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Nov 249 min read

AMC Weekly

Welcome to the fourth issue of the Bocconi Student Asset Management Club newsletter!


Global Economy


U.S.

The Federal Reserve's latest survey shows that inflationary pressures are easing, reflecting both consumer and business expectations. The inflation outlook seems healthier, due to the combination of consumers’ confidence in stabilizing prices and lower increase in pricing of goods. Nonetheless, the Fed continues to adopt a vigilant approach. The Fed’s cautious optimism would allow it to react to the resurgence of risk factors, such as trade policy shifts or unforeseen fiscal challenges.

 

For instance, a new administration’s trade policies could result in tariff adjustments or shifts in global supply chain dynamics, potentially triggering inflationary pressures. Similarly, market sentiment might be affected by concerns about elevated national debt levels and could impact market sentiment, particularly if the costs of servicing debt rise in a higher interest rate environment.

 

For financial markets, the current environment presents a complex mix of stability and risk. The moderation in inflation provides a positive backdrop for equities, particularly sectors sensitive to consumer spending, as households may feel less pressure from rising prices. However, the uncertainties tied to fiscal policy and trade remain a wild card. Investors will need to weigh the Fed's likely cautious stance against the backdrop of potential policy shifts that could reintroduce volatility.

 

Therefore, while inflation may no longer dominate the headlines, the financial market’s attention will likely pivot to how policymakers navigate other macroeconomic challenges.


Europe

The European Central Bank’s (ECB) November 2024 Financial Stability Review warns of a looming sovereign debt crisis in the Eurozone citing rising interest rates, low growth, and global trade uncertainty. 

 

A sovereign debt crisis is characterized by a government’s inability to meet their debt obligations at maturity. The Eurozone is struggling now since the bonds that were issued at lower interest rates back in the 2010s are maturing and must be paid back at significantly higher rates. Governments with limited fiscal space and high debt burdens are especially vulnerable to this looming crisis as their options are to raise taxes, rely on other economies to pay their interest rate bill, or default on their obligations. Italy is a prime example of this with a 136.9% debt-to-GDP ratio versus the Eurozone average of 88.1%.

 

Low economic growth across the Eurozone only furthers the looming sovereign debt crisis issue as it leaves governments with fewer resources to service debt. Sluggish growth has stemmed from weaker demand for exports, decline of key industries, and cyclical downturns in productivity. Construction has been a driver of this slowdown as it is traditionally a key source of job creation. Political instability also adds to the strain as it erodes investor confidence and economic policy efficiency. At the forefront of this instability stands Germany with a collapsed government, leading to widening bond spreads which is reminiscent of the Eurozone debt crisis from a decade ago. 

 

Geopolitical and trade tensions also raise the possibility of this sovereign debt crisis because of their negative impact on trade. The return of Trump’s administration signals a protectionist era for the U.S., threatening European exports with proposed tariffs on 20% of goods sent to the U.S. Financial stability for the Eurozone remains uncertain as policymakers now have to simultaneously manage high debt levels and low growth to stimulate economic activity.


India

Hours after Maharashtra’s assembly elections wrapped up in India, the U.S. Department of Justice filed criminal charges against Gautam Adani, India’s infrastructure tycoon and Prime Minister Narendra Modi’s close ally. The charges against Adani allege his involvement in a $250 million bribery scheme raising serious concerns about the implications for the Adani Group, India’s political landscape, and international trade prospects. 

 

As per the DoJ’s 54-page indictment, Adani Green Energy Ltd bribed the Indian government $250 million in bribes in 2020 to ‘motivate’ state-owned electricity companies to purchase solar power at above fair market prices. The case involves the U.S. financial system since Adani sought international investors for these energy contracts, warranting American jurisdiction. This indictment has already hit the Adani Group hard, with a 15% drop in market capitalization to $142 billion. 

 

Domestically, this scandal has increased scrutiny on Modi’s close ties with Adani, raising allegations of crony capitalism from opposition leader Rahul Gandhi. Adani’s business rise has coincidentally always mirrored Modi’s favourable policies for renewable energy and infrastructure. This controversy comes right after the elections, making it unfortunate timing for Gandhi but still undermining public confidence in the government.

