Asia open: Growth vs rates and a case of deja vu

Markets

Both stocks and bonds in the US are struggling despite the positive development in Washington, DC, but stronger-than-expected ISM data saw rates on the move again. So, investors were on the fence, carefully considering the relationship between economic growth and interest rates and what actions the Federal Reserve might take in response to these factors.

Any 'relief rally' from the US government spending deal appears to have been short-lived as bond markets witnessed a deepening selloff, leading to rising yields across the curve, with an increase of 10 basis points in a single day. Notably, the yield on the 10-year benchmark Treasury bond reached its highest level since 2007, hitting 4.7%, while the 30-year bond yield climbed to 4.81%, marking its highest level since 2010. This yield surge reflects the market's response to messaging from the Federal Reserve, indicating the central bank's commitment to keeping borrowing costs elevated to combat inflation. Consequently, US stocks struggled to gain traction as investors recoiled across the capital market spectrum in the face of higher yields. The global bond market selloff has gained momentum, partly driven by the reprieve from a US government shutdown. 

US manufacturing activity for September contracted for the 11th consecutive month, as indicated by the Institute for Supply Management (ISM) manufacturing index. However, the headline ISM print 49 surpassed expectations, with a consensus estimate of 47.9. Economists' forecasts for the index ranged from 46.5 to 50. This reading of 49 represents the best performance since November, providing a positive signal despite the ongoing contraction in manufacturing activity. According to ISM's Tim Fiore, companies are still adjusting their outputs due to softening orders, but the month-over-month improvement in September is seen as a positive development.

The overreaching takeaway from recent data is that the long-standing issues in the US manufacturing sector are being resolved. Both surveys show an increase in production. The ISM production figure 52.5 is the highest in 14 months. ISM's Fiore highlighted that only 6% of the sector's GDP registered a PMI below 45 last month, compared to 25% in July.

Hence, the surprisingly resilient ISM data prompted traders to raise bets on a November rate hike from the Fed. They now see a roughly one-in-three chance of a November move, up from the 25% likelihood priced on Friday.

After starting the trading day with a more positive tilt, markets reversed mid-day, with most equities trading lower but recovering lost ground into the close to finish the day mostly unchanged. Conversely, almost all US debt yields are higher today, with yields on 10-year Treasury up 10 bps, nearing 4.7 %. Interestingly, longer-duration Mega-cap Tech stocks (the FANGMAT complex) are among the best performers today, with all 7 stocks trading up on the day. But maybe Mega-cap Tech stocks are cheap?

Despite experiencing a significant de-rating in recent weeks due to the rise in US real yields, the most highly prized tech stocks still trade at a substantial valuation premium. Goldman Sachs provided a more nuanced perspective in a recent note, however. Part of the perceived de-rating can be attributed to factors affecting the denominator. Analysts have been raising their forward 12-month net income estimates for the seven largest tech stocks by 8% since the end of July, compared to just 2% for the rest of the index. When considering growth-adjusted valuations, characterizing these stocks as "expensive" becomes less compelling and may even suggest that they are cheap. 

After adjusting for expected long-term earnings growth, the largest tech stocks are trading at their cheapest relative valuation compared to the median stock in over six years. The vaunted price-to-earnings-to-growth (PEG) ratio for the largest tech stocks is 1.3x. In contrast, the median S&P 500 stock has a PEG ratio of 1.9x, marking the most significant discount since January 2017 and a level that has only been reached five times in the past decade.

Forex markets

The recent surge in the dollar has revealed particular global vulnerabilities that could push it even higher. One of the most significant factors is the US economy's greater resilience to rising interest rates compared to most other parts of the world. This resilience allows the US to offer relatively higher yields to investors, making the dollar an attractive choice.

While the dollar may eventually face some headwinds and potential pullbacks, its overall strength could persist if the global economic rebalancing process does not meet expectations. The dollar's role as a safe-haven currency and its economic resilience make it a prominent force in currency markets.

Oil markets

Oil futures experienced a sharp decline in the first trading session of October, erasing earlier gains. A stronger US dollar and the potential resumption of oil flows from Kurdistan drove this drop.

The crude oil market faced increased selling pressure on Monday due to a stronger US dollar. This strength in the dollar followed the release of unexpected improvements in US manufacturing activity for the third consecutive month in September, as reported by the Institute for Supply Management (ISM). Paradoxically, this positive data is bad for risk assets; it reinforced the notion of "higher for longer" while raising the spectre of a possible Q4 Fed hike.