Don’t Fall for the Growing Oil Crisis Narrative Yet

Economic

Summary:

As tensions escalate between Israel and Iran, talks of supply disruptions are triggering sentiment shifts and market volatility, but what might really happen to USOIL prices in the coming weeks?

One of the oldest adages in trading is “buy the rumor, sell the news.” This approach or perspective suggests that prices often rise on speculation (or rumors) of a potential event but fall when the actual event comes and goes and the news is fully digested. Let’s break down the USOIL narrative forming right now.

The Rumor - Fear of a broader Middle East conflict has led to speculation about supply disruptions, driving oil prices up.

The News - As the conflict progresses and news confirms that oil supplies remain relatively unaffected, prices could fall back to previous levels, as the panic subsides and the market realizes the worst-case scenario has not materialized.

That’s one example of how investor sentiment alone can move markets without a real-world underlying mechanism or change. Those holding and refining crude oil prefer the prices to be high, but not too high, as it tends to trigger political tensions and even trade wars.

Unless recession fears are stalling energy assets, a common range where we don’t see price interference such as production cuts and other oil-defensive actions is between $65 and $85 (USD) per barrel.

Whenever USOIL goes beyond that range, somebody somewhere reacts to return the balance. Whether it’s the US dipping into reserves or increasing fracking to bring down prices, or OPEC cutting production to raise prices, there’s always institutional intervention, and recognizing those imperatives and narratives is the nature of market insights.

Reality versus narrative

Despite the ongoing conflict, major global players like the US and China are incentivized to keep oil flowing, but how much oil are we talking about losing if Iran’s supply is completely disrupted? Let's see just how influential Iran’s barrels per day (bpd) contribution to global oil supplies really is.

United States:~12.8 million barrels per day (bpd) - (15.6% of global production)

Saudi Arabia:~11.1 million bpd - (13.6%)

Russia:~10.8 million bpd - (13.2%)

Canada:~5.8 million bpd (this likely includes non-crude oil liquids) - (7.1%)

Iraq:~4.5 million bpd - (5.5%)

China: ~4.2 million bpd - (5.1%)

UAE: ~4.0 million bpd - (4.9%)

Iran: ~3.3 million bpd - (4.0%)

Brazil: ~3.1 million bpd - (3.8%)

Kuwait: ~3.0 million bpd - (3.7%)

Iran accounts for 4% of global oil production. Assuming that 100% of Iran’s oil production is disrupted, how bad might a shortage get? For this, we need to know if the remaining countries could pick up the slack. To gauge production capacity over actual production, we need only look at production cuts.

In October 2023, OPEC cut production by 2.2 million bpd, which was extended in June 2024. The massive cut is already set to gradually reduce throughout 2024/2025, but will likely get accelerated given recent events. Add to that, The United States, Brazil, Guyana, Norway, and Canada are already leading the charge in increased oil production, with a combined projected increase of roughly 1.1 million bpd in 2024.

While it’s probably a coincidence that the ending of a production cut and a production increase perfectly matches Irans’ oil output, it nevertheless confirms that the world’s addiction to petroleum is covered, with or without Iran, even if 100% of Iran’s oil is blocked.

No need to panic, no need to raise prices. Whatever happens, the world will get its demands met, even if other producers must rally together to fill the gap. For now, there’s no reason to assume an oil shortage, which means there’s no reason for prices to react… from a mechanistic perspective.

Conclusion

As is often the case, sentiment is like a child reacting to a jump scare. There is a loud scream followed by the realization that everything is fine. After the initial shock, market prices, like the child’s heartbeat, returns to the normal range and life goes on.

For traders watching the oil market closely, the “buy the rumor, sell the news” approach suggests that the recent price bump may already have factored in much of the fear surrounding the conflict. Now that this conflict is part of the ongoing news cycle, oil prices could be headed for stagnation and later a fall as the market calms.

Expect to see some sporadic volatility as the supply shortage narratives begin to saturate financial news channels fueling panic volume, but keep in mind coming production quotas that can easily counteract future supply issues.

