Duet Protocol Global Market Recap and Outlook — 20231023

Duet Protocol
12 min readOct 23, 2023

Under the influence of war risk aversion, Q3 financial reports falling short of expectations, record-high national bond rates, and the Fed’s hawkish tone combined with better-than-expected economic data (retail and initial unemployment benefits), U.S. stock indices plummeted last week after a slight rise in the previous two weeks. The NAS100 fell by over 3%, the SP500 by 2.5%, closing below the 200-day moving average, with major tech companies leading the downturn. In addition, European and Asian stock markets generally declined, with Germany’s DAX dropping 2.4%, China50 down by 4.3% (despite China’s GDP significantly exceeding expectations at 4.9% and deflator at -1.4%), and Japan’s Nikkei 225 falling by 2.7%. Both U.S. small caps and Chinese stocks hit a year-to-date low.

Gold prices rose nearly 3% last week, marking a five-month high. Against the backdrop of widespread macroeconomic headwinds, cryptocurrencies, led by Bitcoin, surged. This aligns with our viewpoint presented in last week’s report; in times of rising uncertainty, the demand for diversified assets like gold and cryptocurrencies becomes evident, even if crypto lagged a week behind gold in its bullish movement.

The ability of cryptocurrencies to rally amid a global stock market downturn challenges the previous direct correlation between the two, potentially restoring confidence in an independent crypto market trend.

Defensive stocks showed stronger performance.

According to GS PrimeBook data, last week saw significant portfolio reductions and profit-taking among institutional investors in the tech sector, particularly in low-quality stocks.

The yield on the 10-year U.S. Treasury bond almost touched 5% during Thursday’s trading, a peak not seen since July 2007. The 30-year bond challenged the 5.1% mark on both Thursday and Friday, a high not reached since May 2007. Since August, the rise in the 10yr and 30yr rates equates to four interest rate hikes. Moreover, major European countries’ bonds are challenging multi-year highs (DE 10yr 2011, IT 10yr 2012, GB 10yr 2008).

Historically, U.S. bond yields have peaked ahead of the Fed’s policy rate. If we anticipate the Federal Reserve nearing the end of its rate hikes, then yields may already be nearing their zenith.

The Bank of Japan couldn’t prevent the 10-year national bond yield from exceeding the 0.8% level (highest since 2013), which could further reduce Japanese reliance on U.S. dollar assets.

S&P has affirmed Italy’s sovereign debt rating at BBB, with a stable outlook. The widening spread of Italian government bond yields against those of Germany and other core Eurozone countries may be a focal point for this week’s European Central Bank meeting. It remains to be seen whether support will be provided through the PEPP reinvestment plan.

Data released by the U.S. Treasury Department on Wednesday revealed that in August, Chinese investors sold a record $21.2 billion in U.S. bonds and stocks, the highest in four years. This includes an unprecedented $5.1 billion in U.S. stocks, fueling speculations of liquidating assets to secure U.S. dollar cash in anticipation of interventions to defend the yuan.

3Q Financial Report Progress:

Based on the reported results of 86 companies and the forecasts for those yet to be announced, the earnings outlook for companies in the S&P 500 index has deteriorated.

Factoring in last week’s financial reports, net profits are projected to decline by 0.4% compared to the same period last year. This projection slightly revises down from the previous week’s anticipated 0.4% YoY growth.

Of particular note is Tesla. Its Q3 2023 financial report shows Q3 revenues of approximately $23.4 billion, a 9% YoY growth but below Wall Street’s expectations of $24.3 billion, marking the slowest growth in three years. Net profit stood at $1.853 billion, a 44% YoY decrease, and the gross margin further declined to 17.9%, a 0.3% dip from the previous quarter, hitting a 4-year low. Given the general tech stock correction, Tesla’s stock plummeted by 15.22% last week, wiping over $100 billion in market value.

Contrasting with Tesla’s fate, TSMC announced Q3 revenues of TWD 547 billion (equivalent to $17 billion), down 11% YoY. However, their net profit was TWD 211 billion, exceeding analysts’ forecast of TWD 190 billion but down 25% YoY. The company predicts a broader recovery in semiconductors next year with stronger demand for high-end chips. Consequently, TSMC’s stock went against the trend, closing up 1% last week.

Worth noting is that high-performance computing, including high-end AI chips, accounted for 42% of its total sales, down from 44% in the previous quarter but up from 39% YoY.

