This is the CMC APAC Q4 Outlook, presented by market analysts Tina Teng, Azeem Sheriff & Leon Li. You can follow us on our socials below.
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This outlook has been broken into 3 sections and hyperlinks are provided for reference/navigation.
Click here to read Part 2 (Australian Market & AUD/USD)
Click here to read Part 3 (Chinese equities, Yuan & Commodities)
US markets outlook for the fourth quarter
The US Fed confirmed to keep hefty rate hikes in the coming months in its September policy meeting, signalling an economic recession might be the cost of taming inflation. The Fed’s recent dot plot shows that the median rate will reach 4.35% by the year-end and 4.6% by 2023, which is higher than previously projected. A higher rate expectation may cause a further devaluation in equities. Since the central bank has clarified its hawkish guidance, the discussion is now centred around whether there will be a recession in the fourth quarter.
A potential further drop in US equities
Historically, the S&P 500 falls about 30% during an economic recession, which could mean there is a possibility that the index may go further down to 3,200, or 33% from its January high, if there is an economic recession in the fourth quarter. The below chart illustrates that the downside risks are still high, with the VIX picking up to above 30 whilst the Fed is still in its rate hike cycle. However, the probability of a fourth-quarter systematic crash in US equity markets is low as illustrated by the below charts that the two recent crises, the GFC in 2008 and the pandemic in 2020, all happened in the second half of a rate cut cycle, but not in a rate hike cycle. In short, the all-year-long selloff in equity markets is pricing in a slowdown in economic growth, but not an economic crisis.
Therefore, if equity markets continue to price in an economic slowdown without a material recession, the S&P 500 could cushion its downtrend to around 3,400 – 3,500.
The US dollar will remain stubbornly high
The US dollar index (DXY) rises to a 20-year high amid a surge in US bond yields and the Fed’s hawkish stance. As shown in the below chart, a financial crisis usually occurred when bond yields were falling when the yield on 2-year government treasury notes dropped below it was on 10-year government treasury notes, or in short, after the bond yield inversion period. The DXY usually falls during a rate cut cycle, along with an economic recession, which suggests that the king dollar will most likely remain high against the other major currencies throughout most of the fourth quarter, but a retreat may be near as it hits a channel resistance. A 5%-6% down from the current level may be possible, with a potential range movement between 109-115 for the rest of the year.
A possible softened tone of the Fed towards the year-end
Cooling inflation and a possible rise in the unemployment rate may soften the Fed’s hawkish stance and support a rebound in the US equities toward year-end. The US unemployment rate reached a pre-pandemic low but shows signs of picking up, while both the Fed 5-year (T5YIE) and 10-year (Y10YIE) forward inflation expectation rates are falling, which may encourage the Federal Reserve to slow down its pace on rate hikes in its last two meetings in November & December, which may promote another Christmas rally into the new year.
Click to enlarge the chart
US Sector performance
The US economy may be entering into stagflation in the fourth quarter as the Fed’s “front-loading” rate hikes will eventually cause a rise in the unemployment rate, coupled with high inflation and a slowdown in economic growth.
According to the famous Merrill Lynch Investment Clock, the selection of asset class starts turning from commodities to defensive classes during a “stagflation” cycle, which implies that the energy sector may be slowly phasing out, while defensive sectors, such as consumer staples, healthcare and utilities may outperform. In addition, financials and consumer discretionary might also be a great opportunity for dip buyers.
11 sectors performance in the S&P 500 for the last three monthsSource: TradingView as of 29 September
The table indicates that the sectors framed in green have been outperforming for the last three months and recently, in which Healthcare and Consumer Discretionary were the most resilient sectors, followed by Consumer Staples, Financials and Utilities.