While sentiment these days is rarely grounded in facts or logic, it remains perhaps the most powerful influence over the markets today, and should not be ignored. Whenever a hype narrative appears in the media, anything can happen, and often does in the short term, so be sure to apply Stop Loss and possibly set pending hedge orders just for peace of mind.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Warren Takunda

Stocks

London stocks were set to rise at the open on Monday following an upbeat session in Asia, as investors mulled the latest house price data from Halifax.

The FTSE 100 was called to open up around 25 points.

Figures released earlier by Halifax showed that house prices rose in September for the third month in a row and were close to record highs.

Prices rose 0.3% on the month, matching the increase seen in August. On the year, meanwhile, house prices were up 4.7% in September following a 4.3% jump the month before. This was still the strongest rate since November 2022.

The average price of a home stood at £293,399 - just shy of the record high of £293,507 set in June 2022 - versus 292,540 in August.

Amanda Bryden, head of Mortgages at Halifax, said: "It’s essential to view these recent gains in context. While the typical property value has risen by around £13,000 over the past year, this increase is largely a recovery of the ground lost over the previous 12 months. Looking back two years, prices have increased by just +0.4% (£1,202).

"Market conditions have steadily improved over the summer and into early autumn. Mortgage affordability has been easing thanks to strong wage growth and falling interest rates. This has boosted confidence among potential buyers, with the number of mortgages agreed up over 40% in the last year and now at their highest level since July 2022.

"While improved mortgage affordability should continue to support buyer activity - boosted by anticipated further cuts to interest rates - housing costs remain a challenge for many. As a result we expect property price growth over the rest of this year and into next to remain modest."

In corporate news, Rio Tinto confirmed speculation that it has approached Philadelphia-based lithium chemicals producer Arcadium Lithium regarding a possible takeover.

"The approach is non-binding and there is no certainty that any transaction will be agreed to or will proceed," Rio Tinto said. US-listed shares in Arcadium were up 10% on Friday, while its secondary shares in Australia soared 45% on Monday.

Mitie Group said it had bought Spanish security business Grupo Visegurity for up to €11m (£9.2m), comprising an initial payment of €9m and performance-linked deferred payments of up to €2m over the next two years.

Grainger reported strong full-year income growth, adding 1,113 new homes and achieving like-for-like rental growth of 6.3%, with occupancy at 97.4%.

The FTSE 250 private landlord said it generated £274m from non-core asset sales to support its growth strategy, adding that its build-to-rent schemes were leasing ahead of expectations.

It said it expected continued growth in the new financial year, underpinned by wage growth and a favourable political environment, as it prepared for its conversion to a real estate investment trust next October.

Source: Sharecast

Risk Warnings and Disclaimers

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Owen Li

Cryptocurrency

While Bitcoin is solidifying its position in mainstream finance, opportunities for growth in Bitcoin-based decentralized finance (BTCFi) products are also expanding. Cointelegraph Research recently released a report written by HTX Ventures, which explores how projects such as Babylon and Fractal Bitcoin are pushing the boundaries of BTCFi. It demonstrates how Bitcoin’s evolving programmability will be used to create advanced financial applications.

Babylon: A new era of Bitcoin staking and liquidity

One of the standout narratives in BTCFi is Babylon’s introduction of Bitcoin-native staking. Historically, there has been no staking on Bitcoin. However, the implementation of Schnorr signatures via Bitcoin Improvement Proposal 340, the Taproot upgrade through BIP 341 — which included Merkelized Abstract Syntax Trees (MAST) — and the update to Bitcoin’s scripting language, Tapscript, in BIP 342, have opened up new opportunities. Bitcoin can now support more complex smart contracts with tens of thousands of spending paths. Babylon leverages these features to enhance both the efficiency and privacy of staking transactions.

According to the HTX report, Babylon has already attracted dozens of projects in an effort to bring liquidity into its ecosystem. Notable examples are StakeStone, which provides native staking yields on different layer-2 networks, and Uniport, an interoperability protocol that ports Bitcoin ecosystem assets such as BRC20 tokens, RGB and Taproot assets to Ethereum. Chakra, a restaking protocol based on zero-knowledge proofs, will also use Babylon.

