Economic Data Watch and Market Outlook
Global equity markets declined globally with the MSCI World Index down 2.11%. The S&P fell 2.52% and US bonds rose 68 basis points. For the week, there appeared to be little deviation between growth and value equities as we have seen in past weeks with both falling over 2.50%.
The Energy Administration released data this week including US Crude inventories which increased 1.37 million barrels, higher than the 0.23 million barrel expected increase. Commercial firms also released data relating to gasoline inventories which also increased 0.156 million barrels compared to the decrease of 0.897 million that had been expected. These data points seem to indicate a slowing in the economy but run counter to the significant economic results later in the week. GDP on a quarter over quarter basis increased 4.9% with economists expecting a 4.3% increase. Durable goods orders also increased significantly beyond expectations, 4.7% versus 1.7%.
Late Friday, the Bureau of Economic Analysis released the Personal Consumption Expenditure Index on Friday and results came in as expected. However, personal spending increased more than expected 0.7% versus consensus of 0.5%
Germany is expected to surpass Japan as the world’s third-largest economy in 2023, according to the International Monetary Fund (IMF). The projection is based on Germany’s nominal gross domestic product (GDP) of $4.43 trillion, compared to Japan’s $4.23 trillion. This shift is attributed to the weakening of the yen against the dollar and the euro. The yen’s decline is mainly due to differences in monetary policy, with the Federal Reserve and the European Central Bank raising interest rates to combat inflation while the Bank of Japan remains in stimulus mode. Japan is looking to implement economic measures to boost its growth potential and address its sluggish economic performance. The IMF data also highlights that the average GDP per person in Germany is significantly higher than in Japan, with Germans projected to have an average GDP per person of $52,824, compared to $33,950 in Japan.
Cocoa prices have reached a 44-year high due to global shortages, causing concerns for chocolate makers. Cocoa futures in New York surged by up to 2.5%, hitting their highest level for a most-active contract since 1979. The increase is attributed to anticipated poor crop yields in Ivory Coast and Ghana, major cocoa producers, while demand for cocoa is on the rise. The is leading analysts to predict a third consecutive cocoa deficit. The situation is compounded by the threat of an El Niño event causing dry conditions in West Africa, further harming cocoa production.
Investors continue to have concerns regarding Chinese equities. The Bloomberg Fear and Greed indicator reached its highest level in the past year. This measure, which assesses buying strength versus selling strength, hit its lowest point since October 2022 for the Shanghai Composite index. The ongoing market downturn has brought the equities gauge dangerously close to breaching a significant 18-year trend line. Another measure is the rotation between the assets flowing out of EEM, an IShares ETF, and into the ex-China option, EMXC.
Equities
Major US equity benchmarks finished lower for a second consecutive week as mixed corporate earnings and interest rates concerns weighed on them. The Dow Jones Industrial Average dropped (-2.1%), the S&P 500 fell (-2.5%), the NASDAQ closed the week down (-2.6%), and the small cap Russell 2000 Index was down (-2.6%). Stocks were mixed to start the week before better-than-expected earnings from General Electric, Coca-Cola, and Raytheon Technologies attracted buyers back into the market snapping a 5-day losing streak for the Dow. From a sector standpoint, utilities were the strongest sector and energy was the weakest. Communication services, healthcare, financials, and industrials also struggled during the week. Value beat growth this week across market caps as both Russell 1000 and 2000 value indices were slightly better than the Russell 1000 and 2000 growth indices despite both finishing the week in the red.
Nearly a third of third of the S&P 500 Index reported this week leading investors to focus on results from Amazon, Google, Meta Platforms, and Microsoft which are all members of the “Magnificent Seven” and have been responsible for most of the S&P 500 gains this year. Most numbers (but not all) reported by these companies signaled strong growth and exceeded expectations but concerns around rising costs weighed on their stock prices. Mixed earnings across companies and rising yields, notably the US Treasury Note briefly rising above 5%, weighed on US equities negatively.