 

Globally, this scandal underscores the rampant corruption in India, hampering its attractiveness as an investment destination. In a time where businesses are aiming to shift production out of China, India needs to boost international confidence in its governance and regulatory environment. Adding to the strain, Trump’s return to office could complicate India-U.S. relations, as Washington may leverage the scandal to secure concessions like greater access for American tech firms. 

 

It is evident that corruption remains deeply intertwined with India’s economic and political framework. While the Adani Group may eventually regain domestic investors’ trust, this scandal casts a shadow over India’s geopolitical and economic ambitions as it seeks to solidify its role on the global stage. 


 

Equity Highlights


U.S.

Major stock indexes ended the week higher, recovering some losses from the previous week despite uncertainty around Trump administration policies and heightened geopolitical tensions from the Russia-Ukraine conflict. Gains were broad-based, with smaller-cap indexes outperforming large-caps, and the equal-weighted S&P 500 surpassing its cap-weighted version. Bitcoin continued its postelection rally, rising over 10% for a third consecutive week.

 

With a light economic calendar, NVIDIA’s Q3 earnings took centre stage. Its stock remained steady as investors welcomed the report, though Q4 guidance fell short of expectations. Optimism around AI-driven clean energy demand lifted utilities, while communication services lagged, weighed down by Alphabet’s decline amid a Justice Department breakup proposal.


Europe

On Tuesday, European stock markets reached their lowest point in three months, with a general decline occurring in response to Ukraine's unparalleled assault on a Russian military installation with missiles of an advanced range, manufactured in the United States.

 

Russia's subsequent declaration of its intention to lower the threshold for the use of nuclear weapons served to aggravate market jitters.

 

At the opening of the session, the Euro-Pan Stoxx 600 index declined by 1%, reaching levels last observed on 8 August.

 

The downward trend that had characterised the previous few days was promptly reversed. European stocks concluded the week on a positive note on Friday, as investors closely examined economic indicators in the region that intensified expectations of central bank rate cuts.

 

The UK's FTSE 100 exhibited its most substantial weekly gain in over half a year on Friday, as a decline in the value of the pound enhanced the performance of dollar-denominated stocks, while banks encountered pressure from the release of data indicating weak economic activity.

 

The FTSE 100, a benchmark for blue-chip stocks, closed the day on Friday, 24 November up 1.4 per cent and posted a weekly gain of 2.5 per cent, its best since 7 May.

 

For what concerns the Italian peninsula the FTSE MIB experienced a mixed performance over the course of the week, with notable gains in banking and energy stocks, while telecommunications and industrial stocks exhibited heightened volatility. Market sentiment was characterised by a certain degree of caution, largely due to concerns surrounding inflation and the relatively slower pace of economic growth observed in the Eurozone. The index was driven by sector-specific gains but was simultaneously weighed down by broader economic uncertainties.


Asia

This week the biggest gain for major Asian indices was India’s BSE Sensex, increasing by 1.64%. Despite the media turbulence caused by Gautam Adani’s indictment, Adani Group’s weight in the broader context of India’s stock market was not substantial enough to outweigh gains in other sectors like finance, IT, and real estate, according to J.P. Morgan. Hong Kong’s Hang Seng and Japan’s Nikkei 225 both saw flimsy movements by -1.87% and 0.06% respectively. Recently, the Chinese government renewed visa-free access to Japan which officials hope would boost the economy and instil hope in investors for future growth.


 

Fixed Income Focus: Bond Market Highlights


U.S. Treasuries

As data came out on November 13th, CPI in October increased slightly to 2.6% from 2.4%.

 

On the subsequent speech on November 14th, the FED President Jerome Powell invited “not to be in a hurry”, as the recent signs of economic health, supported by the active job market, would allow central bank to take its time in deciding how quickly to continue reducing interest rates.

 

Treasury yields were mostly higher on Thursday as the latest unemployment claims data showed an unexpected decline in initial claims, but a greater-than-forecasted in continuing claims.


Comparing the interest rate of two weeks ago and last week we can see an increase in 1-year, 2-years and 3-years US Treasuries, which reflects decreasing markets expectations of rate cuts in the future. The market is now discounting a 25-bps rate cut in December with a 53% probability, significantly down from the previous 62% last week.