Babylon generates yield in the form of tokens on the validated chain rather than directly as BTC.

Fractal Bitcoin: Scaling BTCFi beyond the mainnet

Fractal Bitcoin is a network of sidechains that relies on running virtualized instances of Bitcoin core. Fractal creates a recursive, multi-layered system that allows for improved scaling without altering the base layer. The recursive structure of Fractal is reminiscent of fractal patterns, hence the name, and can theoretically provide scalability while maintaining consensus and network security.

Fractal runs multiple instances of Bitcoin Core in parallel, each of which validates its own chain independently. Each instance of Bitcoin Core operates autonomously and uses the inherited Bitcoin protocol rules for internal validation. Fractal periodically submits proofs to the main chain to anchor the instances to the mainnet, such as the Merkle root of aggregated transactions.

This modular approach enables compatibility with Ordinals BRC-20 tokens and Runes. The anchoring process ensures that, despite the virtual instances operating at higher capacities, transactions reach finality with the same level of security as the Bitcoin mainnet. Fractal purports to use discreet log contracts for its asset transfer interface. However, while DLCs can facilitate cross-chain trades, they cannot function as a genuine bridging mechanism that enables peg-ins and peg-outs between the Bitcoin mainnet and Fractal’s sidechains.

Fractal also features a Cadence mining mechanism. In Cadence mining, every third block produced on the Fractal Bitcoin network can be merge-mined with Bitcoin, allowing Bitcoin (BTC) miners to validate both Bitcoin and Fractal Bitcoin blocks simultaneously without extra computational resources. Fractal, therefore, leverages Bitcoin’s security infrastructure.

However, the remaining two-thirds of the blocks must be mined exclusively for the Fractal network. This structure is designed to balance Fractal’s independence from the main chain while still benefiting from Bitcoin’s security during the merged mining intervals.

A bright future for BTCFi

Bitcoin’s recent price surge, fueled by mainstream adoption, will inevitably drive demand for BTCFi. From innovative staking models to novel scalability solutions such as Fractal Bitcoin, these developments signal that Bitcoin’s role in finance is expanding far beyond the digital gold narrative.

Source: COINTELEGRAPH

Risk Warnings and Disclaimers

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IFS

Economic

Recent weeks have seen speculation that the new Chancellor will make changes to pensions taxation to raise revenue in the upcoming inaugural Budget. The current system of pensions tax provides overly generous tax breaks to those with the biggest pensions, those with high retirement incomes and those receiving big employer pension contributions, and there is a strong case for reform. However, insufficient support for pension saving could risk inadequate accumulation of private retirement resources and greater reliance on the state. The taxation of pensions needs to be carefully designed.

Previous research at IFS, funded by the abrdn Financial Fairness Trust, has considered the design of pensions taxation in detail. Here we summarise some of the main options for reforming the tax treatment of private pension saving. We start with what we argue should not happen, before moving on to more desirable reforms.

Capping up-front income tax relief should be avoided

The most commonly suggested way to raise revenue from changes to pensions taxation involves reducing up-front relief from income tax.

Currently, pension contributions (up to an annual limit) attract income tax relief while pension income is taxed. This is a coherent approach. Earnings put into a pension are taxed once – at the time they are withdrawn from the pension.

One implication of this approach is that some people get up-front tax relief at the higher (or additional) rate of income tax but pay the basic rate of income tax on pension income. It is debatable whether this is a problem. By allowing people to smooth their taxable income over time, it creates a more equitable income tax treatment between people whose incomes are spread more or less evenly across years. But clearly some people think this system is unfair.

It may therefore be tempting to reduce up-front relief for higher-rate taxpayers. The sums at stake are large: limiting up-front relief to the basic rate of income tax would be a £15 billion a year tax rise, the vast majority of which would come from those who are in the top fifth of earners when making pension contributions. But it is worth noting that this reform would not only affect those who are higher-rate taxpayers under the current system: more people would be brought into higher-rate tax if their (and their employer’s) pension contributions were no longer excluded from tax. For example, an experienced nurse earning £45,000 would typically get an employer pension contribution that the government values at an additional 23.7% of salary – more than £10,000 a year. Given that valuation, about half of the pension contribution would fall into the higher-rate income tax band, leaving the nurse with an additional tax bill of about £1,000 a year if relief were restricted to the basic rate.