Overseas, emerging markets slightly outperformed developed as the MSCI Emerging Markets Index fell (-0.6%) and the MSCI EAFE Index, which tracks 21 developed markets ex US and Canada, declined (0.8%). The Euro STOXX 600 Index closed the week (-1.0%) lower as uncertainty around interest rates continued. Most major stock indices were negative on the week in Europe as Germany’s DAX dropped (-0.8%), France’s CAC 40 Index fell (-0.4%), Italy’s FTSE MIB was down (-0.3%) and the UK’s FTSE 100 Index declined (-1.5%). This comes after the ECB left its key deposit rate unchanged and reiterated that it would maintain the current rate for longer to help bring down inflation to its 2% target.
In Asia, Japanese stock markets eased during the week as the Nikkei 225 Index fell (-0.9%) and the TOPIX Index was relatively flat. Geopolitical tensions and rising bond yields weighed on equity market sentiment to start the week, but some investors were taking advantage of the sell-off as we saw a rebound in tech stocks. Chinese equities rose as industrial profits signaled that there may be some sort of stabilization in the economy. The Shanghai Composite Index rose 1.2%, blue chip index CSI 300 gained 1.5%, and the main benchmark Hang Seng Index rose 1.3%.
Fixed Income
Treasury yields saw a weekly decline with the 2-year Treasury yield falling 8 bps to 4.99%, the 10-year Treasury yield falling 9 bps to 4.84%, and the 30-year Treasury yield falling 6 bps to 5.03%. Meanwhile major bond indices saw a slight increase for the week with the Bloomberg US Aggregate Bond Index climbing +0.68%, the Bloomberg US Corporate High Yield Index climbing +0.40%, and the Bloomberg US MBS Index climbing +0.86%.
Overseas the European Central Bank (ECB) brought their historic streak of 10 consecutive rate increases to a close. ECB officials agreed on Thursday to hold the banks deposit rate at a record high 4%. ECB President Christine Lagarde signaled that Eurozone borrowing costs could have peaked as rate increases are starting to weigh on the regions housing market and bank lending. Eurozone inflation sits at 4.3% since September, down from over 10% last year. The Bank of Canada also paused this week, leaving rates at 5% on Wednesday – saying that higher borrowing costs are pushing down consumption and equalizing supply and demand.
According to a CBRE analysis, the average monthly new mortgage payment is 52% higher than the average apartment rent. The last time this ratio was so wide was prior to the 2008 housing bubble, where the premium peaked at 33% in the second quarter of 2006. A person taking out a 30-year mortgage on a $430,000 home, with a 10% down payment, will pay approximately 3,200 a month, 60% more than if they had purchased the same house 3 years ago. Rents have risen ~22% in the same period.
Hedge Funds – As of Thursday, October 26th
Hedge fund (HF) returns diverged this past week as performance of equities across regions was relatively mixed (US and Asia stocks underperformed while Europe was flat). The average global HF was able to limit their losses to just 40 bps, representing a fraction of what the MSCI World was down (-1.8% through Thursday). Americas-based long/short (L/S) equity funds felt the most pain across all major strategies, ending 1.5% lower vs. the S&P 500 down 2%. HF returns were heavily impacted by TMT stocks underperforming, which was also reflected in the top 50 crowded longs in the US falling 3%. While the crowded shorts in the US also lagged the index (down ~2.5%), HFs hold higher exposure to the crowded longs than shorts. In both absolute and relative terms, October is shaping up as the most challenging month for US L/S funds in relative terms since January 2022 (meme stock craze). The average L/S equity fund is down ~2.9% MTD, which means they’re capturing nearly 90% of the S&P’s losses. Outside the US, EU-based HF performance moved in lockstep with the Euro STOXX 600, with both ending flat on the week. Meanwhile, Asia-based funds posted losses of 80 bps, representing ~40% of what the MSCI Asia Pacific was down.
