downside risk

Oil remains choppy but flat and in lower range Oil prices are relatively flat today, mirroring yesterday’s session which was broadly choppy but ultimately directionless. Crude has rebounded strongly since falling toward its 2023 lows early last week but remains in its lower range, roughly between $70-$80 per barrel and it’s showing little sign of breaking that in the short term. While some believe the market will be in deficit later in the year, aided by the Saudi-driven OPEC+ cuts, which could support prices closer to what we saw late last year and early this, the economy remains one significant downside risk to this amid an adjustment in the markets toward higher rates for longer.   Gold drifting as we await more data Gold has started the week slightly softer but very little has changed, in that it remains in the $1,940-$1,980 range that it has spent the vast majority of the last month. It was a very quiet start to the week which is why gold has basically continued to drift and that may continue until we see a significant change in the data. The Fed last week made it perfectly clear that it doesn’t believe it’s done and its commentary this week, including Chair Powell’s appearing in Congress on Wednesday, isn’t likely to change in any significant way from that. It will be interesting to see if we get any response to UK inflation data as a potential signal of stickiness more broadly but then, there’s every chance it could be viewed as a UK issue, rather than an indication of something more, considering how much more the country has struggled until now.  

Oil remains choppy but flat and in lower range Oil prices are relatively flat today, mirroring yesterday’s session which was broadly choppy but ultimately directionless. Crude has rebounded strongly since falling toward its 2023 lows early last week but remains in its lower range, roughly between $70-$80 per barrel and it’s showing little sign of breaking that in the short term.   While some believe the market will be in deficit later in the year, aided by the Saudi-driven OPEC+ cuts, which could support prices closer to what we saw late last year and early this, the economy remains one significant downside risk to this amid an adjustment in the markets toward higher rates for longer.     Gold drifting as we await more data Gold has started the week slightly softer but very little has changed, in that it remains in the $1,940-$1,980 range that it has spent the vast majority of the last month. It was a very quiet start to the week which is why gold has basically continued to drift and that may continue until we see a significant change in the data.   The Fed last week made it perfectly clear that it doesn’t believe it’s done and its commentary this week, including Chair Powell’s appearing in Congress on Wednesday, isn’t likely to change in any significant way from that. It will be interesting to see if we get any response to UK inflation data as a potential signal of stickiness more broadly but then, there’s every chance it could be viewed as a UK issue, rather than an indication of something more, considering how much more the country has struggled until now.

Prioritise quality companies. If an investor needs to take a defensive stance, it is worth turning to quality stocks, as their robust balance sheets and stable cash flows should insulate them from unforeseen downside risk. With this in mind, many of the largest technology and Internet stocks meet these criteria, while exposure to highly cyclical sectors and companies with excessive leverage should be kept to a minimum. Thus, in order to increase the resilience of your portfolios, you should focus on high quality companies, strong dividend payers and also not forget about regional diversification, as lower valuations and a weaker US dollar can also make global stock markets outside the US attractive.   The general understanding is that the market is likely to come out of the correction this year with expectations of a continued recovery in the second half of the year and a return to a bullish trend. This recovery is expected to help recoup portfolio losses from 2022.   However, there are several factors that pose risks to the market in the near future. These risks include the potential for a bear market, which could be triggered by inflation statistics such as the PCE index and strong labour market conditions. Another risk is the narrow scope of the current rally, where only some sectors have shown growth while others, including cyclical, defensive and growth sectors and assets such as bonds, have remained weak. There is also uncertainty about the timing and severity of a possible recession this year. The market is now looking at the likelihood of a moderate recession, which is already factored into current expectations and prices.   Once there is more clarity on these risk factors, portfolio allocation can be adjusted accordingly, considering both bonds and stocks, with a focus on the second half of the year and recovery of losses incurred in 2022. Two scenarios were considered for such an adjustment:   Scenario No. 1, the positive outlook, sees the market rising and breaking through significant resistance levels of 4200-4300 in the SPX index, which would lead to a rally. In this case, it would be prudent to increase long positions. Risky stocks should be held until they reach the most likely level of local recovery, and then locked in. For positions that still have potential, they should be held. The portfolio as a whole should then be rebalanced, creating a new balanced structure with a 25% allocation to cyclical assets, 35% to growth assets, 10% to protection and 30% to bonds.   Scenario #2, the negative outlook, assumes that the market continues to decline either from the current level or below 4100. In this scenario, protection should be strengthened by using inverse ETFs and reducing long positions (using stop losses) until the target stock is reached. This approach aims to minimise further drawdown until the correction is finally resolved in 2023.   The US stock market has thus experienced a strong recovery since the start of the new year, supported by a resilient technology sector, growth in the semiconductor industry due to AI development, a strong Q1 2023 reporting season, a pause in the Federal Reserve's rate hike, expectations of future rate cuts, lower inflation, a resilient economy, a smooth economic landing and a debt limit increase. While risks are still present, a focus on longer-term investment strategies can help investors benefit from the market's upward trajectory and continued recovery in 2H.  