Tempting as it may be, there is no coherent logic to making relief on contributions flat-rate while continuing to tax pension income at the individual’s marginal rate.

The same logic that says it is ‘unfair’ for people to get higher-rate relief on contributions and pay only basic-rate tax on withdrawals would presumably imply that it is equally ‘unfair’ for people to get basic-rate relief on contributions and pay no tax on withdrawals if their income in retirement was below the personal allowance – yet that argument is never made. And restricting relief on contributions while leaving the taxation of pension income unchanged clearly would be unfair on those (few) who are higher-rate taxpayers both while in work and in retirement: they would in effect be taxed twice on the same income, creating a large penalty for saving in a pension.

The point of both these examples is that a coherent tax treatment of pensions must consider the treatment of pension contributions and the treatment of pension income together. If there is a case for relieving all pension contributions at the same rate, there would equally be a case for taxing all pension income at the same rate. And if the real aim of reform is simply to increase income tax on higher earners, then this should be done directly, through increases in income tax rates or cuts in income tax thresholds.

Principled arguments aside, moving away from up-front income tax relief at the taxpayer’s marginal rate would raise major practical challenges for defined benefit pensions as the value of employer contribution that should be assigned to each individual employee is not straightforward to measure. This is not a minor issue: HMRC estimates that almost half (46%) of all up-front income tax relief is attributable to defined benefit schemes. A reform that treated these schemes (many of them in the public sector) more favourably would be inequitable. There are more coherent and implementable ways to reform the system – including better ways to raise revenue from those with the highest income and wealth.

Pensions should be subject to inheritance tax

Unlike with housing wealth or other savings, if someone dies and passes on a pension pot to a non-spousal heir, the pension does not count as part of their estate for inheritance tax purposes. Ending this inequitable treatment could raise several hundred million pounds a year in the short term, rising quickly thereafter (potentially to as much as £2 billion a year, though probably less) as the introduction of ‘pension freedoms’ in 2015 means more and more people will be dying with pension wealth.

The 25% tax-free component should be targeted towards those with smaller pensions, not those with higher incomes

When withdrawn, 25% of a pension can be taken tax-free (up to a limit of 25% of £1,073,100, i.e. £268,275), with income tax payable on other withdrawals. This subsidy to pension saving has an estimated long-run annual cost of £5.5 billion, with 70% of the relief going to pensions accumulated by those in the top fifth of earners when making their contributions. This well-known part of the pensions landscape could have some justification if it encouraged saving on the part of those who would otherwise save too little. However, it is poorly targeted in two regards.

First, the 25% tax-free component subsidises further pension saving even for those who already have large pensions. While there is a case for encouraging people to save at least a certain amount for their retirement, it is hard to justify continuing to subsidise extra saving for individuals with pension wealth little short of £1,073,100.

The incentive should be removed from those with larger pensions. Reducing the amount that can be taken tax-free from £286,275 to £100,000, for example, would affect about one-in-five retirees (and almost half of those who had been employed in the public sector) but would mean about 40% of pension wealth lost the benefit of the tax-free component. Such a change would raise around £2 billion a year in the long run (40% of the long-run revenue yield from abolishing the tax-free component completely), with losses concentrated among the relatively wealthy.

Second, the 25% tax-free component provides a more generous subsidy for higher-rate taxpayers than for basic-rate taxpayers, and provides no subsidy at all for the part of pension income below the income tax personal allowance – that is, for those low-income pensioners whose pensions arguably most need boosting. A better alternative would give an equal top-up on all withdrawals from pensions. A top-up of 6.25% (before applying income tax), for example, would be equivalent to the 25% tax-free component for someone who is a basic-rate taxpayer in retirement. But such a change would mean a bigger subsidy than now for non-taxpaying pensioners and a reduction in the subsidy going to those paying the higher or additional rate of income tax in retirement. Overall, it would be a tax cut of around £1½ billion a year in the long run – although such a change could be implemented alongside a cap on the cumulative amount of pension income to which the top-up was applied, further reducing the subsidy for those with large pension pots and therefore the overall cost.

