping market dynamics.

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Source:

[1] Transcript of Chair Powell’s Press Conference September 20, 2023 (federalreserve.gov)

[2] Morning Bid: Treasury yields march on | Reuters

[3] Yen hits 11-month low against dollar, watched for intervention risk | Reuters

[4] Oil Price Surge Upends Emerging-Market Disinflation Trade - Bloomberg

[5] Goldman Sachs says OPEC can sustain Brent in $80-$105 range in 2024 | Reuters

[6]  Goldman Sachs says OPEC can sustain Brent in $80-$105 range in 2024 | Reuters

 

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