As benchmark indices in the US sold-off, HFs were net sellers of North American (NA) equities, although the magnitude of the selling on the week was not all that outsized vs. prior equity sell-offs. Looking at macro products and sectors, most of the selling was concentrated across single-name equities as opposed to ETFs (where HFs tilted towards buying). Of that selling, >85% came via short additions with the balance from long sells. Most sectors tilted towards being sold on a net basis, with the selling of TMT-related industries leading the net selling on both sides of the book. Within TMT, the selling on the short side was concentrated in the Magnificent Seven stocks (amid mixed earnings) and semiconductors, while interactive media attracted most of the long sells. Consumer discretionary, real estate, and materials were also net sold this past week. On the other hand, industrials and energy were the only exceptions to the single-name selling in NA, with the industrials buying more noteworthy given the sector had been steadily sold throughout October. At the sub-sector level, the buying this past week was seen across machinery, building products, and industrial conglomerates. As a result of the net selling, US L/S net leverage fell to 40%, which not only sits in the lower decile on a 1/3/5/10 year lookback but is also only 5% off from decade-lows. European equities were also sold, and similar to the US, it was relatively dispersed across most sectors. Throughout broader Asia, the net flow was flat as long and short additions paired off.
Private Equity
This year’s European venture capital (VC) dealmaking is anticipated to fall below the 2022 levels, despite some hopeful signs of eventual recovery, as per PitchBook’s Q3 2023 European Venture Report. The report highlights five key trends that have shaped the VC market in Europe during the first nine months of the year.
In Q3, European VC deal value increased for the third consecutive quarter, reaching €15.8 billion, reflecting a 6% quarter-over-quarter growth. However, it is important to note that this still signifies a substantial 22.5% decrease from the same period in the previous year. Contrarily, the deal count continues to decline, with an estimated 2,213 rounds closed in Q3, marking the lowest quarterly figure in the past five years.
The UK and Ireland continue to lead the way in VC dealmaking in Europe, with the France and Benelux region experiencing the smallest decrease in its percentage of overall deal count. It also marginally increased its share of overall deal value. Central and Eastern Europe, however, saw the most significant decline, with deal count and value falling by 59% and 80%, respectively, from the previous year.
The percentage of European VC deals involving nontraditional investors, such as private equity firms, hedge funds, and sovereign wealth funds, has declined in 2023 for the first time since 2019. In the first nine months of the year, approximately 2,683 rounds worth €32.3 billion featured nontraditional investor participation.
VC-backed acquisitions amounted to €6 billion in the first nine months of the year, which is significantly lower than the full-year value of €23.9 billion seen in 2022. However, there was an increase in acquisition value in Q3, reaching €3 billion compared to the previous quarter’s €1.9 billion.
Like dealmaking and exits, VC fundraising in Europe has been weaker in 2023. Only €13.9 billion was raised across 91 funds through Q3. This lack of mega-funds has contributed to the hampering of fund value. Additionally, lower returns compared to other asset classes may have driven limited partners (LPs) to allocate their funds to other areas of the private markets.
Overall, the European VC market appears to be navigating through challenging times, marked by a mixed bag of increasing deal values in certain quarters but a consistent decline in deal counts. The report suggests that several factors, including the presence of nontraditional investors and the health of VC fundraising, will continue to shape the landscape in the coming months.
Authors:
Jon Chesshire, Managing Director, Head of Research
Elisa Mailman, Managing Director, Head of Alternatives
Katie Fox, Managing Director
Michael McNamara, Analyst
Sam Morris, Analyst
Josh Friedberg, Fall Associate
Data Source: Apollo, Barron’s, Bloomberg, BBC, Charles Schwab, CNBC, the Daily Shot HFR (returns have a two-day lag), Goldman Sachs, Jim Bianco Research, J.P. Morgan, Market Watch, Morningstar, Morgan Stanley. Pitchbook, Standard & Poor’s and the Wall Street Journal.