Israel-Palestine War Update

The Israel Defense Forces and reserve forces are currently massed on the border with Gaza, ready to launch a ground offensive into Gaza at any time.

In an attempt to prevent escalation of the Israel-Hamas war, dozens of countries held a peace summit in Cairo over the past weekend. Major global powers sent officials, but embarrassingly Israel refused to attend. In the end, no joint statement was issued after the summit due to differences between Arab and Western leaders. Arab leaders condemned Israel’s bombing of Gaza and called for an immediate halt to actions. Western leaders mostly emphasized that civilians should be protected and humanitarian aid provided.

Biden visited Israel last week, a clear show of support amidst the war. He then proposed $14 billion in aid to Israel and Congress (on top of $100 billion total, big fiscal spending), and said he does not want to deploy US troops to Ukraine to fight Russia, but did not make the same commitment about Israeli territory.

According to sources, the US government has pressured Israel to delay its impending Gaza invasion in order to release more Hamas hostages. Blinken: “There are still 10 Americans unaccounted for in this conflict…We know that at least some of them are being held by Hamas, and there is an estimated couple hundred hostages being held in Gaza.” At the same time, the US military is sending more missile defense systems to the Middle East and preparing to deploy more troops per standing orders.

Israel has stated firmly that regardless of the hostage situation, they will dismantle Hamas. On Saturday, Hamas offered to return two Israeli women, but Israel rejected accepting them, with the PM’s office calling it a Hamas publicity stunt for international sympathy.

IDF spokesman Daniel Hagari said Saturday that the IDF will increase airstrikes on Gaza starting today. When asked if Israel had stopped ground operations in Gaza due to US pressure, Hagari said the IDF would launch such operations under optimal military conditions.

Israel’s PM warned Hezbollah that joining the fight would be “devastating” for Lebanon.

According to Gaza’s Health Ministry on Sunday, the death toll in Gaza since Oct 7 has risen to 4,651, with over 14,245 injured.

**It appears the Israel-Hamas war may not have truly started yet, and the US is unlikely to prevent an Israeli ground invasion, so the impact on oil prices may persist for some time. Middle Eastern countries could wield oil as a weapon against Israel and its allies, as Iran’s Foreign Minister called last week for all Muslim nations to impose an oil embargo on Israel, further boosting prices. **

Reduced Iranian oil exports are the most likely near-term consequence. Iran’s oil exports are currently at 2 million bpd, highest since 2018 due to relaxed US sanctions. However, open support for Hamas and Hezbollah could prompt a major US policy shift on Iran, though the impact is small for OPEC’s >36 million bpd output.

Also remember last week’s drone strikes on US forces in Iraq and Syria, and on the Navy by Yemen.

Additionally, the US Energy Department last week said it is prepared to purchase 6 million barrels of oil for the Strategic Petroleum Reserve at $79/bbl or lower in Dec-Jan. Of course this implies no refilling, as oil is unlikely to fall that low with geopol risks at multi-year highs and the SPR already half-depleted:

News of the SPR replenishment plan helped boost oil prices, with $79 seeming like the new floor.

More Trouble Electing House Speaker

Last week we mentioned Jim Jordan’s eventual loss. Some comments called this one of the “most severe institutional crises” the US political system has faced in decades, from McCarthy’s 15 rounds of voting in January to the GOP now unable to even put forward a consensus candidate from their own party.

With temporary government funding expiring Nov 17, concerns about a government shutdown will return as time passes. Plus Biden’s >$100 billion plans to fund Ukraine and Israel combine with the market pricing rising fiscal spending and internal US turmoil to send 10Y yields to fresh 2007 highs.

There are shades here of the UK’s Truss Moment last year, when the UK tried deficit spending in the face of inflation, crashed capital markets, and produced the shortest-serving PM ever in Truss.

Hawkish Fed Officials

Powell: Hinting a pause in hiking is possible at the next meeting ending Nov 1, but inflation is still too high and more hikes are possible if the economy remains strong. (Hawkish)

Logan: There is absolutely no thought of rate cuts now, and it is uncertain inflation is moving back to 2%. While encouraged to see some welcome developments on inflation, it remains at very elevated levels that warrant a continued restrictive stance on policy. (Hawkish)

Bostic: The long-run equilibrium for the US economy continues heading in a positive direction. He doesn’t see potential for rate cuts before mid-2024, with some chance in the second half of 2024. He believes inflation will return to the 2% target but the Fed should be very careful, patient, and emphasizes no recession for the US economy. (Dovish)

Harker: The US economy is very healthy and the labor market very robust. Reiterated a bias to holding rates but closely monitoring data. (Hawkish)

Mester: Still supportive of one more hike. We’re probably at or close to peak rates now. Expects rates to remain at peak for some time. QT can operate fully independently of hikes. (Hawkish)

Expert Views

[Morgan Stanley: Surging Yields Equal 3 Hikes, Slowdown in Q4 Will Prompt Fed Pivot]

The rise in bond yields has notably tightened financial conditions. Compared to the September policy meeting, the MS Financial Conditions Index (MSFCI) suggests conditions have tightened equivalent to about three additional 25bp hikes.