One complication with such a change is that it would (unless implemented over a generational time frame) involve some degree of retrospection: people could reasonably argue that they had saved on the understanding that they would be able to take 25% of their pension tax-free. A slower transition would temper that retrospection but would also need to be weighed against the ongoing costs of providing large tax subsidies for individuals with sizeable pension pots.

Reform the generous NICs treatment of employer pension contributions

Employer contributions to pensions are not subject to employer or employee National Insurance contributions (NICs). These subsidies to saving are generous, opaque and poorly targeted, and could be sensibly reformed – though Labour’s manifesto pledge not to increase NICs might make that difficult.

Different ways forward are required for employer and employee NICs. It would be sensible to move towards levying employer NICs on employer pension contributions. If levied at the full rate (13.8%), this would raise around £17 billion per year. We estimate that £14 billion of this rise relates to contributions for new pension accrual (as opposed to contributions plugging deficits in defined benefit schemes), with around £6 billion of that £14 billion coming from contributions made to pensions held by the top 10% of earners. A ‘big-bang’ change that completely eliminated this subsidy would risk a large decline in contributions to pensions. A more cautious approach could be taken where employer NICs are levied on employer pension contributions while a subsidy to employer contributions is introduced at a lower rate. For example, levying employer NICs (at the rate of 13.8%) alongside a new subsidy for employer pension contributions of 10% would mean a tax rise of around £4½ billion per year.

In the case of employee NICs, there is a good case for moving towards a system with up-front relief for employee, as well as employer, pension contributions. In return, employee NICs would be levied on private pension income. In the long term, such a change could raise substantial revenues (if pension funds’ investment returns are strong) and re-target financial incentives to save away from the top tenth of earners and towards those in the middle of the distribution. The transition to such a system would need to be carefully considered. If relief from employee NICs were given immediately for all new employee pension contributions, the annual cost would be around £2–3 billion. This initial outlay would be less than the £4½ billion that would be raised by replacing the existing employer NICs subsidy on employer pension contributions with a flat 10% subsidy. In addition, each percentage point of NICs levied on private pension income would raise around £¾ billion currently; but immediately charging full employee NICs on private pension income might be seen as unfair because current pensioners may have paid employee NICs on their employee contributions (implying some paying employee NICs twice) and many might have saved in the expectation that they would not face this tax in retirement. There is no perfect solution here, but one way forward might be to phase in NICs on pension income by date of birth, with later-born cohorts (more of whose pension contributions would have received NICs relief) paying higher rates of NICs on their pension income.

Stability is valuable

There are sensible reforms to the taxation of pensions which could refocus the support for pension saving towards those more at risk of undersaving. A package of reforms along the lines set out above could be designed in such a way as to raise revenue while ensuring that the bottom eight deciles of earners gain on average (in the long run) – and see their incentives to save in a pension strengthened. Comprehensive reform is preferable to reintroducing a lifetime limit on tax-privileged pension wealth (a change which Labour had pledged to make but dropped during the election campaign). There would be political choices to be made about how quickly to phase in some reforms.

Constant tinkering with pensions taxation is not welcome, though. Whatever package of reforms is pursued at the Budget, it is important to set out a clear and coherent direction of travel for pensions policy and, as far as possible, provide a predictable environment for savers. As the government undertakes its promised review of the pensions system, it should articulate how it sees tax fitting into an overall plan for state and private pensions.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Pepperstone

Economic

There was absolutely no ambiguity in the way the market traded the US jobs data - it was solid across all metrics, and remaining US recession calls have once again been pushed out. The more pertinent question is whether the consensus ‘soft landing’ thesis is at risk of becoming a ‘no landing’ scenario.

