Ear to the Ground

June 09 2023

This week could perhaps be defined as one of mixed messages and about turns.  Starting with Canada, we saw the surprise decision by the Bank of Canada to raise the target for its overnight rate by 0.25% to 4.75%.  The central bank had paused their hiking cycle, which we saw at their last two meetings.  This puts the borrowing cost there now at the highest seen for 22 years.  Policy setters felt that monetary policy was not restrictive enough to help bring inflation back to the 2% target.  They were particularly concerned that the six month annualised rate for the consumer price index has now been stuck in the 3.5 to 4% range for several months now. 

The market, for now, does not appear to think that they will stop there.  The bond market is pricing in a nigh on certainty that they will raise rates again by a further 0.25% at their next meeting in September.  This potentially has connotations for both the Canadian economy and residential property market, time will tell.

Sticking with the housing market, this week saw the release of the latest Halifax UK house prices report.  Here it was reported that the house price index fell 1% year on year in May.  Whilst this was in line with expectations, it was the first decline since December 2012.  The market was mixed however, with the prices of existing houses falling, whilst new house prices continued to increase.  Not sure if there is anything to read into that fact just yet.  This week we have also seen a number of banks withdraw their current mortgage offers, such as HSBC, so it would appear lenders are preparing for higher rates in the UK also.

Back across the pond, this time to the US, and this week we saw the release of the Institute for Supply Management (ISM) Services Purchasing Manages Indices (PMI).  Here it was reported that there had been a fifth consecutive month of expansion in the service sector.  A reading above 50 denotes expansion.  The reading was just above the waterline however and was below the consensus forecast reading of 52.2, perhaps suggesting the purse strings are beginning to tighten.

The probability of a US recession 12 months ahead meanwhile, as predicted by the spread in yield between the 10 year and 3 month Treasury bond, continues to rise sharply.  Now this fact does not lead to or create a recession, but it has historically proven a strong indicator that there is potentially one around the corner. 

This is somewhat contradictory to what we have seen in the performance of the S&P 500 however, where the index has entered into a bull market, defined as being more than 20% above the previous low.  A delve deeper into the performance however shows that care is perhaps needed here.  Data from Bloomberg shows that from the end of 2022 to the 7th June it is the top seven stocks within the index which have driven performance, being Apple, Nvidia, Tesla, Microsoft, Amazon, Alphabet (Google) and Meta.  The remaining 493 companies as a separate index would have posted no growth over this same time period.  Concentration of return therefore is extremely high. 

Concentration in terms of position size however is even more startling in the Nasdaq 100, where data from Invesco shows that these same seven stocks now account for in excess of 50% of this index, with Microsoft and Apple accounting for c.25% between them.  Whilst these companies are likely to feature in the trends of tomorrow, some valuations are now potentially becoming a little frothy.  Nvidia, for example, according to data from Macrotrends.net, now trades on a price to sales ratio in excess of 36 times, i.e. for every $1 of sales, buying the stock at this price, costs $36.  That is already some future growth priced in.

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