The growth and inflation impact of tighter financial conditions depends greatly on whether tightening is exogenous or endogenous. Sustained exogenous upward rate pressures should slow economic growth, prompting the Fed to adjust its policy rate path over time to offset the drag from higher rates. In contrast, if the rate rise is an endogenous reaction, reflecting ongoing strength from more fiscal support, higher productivity, or both, the Fed may see no need to dial back its policy path.

“We lean more towards the former explanation rather than the latter. We don’t believe the growth momentum of Q3 is likely to persist. MS Chief US Economist Ellen Zentner notes the Q3 consumer spending benefited from large one-time events — Lollapalooza, Taylor Swift’s The Eras Tour, and Beyoncé’s Renaissance Tour…The conclusion of these events, along with the expiration of the student loan pause, will weigh heavily on real personal consumption in Q4 2022, and thus on growth. The tightening in financial conditions from the rise in long-term yields will only exacerbate this drag. As such, we expect the Q4 data to show slowing growth, prompting a reversal of the recent yield spike caused by declining term premia.”

Fund Flows & Positioning

US money market funds saw the largest weekly outflow since Lehman Brothers (Q3 2008), at -$99 billion:

Outflows were all institutional money (retail saw inflows):

This may be driven by extended tax payment deadlines, or something else?

Both subjective PM positioning (37th percentile) and systematic positioning (36th percentile) edged down, slightly below neutral:

Global equity funds saw a second week of outflows ($52 billion). The US ($3 billion) had minor inflows while other major regions saw outflows. Bond fund inflows ($21 billion) slowed versus the prior week.

CTAs continued cutting their overall equity exposure last week after first going short equity indexes since November 2022.

By sector, nearly all are below average and below 50th percentile except energy (68th percentile). Materials (27th), healthcare (17th), and financials (12th) significantly below average. Utilities (5th percentile) and real estate (2nd percentile) at extreme lows.

CFTC futures data shows overall equity net longs rose on increased S&P 500 and Nasdaq 100 net longs while Russell 2000 net shorts declined.

On bonds, overall net shorts marginally fell on declines in 10Y and 30Y net shorts overpowering increases in 2Y and 5Y.

On FX, overall USD net shorts edged up slightly on increased Euro net longs:

On commodities, crude oil net longs rose slightly; silver net shorts flat while gold and copper flipped from net short to net long; copper net shorts increased further.

Sentiment Indicators

BofA Bull & Bear indicator has entered “extreme bearish” zone, which per BofA’s CIO Hartnett suggests the contrarian buy signal for risk assets has been triggered: Historically, median 3M returns after buy signal means 5.4% upside for US stocks, 7.6% for global stocks, and 9.1% for IG bonds.

Goldman Sachs Institutional Sentiment indicator flipped positive last week:

AAII survey bulls and bears both declined, with neutrals rising, highlighting the tug-of-war underway:

CNN Fear & Greed Index plunged, nearing extreme fear:

Key Events to Watch

US Q3 GDP — First estimate out Thursday, expected to show growth accelerated to 4.3% QoQ annualized vs 2.1% in Q2.
US September Core PCE — Market expects core PCE slowed slightly to 3.7% YoY vs 3.9% in August, but accelerated 0.2% MoM from 0.1%. Overall PCE seen slowing to 3.4% YoY from 3.5%, and 0.35% MoM from 0.4%.
ECB Rate Decision — Pause from hikes is certain, but watch for Lagarde’s outlook on economy and future hikes — still possible in December.
Big week for earnings — 162 S&P 500 companies reporting, most notable Microsoft, Alphabet, Coca-Cola, GE, GM, Meta, IBM, Amazon, Intel, Mastercard, Colgate, and Exxon Mobil. Though Wall Street expects a slight aggregate decline in S&P 500 profit growth, mega-cap techs like Meta and Amazon with huge valuations are seen contributing greatly.

The End.

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