With the positive turn in the US economic data we saw throughout last week, US interest rate swaps price a more gradualist path to Fed easing, with a conviction 25bp cut expected in both the November and December FOMC meetings. However, with rate cuts still being the default position, and when married to upbeat earnings expectations and China going hard on liquidity and fiscal, the equity bull case and the USD get a shot in the arm.While geopolitical headlines and the possibility of an energy supply shock remain a continued threat to sentiment, those set long of risk haven’t heard anything significantly market moving through the weekend and head into the new trading week feeling pretty good about the prospect of further upside.

Can US economic exceptionalism be sustained?

The market has seen yet another case study where growing concerns around a sustained deterioration in the US data flow have collided with a series of better key economic data points (JOLTS, ISM Services and NFP). The result has been market players having to rapidly rethink exposures – notably in US Treasuries where yields have teared higher on the week. In turn, the US economic exceptionalism trade has made a comeback, and tactical traders question whether this theme could last into the November US Election, especially if Trump’s odds were to improve.

The Citigroup US economic surprise index has risen to the best levels since April (see chart above), highlighting the trend of US data releases beating economists’ consensus expectations. We can also see the US economic surprise index having the strongest positive trend relative to other major nations' economic surprise indices, and while not yet at levels which really cement a consensus US exceptionalism/long USD position trade, it is certainly adding to the current upside momentum.

US Treasuries driving USD flows

US 2-year Treasuries aligned with the moves in the US surprise index, closing the week with a gain up a sizeable 36bp w/w, with yields eyeing a retest of the 4% level, driven by Fed rate cuts massaged out of the US rates curve. The USD responded hard, having its best week since Sept 2022, with the DXY (USD Index) closing higher on each consecutive day last week. On a broader basis, the USD gained ground vs all G10 currencies, notably vs the JPY, aided by calls that the BoJ (and new PM Ishiba) may be making a policy mistake by flipping to a more dovish stance and backing away from further hikes.

There has been a focus on relative fiscal trends too, with France set to announce its budget as it starts its proposed staggered journey to a 3% deficit of GDP by 2029. A more austere fiscal program in France, Italy, and Spain, will pale in comparison to ever-increasing debt levels in the US, and over time this could prove to be another factor that drives EURUSD lower.

US Economic Exceptionalism Makes a Comeback_3

Importantly for the USD, we see US Treasury yields rising sharply on a relative basis to the G10 peers, where yield differentials have been a key factor driving the USD outperformance. Should the US Treasury yield premium continue to increase vs other developed market bonds (e.g. German bunds, UK gilts) then the USD move has legs.

Client flows to trade the USD have ramped up, with the break of 1.1000 in EURUSD getting clear attention, as it has in GBPUSD on the test of the 50-day MA, and USDJPY smashing through 148. The skew in USD directional risk remains towards higher levels this coming week and I see weakness in USDJPY and rallies in EURUSD offering entries to initiate new positions.

US CPI is the marquee data point for the week ahead

In the absence of any tier 1 economic data in Europe, Australia, the UK, and China this week, the focus falls again on the US economic data flow, where the highlight will be September CPI and PPI prints. With the Fed putting far greater emphasis on the labour market and feeling its war on inflation is over (for now), a lower-than-consensus outcome in the US CPI print is unlikely to lift expectations for a 25bp cut in November too greatly, given the barrier to a 50bp cut has been sufficiently lifted.

Conversely, we’d need to see a significant upside surprise relative to the core CPI estimates of 3.2% y/y to have the market really throw doubt about a 25bp cut at the November FOMC meeting.

With some 20 Fed speakers through the week, we should get a guide on how the respective Fed officials see Friday’s NFP print affecting their thought process on policy. One would imagine most should guide to a 25bp cut in November, however, should any hint at a pause in the cutting cycle the USD should continue to follow US Treasury yields higher.

US Q3 earnings start to roll in

The S&P500 closed on its session high on Friday, with longs showing little concern about holding exposures over the weekend and the prospect of gapping risk stemming from Israel/Iranian headlines. New ATHs in the S&P500 are just 15 points away, and as equity traders look towards the start of the Q3 reporting season, with JP Morgan leading us off on Friday, longs will be feeling confident that the bullish momentum in the S&P500, Dow, Russell 2k, and NAS100 holds.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Goldman Sachs

Economic

Stocks

The downdraft in stock markets in August, when US equities dropped 8% from the highs the previous month, may have been a warning shot, according to Christian Mueller-Glissmann of Goldman Sachs Research. While markets have mostly recovered since, the speed and drivers of the equity decline signal that there’s a higher risk of further setbacks.