EU Investors overwhelmed by bonds

Private markets are expected to absorb more than 660 billion euros of net bond supply for 2025. With the quantitative tightening by the ECB, which is trying to reduce its balance sheet, the private markets are the designated recipients of the outstanding amount of eurozone government bonds for a third straight year. Analysts’ opinion is that the private market will be able to soak up the bond issue.

 

After the news of November 19th of a confirmed 2% inflation in October by Eurostat, the eurozone yield curve has lowered a bit, following the expectations of future rate cuts.

However, the high level of bonds sales could push up long-term borrowing costs relative to yields on short-term debt, which are anchored by central bank expectations, resulting in a steeper yield curve. As a result, Europe may not see big declines in borrowing costs even as the ECB lower rates.


Are stocks overvalued?

As new earnings are coming out during these days, we can use the new data to evaluate a very important indicator that permits us to understand better the current market prices: the S&P 500 Earnings Yield vs. the 10-Year U.S. Treasuries rate.

 

This gap has been used to assess the valuation of the US stock market (even if the S&P 500 is not totally representative of the US stock market) relative to the bond market. If the gap is positive, we can say that the stock market is undervalued relative to bonds; if the gap is negative, the stock market is overvalued relative to bonds.

 

In the last 20 years (not considering a small window of time during the 2008 financial crisis) this gap has been positive showing a relative undervaluation of the stock market, but now the situation has changed: with 10-year Treasuries rate at 4.37% and the Earnings Yield at 3.32% the gap is now negative, showing a relative overvaluation of the stock market.

 

Let’s get deeper into the indicator: with data collected since 1960, the average long-term value of the gap has been +0.27%, while the standard deviation of the gap has been 2.11%. The current gap is at -1.05%, this means that we currently are 0.63 standard deviations from the average value.

 

We can conclude that, at the time of speaking, there is still no significant evidence that the stock market is overvalued according to this indicator (the threshold is set on -1 standard deviation from the average), however, as many other indicators are suggesting (look at the previous newsletter regarding the Warren Buffet index), the current market prices seem higher than normal. This is something to keep an eye on.

 

Corporate Bonds

Corporate borrowers are rushing to take advantage of the US bond market, given the extraordinary conditions after Donald Trump’s election victory. Trump’s win has pumped credit and equity markets, pushing corporate borrowing costs relative to US Treasuries to their lowest levels in decades, as investors bet that tax cuts will boost profits.

 

US investment-grade bond spreads - which are the premium highly rated companies must pay in order to borrow, relative to the government - were at 0.8 percentage points last week, close to their lowest level since 1998.

Many companies are now pulling forward bonds issuance they had planned for early next year. Firms such as Caterpillar, Gilead Sciences (active in the biopharmaceutical industry) and Goldman Sachs have raised more than 50 billion dollars last week, according to LSEG.

 

New research by Barclays showed how ETFs issuers are adding more products that track segments of the credit market, such as maturity or rating. One implication is an increased liquidity in the credit market, because ETFs issuers need the bonds to track their benchmarks


 

Wrap up for the Asset Management Division

In recent years, the 60/40 portfolio strategy has faced challenges as bonds haven’t delivered the same diversification benefits they once did. Stocks and bond prices have often moved in the same direction, weakening the typical offset between the two. This has made the traditional approach feel less effective, especially during the Fed’s recent tightening cycle.

 

Even so, there’s a good argument to be made for long-term bonds right now. The 10-year U.S. Treasury yield has jumped nearly 70 basis points since the Fed’s September meeting, pushing it to levels that are attractive compared to the 20-year average.

 

While there’s still a chance that yields could climb higher, recent economic data and political developments suggest that longer-maturity bonds could be a good spot for excess cash.

 

For investors looking for balance, the 60/40 split is still a solid strategy, but it needs a broader approach. The 60% allocated to equities shouldn’t rely entirely on U.S. large-cap stocks. Adding exposure to mid-caps, small-caps and international markets can provide a better cushion against market swings.

 

 

Credits:

Andrea Zito (Team Leader)

Lavinia Catalano (Global Economy analyst)

Mahek Dodani (Global Economy analyst)

Pablo Ruiz (Equity analyst)

Vladimir Pashov (Equity analyst)

Filippo Caselli (Equity analyst)

Mattia Caiti (Fixed Income analyst)

 

 

References



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