Euro stocks, plus Santa delivers, inflation expectations, and currency devaluation
The Sandbox Daily (1.5.2023)
Welcome, Sandbox friends.
Today’s Daily discusses our friends across the Atlantic, the Santa Claus Rally delivers, inflation expectations remain anchored, and currency devaluation.
Let’s dig in.
Markets in review
EQUITIES: Dow -1.02% | Russell 2000 -1.09% | S&P 500 -1.16% | Nasdaq 100 -1.59%
FIXED INCOME: Barclays Agg Bond -0.08% | High Yield -0.20% | 2yr UST 4.464% | 10yr UST 3.722%
COMMODITIES: Brent Crude +1.28% to $78.84/barrel. Gold -1.14% to $1,837.9/oz.
BITCOIN: +0.15% to $16,850
US DOLLAR INDEX: +0.84% to 105.122
CBOE EQUITY PUT/CALL RATIO: 0.76
VIX: +2.04% to 22.46
Our friends across the Atlantic
When the stock market bottomed last year in October, some significant divergences started to emerge across different geographical regions when looking at stocks.
Europe is particularly interesting because it represents a common theme that emerged throughout 2022 – a return to value-oriented investing. The less Tech exposure the better, right? And Europe is heavily weighted in sectors outside Tech – hence Europe’s major underperformance relative to the U.S. coming out of the Global Financial Crisis.
Here are the sector weightings of the Euro Stoxx 50 ETF (FEZ), a stark contrast (14.17%) to the more Tech-heavy makeup of the S&P 500 (officially 25.46% but this number is understated due to other Tech names having been recategorized across Consumer Cyclical (AMZN, TSLA), Communication Services (GOOGL), etc.)
So while the Eurozone is facing severe inflation, a weak euro currency, high odds of a recession, and an underlying energy crisis, the charts are saying something else and the only thing that pays is price. The Euro STOXX 50 appears to be forming a base and potentially gearing for an upside breakout.
Something to keep a close eye on…
Source: Sam McCallum, State Street Global Advisors
Santa Claus delivers
The Santa Claus rally delivered, albeit a smaller-than-normal return of +0.80%.
Is this good news? Well, as the saying goes, "If Santa should fail to call, the Bears will come to Broad & Wall." AKA – the New York Stock Exchange.
A seasonal term coined by Yale Hirsch (founder of the Stock Trader’s Almanac) back in 1972, the Santa Claus Rally describes what happens over the last five trading days of the year and the first two trading days of the new year. So, this year it began Friday, December 23rd and ended Wednesday, January 4th.
The seasonal pattern garners headlines because of its impressive historical results. The average performance during these 7 days is +1.33% and is positive 79.2% of the time. This is a big difference from all other rolling 7-day periods throughout the year that only average +0.24% returns and are positive less than 60% of the time.
When the Santa Claus Rally period is positive, the S&P 500 has averaged +10.9% returns per year, and it's been higher 75.4% of the time. When Santa doesn't show, those numbers drop to just +4.1% returns.
Source: Bespoke Investment Group, All Star Charts, LPL Research
Inflation expectations remain anchored
The dance between the Federal Reserve and financial markets, specifically the bond market, continues.
Our central bank remains unconvinced that inflation is on a consistent downward path and is adamant to keep rates higher for longer – with no cuts in 2023. In fact, as the recent Fed minutes show, Fed members are voicing concerns that the recent easing of financial conditions and plowing back into equities (at even a hint that rate hikes are nearly over) is making their job tougher.
So while the Fed continues to fret about inflation, the smart money (a.k.a. the bond market) is striking a different tone, with prices implying the Fed's mission to crush inflation is pretty much accomplished.
In the bond market, a key measure of inflation expectations paints a rosy picture — one in which prices drop and settle at the Fed's 2% target in short order. Treasury breakevens — or the rate of future inflation suggested by the difference between yields on regular Treasury bonds and inflation-protected bonds — suggest inflation will average roughly 2.2% over the next five years, well below last year's peak expectation of 3.6%.
So what does it all mean? The bond market expects inflation to drop back to more tolerable levels, and investors expect the economic backdrop will be weak enough to nudge the Fed to slash rates this year. Puzzled Fed officials have repeatedly said rate cuts are not on the horizon.
The dance continues.
Source: AXIOS
Currency devaluation, a tale as old as time
During the 73 years between Marcus Aurelius’s reign ending in 180 CE and the beginning of the reign of Emperor Gallienus, the denarius silver coin was periodically debased – by mixing in a cheaper base metal, like lead – from 75% silver to only 5%.
Over the past 73 years, the US Dollar also lost over 91% purchasing power through persistent debasement. Currency devaluation is hardly a new phenomenon.
Source: Horizon Kinetics
That’s all for today.
Blake
Welcome to The Sandbox Daily, a daily curation of relevant research at the intersection of markets, economics, and lifestyle. We are committed to delivering high-quality and timely content to help investors make sense of capital markets.
Blake Millard is the Director of Investments at Sandbox Financial Partners, a Registered Investment Advisor. All opinions expressed here are solely his opinion and do not express or reflect the opinion of Sandbox Financial Partners. This Substack channel is for informational purposes only and should not be construed as investment advice. Clients of Sandbox Financial Partners may maintain positions in the markets, indexes, corporations, and/or securities discussed within The Sandbox Daily.