“It shows that you're entering a more fragile macroeconomic backdrop,” says Mueller-Glissmann, who heads asset allocation research within portfolio strategy. “For the first time in a long time, you have more concern about growth. And when you have concern about growth, that can drive larger equity drawdowns, because equities are very sensitive to growth.”

The US labor market has softened, and global manufacturing data is showing signs of more weakening. China’s economy is sputtering, and consumer spending in Europe has been lower than some economists expected. “That has broadly increased equity fragility,” Mueller-Glissmann says.

But that doesn’t mean it’s time for investors to be bearish and avoid stocks. While equity declines are becoming more likely, those declines, or dips, could be an opportunity. “Ultimately, we would want to buy the dips as they occur, he says. “The August dip was obviously an opportunity to buy in hindsight, with equities just making new all-time highs.”

The risk of a bear market is still relatively low

Mueller-Glissmann’s team uses a framework using macroeconomic and market variables to assess the likelihood of a major bear market in equities, or drop from peak to trough, of more than 20% over 12 months, as well as the risk of a shorter-term hiccup, or correction, of about 10%.

Investors May Have Opportunities to Buy the Dips in the Stock Market_1

“This is really helping you to answer the question of whether you want to buy a dip,” Mueller-Glissmann says of the model.

Right now, the team’s research indicates the risk of a stock market drawdown has increased “a bit,” he says, as a result of negative growth momentum and slightly elevated stock valuations. That’s counterbalanced by a positive equity price momentum in the last 12 months, which reflects solid macroeconomic conditions. “These macro conditions usually linger — they don't disappear overnight,” Mueller-Glissmann says. “A strong positive trend in equities tells you the risk of an imminent bear market is low, because it usually takes time for macro conditions to deteriorate from such a healthy starting point.”

Even more importantly, inflation momentum has been declining for more than a year.

The US Federal Reserve reduced its policy rate in late September by 50 points to 4.75%-5%, showing the central bank is increasingly focused on economic growth, as opposed to stamping out inflation. Policymakers have scope to reduce interest rates to support the economy.

“You can have a correction, but most likely the central bank will step in and buffer the equity market and the economy,” Mueller-Glissmann says. “The Fed put reduces the risk of an equity bear market, though it cannot reduce the risk of an equity correction.”

Mueller-Glissmann’s team is “mildly pro-risk” in portfolio construction for the coming 12 months. Financial markets are “early in the late cycle” of economic growth: unemployment rates are low, profit margins are relatively high, and risk premiums for financial assets are low, for example. “All of those are typical late cycle tendencies,” he says.

Stocks should get some support because consumer and corporate balance sheets are in good shape. The savings rate for European consumers is very high, around 15%, and companies haven’t increased their debt burdens significantly. And while inflation seldom surges early in the economic cycle, that’s exactly what happened following the Covid pandemic amid supply-chain bottlenecks and pent-up demand. That resulted in a jump in interest rates, which prevented a build-up of leverage among consumers and businesses.

“There's re-leveraging potential left in the private sector that can drive growth,” Mueller-Glissmann says. “When you're early in a late cycle backdrop, which can last a long time, you want to be modestly pro-risk in your asset allocation, because equities are an asset that can still deliver good returns in these periods.”

Corporate credit, by contrast, can be a more difficult proposition. The extra yield relative to Treasuries is already low, and credit investors are still exposed to recession concerns.

The outlook for the 60-40 portfolio

Many safe-haven assets have already rallied going into the recent dovish Fed meeting. That may make some of them less likely to cushion a portfolio. But even so, Mueller-Glissmann sees scope for US government bonds to provide some buffer to stocks. Economic conditions could be conducive for the traditional 60-40 portfolio, which is split between stocks and Treasury bonds.