The services sector is still thriving, however, and enjoying the post-pandemic shift from goods to services. Services most affected by lockdowns are currently experiencing much faster price growth than other services or goods. While the upcoming summer holiday period could still fuel service price inflation, we did see a decline last month. The drop was largely due to cheaper public transportation tickets in Germany, however, so it seems too early to call a significant improvement in services inflation just yet. Finally, services inflation traditionally shows a much stronger correlation with wage growth than goods inflation. With wage growth trending up and probably coming in at around 5% year-on-year in the eurozone, services inflation remains the largest problem for core inflation and the ECB.   Still, a key question remains over how long the divergence between goods and services inflation can last. Historically, we don’t see much evidence of an extended difference between the two. Goods inflation typically leads services inflation by approximately six months, which means that the peak in the former from February suggests that the latter is unlikely to remain elevated for the rest of the year. If we are right and the post-pandemic shift ends after the summer holiday period, we could see services inflation starting to come down before the end of the year.   Core inflation set to trend down from here on out While services inflation continues to see some upside risk for the months ahead, core inflation overall looks set to trend down on the back of slowing goods prices. Even services inflation could already be trending down, but perhaps not as fast as policymakers would like it to. When looking at selling price expectations for sectors that sell most to consumers, we see that there has been a steady downturn in the number of businesses intending to raise prices. This generally correlates fairly well with core inflation developments seven months later, which would point to a significant slowdown in the core rate. At the current juncture, experts and central bankers will be hesitant to make an outright call for a sharp drop in inflation. The latest track record of inflation forecasting is simply not on their (or our) side. Nevertheless, as much as it was once obvious that the era of low inflation had to end at some point, it's now clear that the short period of surging inflation will also cease sooner or later. Historical evidence and the latest developments in both goods and services give enough comfort to expect both headline and core inflation to decline. We currently expect core inflation to drop below 4% at the end of the year and for it to fall to 2.5% by mid-2024. The risks to that outlook seem to be fairly balanced, with more stubborn core inflation on the back of faster wage growth and a faster drop on the back of weak goods inflation both decent possibilities.        

06:00BST Wednesday 30th August 2023 US ADP set to slow in August   By Michael Hewson (Chief Market Analyst at CMC Markets UK)     We've seen a strong start to the week for European markets with the FTSE100 outperforming yesterday due to playing catch-up as result of the gains in the rest of Europe on the Monday Bank Holiday. US markets also saw a strong session, led by the Nasdaq 100 as yields retreated on the back of a sharp slowdown in US consumer confidence in August, and a fall in the number of vacancies from 9165k to 8827k in July, and the lowest level since March 2021.     The sharp drop in the number of available vacancies in the US helps to increase the probability that the Federal Reserve will be comfortable keeping rates unchanged next month, if as they claim, they are data dependent, and that rates are now close to restrictive territory.   This belief was reflected in a sharp fall in bond yields, as well as a slide in the US dollar, however one should also remember that the number of vacancies is still well above pre-pandemic levels, so while the US labour market is slowing, it still has some way to go before we can expect to see a significant move higher in the unemployment rate. Today's ADP jobs report is likely to reflect this resilience, ahead of Friday's non-farm payrolls report. The ADP report has been the much more resilient report of the two in recent months, adding 324k in July on top of the 455k in June. This resilience is also coming against a backdrop of sticky wages, which in the private sector are over double headline CPI.   Nonetheless the direction of travel when it comes to the labour market does suggest that jobs growth is slowing, with expectations for that jobs growth will slow to 195k in August. We also have the latest iteration of US Q2 GDP which is expected to underline the outperformance of the US economy in the second quarter with a modest improvement to 2.5% from 2.4%, despite a slowdown in personal consumption from 4.2% in Q1 to 1.6%.     More importantly the core PCE price index saw quarterly prices slow from 4.9% in Q1 to 3.8%. The resilience in the Q2 numbers was driven by a rebuilding of inventory levels which declined in Q1. Private domestic investment also rose 5.7%, while an increase in defence spending saw a rise of 2.5%.     Before the release of today's US numbers, we also have some important numbers out of the UK, with respect to consumer credit and mortgage approvals for July, and Germany flash inflation for August. Mortgage approvals in June saw a surprise pickup to 54.7k, which may well have been down to a rush to lock in fixed rates before they went higher. July may well see a modest slowdown to about 51k.   Net consumer credit was also resilient in June, jumping to £1.7bn and a 5 year high, raising concerns that consumers were going further into debt to fund lifestyles more suited to a low interest rate environment. This level of credit is unlikely to be sustained and is expected to slow to £1.4bn.     As long as unemployment remains close to historically low levels this probably won't be too much of a concern, however if it starts to edge higher, or rates stay higher for an extended period of time, we could start to see slowdown in both, as previous interest rate increases start to bite in earnest.     In comments made at the weekend deputy governor of the Bank of England Ben Broadbent said he that interest rates will need to be higher for longer despite recent declines oil and gas prices as well as producer prices. These comments prompted a sharp rise in UK 2 year and 5-year gilt yields yesterday, even as US yields went in the opposite direction. This rise came against a welcome slowdown in the pace of UK shop price inflation which slowed to 6.9% in August.     Headline inflation in Germany is expected to slow to 6.3% from 6.5% in July, however whether that will be enough for Bundesbank head Joachim Nagel to resile from his recent hawkishness is debatable. As we look towards European session, the continued follow through in the US looks set us up for another positive start for markets in Europe later this morning.     EUR/USD – rebounded off trend line support from the March lows at 1.0780 yesterday. Still feels range bound with resistance at the 1.1030 area, and a break below 1.0750 looking for a move towards the May lows at 1.0630.     GBP/USD – has rebounded from the 1.2545 area, but the rally feels a little half-hearted. We need to push back through the 1.2800 area to diminish downside risk and a move towards 1.2400.         EUR/GBP – the rebound off last week's 11-month low at 0.8490 has seen a retest and break of the 0.8600 area, however we need to push through resistance at the 0.8620/30 area to signal further gains, towards the 50-day SMA resistance.     USD/JPY – wasn't able to push through resistance at 147.50 and has slipped back. This remains the key barrier for a move towards 150.00. Support comes in at last week's lows at 144.50/60.   FTSE100 is expected to open 28 points higher at 7,493     DAX is expected to open 49 points higher at 15,980     CAC40 is expected to open 21 points higher at 7,394