“The equity-bond correlation from here should be more negative,” he says. “This is consistent with the market shifting from inflation as a concern towards growth as a concern, and that means there is more benefit of 60-40-type portfolios.”

Investors May Have Opportunities to Buy the Dips in the Stock Market_2

But with potentially a smaller buffer from long duration bonds there is more value in alternative safe havens such as gold investments. Stocks with defensive characteristics could also be more valuable at this point in the economic cycle, as may some strategies using option overlays.

Overall, Mueller-Glissmann says it isn’t the time to completely avoid risk in portfolios. “Correction risk is probably a bit elevated, but bear market risk seems quite low,” he adds.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Warren Takunda

Stocks

Asian shares advanced Monday after a surprisingly strong U.S. jobs report raised optimism about the economy, sparking a rally on Wall Street.

U.S. futures slipped and oil prices also fell.

Japan’s Nikkei 225 index gained 1.8% to 39,332.74 after the yen sank against the U.S. dollar. The Japanese currency has bounced on speculation over the central bank’s plans for interest rates since Prime Minister Shigeru Ishiba took office last week. Lower interest rates tend to boost prices of shares and other asset, and both Ishiba and the central bank governor suggested no hikes were likely soon.

Nintendo gained 5% following reports that a Saudi wealth fund was planning to increase its investment in the Kyoto, Japan-based video game maker.

In a policy speech on Friday, Ishiba said he wants to see salary increases that outpace inflation and that he will promote investment to create “a virtuous cycle of growth and distribution.” He promised economic support for low-income households and measures for regional revitalization and disaster resilience.

But he offered no major new initiatives, and his initial public support ratings are around 50% or lower, relatively low for a new leader, according to Japanese media. He plans to dissolve parliament on Wednesday for an election on Oct. 27.

After gaining briefly against the dollar, the yen fell back late last week. Early Monday, the dollar was trading at 148.45 yen, down from 148.72 late Friday.

Elsewhere in Asia, Hong Kong’s Hang Seng index rose 1.1% to 22,977.97, and the Kospi in Seoul surged 1.3% to 2,602.23.

Taiwan’s Taiex gained 1.8%.

Mainland Chinese markets reopen from a weeklong holiday on Tuesday, and the government said it plans to explain details of plans for economic stimulus at a morning news conference in Beijing. Before the Oct. 1 National Day holiday began, announcements of policies aimed at reviving the ailing property market pushed share benchmarks sharply higher and this week could bring more volatility.

“More fiscal stimulus to stabilize the property market and restructure local government debts, and structural reforms to address the over-capacity and deflation issues are needed to turn around the economy,” B of A Securities said in a research note, pointing to continued declines in home sales, housing prices and credit growth.

On Friday, the S&P 500 climbed 0.9% and got close to its all-time high set on Monday, closing at 5,751.07. The Dow gained 0.8% to 42,352.75, and the Nasdaq climbed 1.2% to 18,137.85.

Leading the way were banks, airlines, cruise-ship operators and other companies whose profits can benefit the most from a stronger economy where people are working and better able to pay for things. Norwegian Cruise Line steamed 4.9% higher, JPMorgan Chase rose 3.5% and the small companies in the Russell 2000 index gained 1.5%.

Worries over tensions in the Middle East still are casting a shadow, having pushed oil prices sharply higher as the world waits to see how Israel will respond to an Oct. 1 missile attack by Iran.

But U.S. benchmark crude oil slipped 19 cents to $74.19 per barrel early Monday, while Brent crude, the international standard, lost 29 cents to $77.76 per barrel.

Treasury yields soared Friday after the U.S. government said employers added 254,000 more jobs to their payrolls last month than they cut. That was an acceleration from August’s hiring pace of 159,000 and blew past economists’ forecasts.

Recent encouraging data on the economy have raised hopes that the job market will hold up after the Fed pressed the brakes on the economy through higher rates in order to stamp out high inflation.

The Fed has begun cutting interest rates and Friday’s jobs report was so strong traders are now forecasting it will not deliver another half-point interest rate cut before the end of the year after doing so in September.

In other dealings early Monday, the euro was unchanged at $1.0967.

Source: AP

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