SUMMARY
Risk markets improved this week, with prices slowly grinding higher. The ongoing improvement in sentiment reflects a combination of :
growing optimism that the Fed’s tightening trajectory is slowing,
a weaker US Dollar, and
lower oil prices.
Thanksgiving effectively cut the US trading week in half as volumes trailed off, but the S&P 500 still managed to register a gain for the fifth week in the last eight, bringing its 4Q22 gain to 12.3%. US Treasuries and corporate bonds also rallied as positive investor sentiment spread beyond US equities.
The Fed toned down its rhetoric compared to the week before, right on cue just as the minutes from the last FOMC meeting were released (here) suggesting a more patient and data-dependent Federal Reserve. Investors cheered this approach which was reflected in price appreciation across risk assets. The S&P 500 rose above 4,000 for the first time since late August, and the best performing US index of the year – the DJIA – is within 7% of its all-time high (reached January 4, 2022). Investors are feeling more positive in the UK, Europe and Japan, too, with the equity markets in all of these regions chalking up solid gains for the week.
So the question is, “is this just another bear market rally or are we really out of the woods?” I would like to think it is the latter, but my suspicion is that there will be a rockier road ahead than investors seem to suddenly be expecting. The reality is that interest rates are significantly higher than they were at the beginning of the year and are likely to go higher albeit at a slowing pace. Earnings growth has also been slowing although generally better than expected. The economic outlook is also unsettled, and this will inevitably weigh on earnings in the coming quarters, especially for many of the more cyclical companies that have in fact led the recent rally. China also remains a wildcard, with optimism rising and fading as news emerges about the country’s latest COVID policies and lockdowns. I have not looked closely at index valuations, but my sense is that whilst the numerator might still be slightly toppy based on historical norms, the real risk in the coming quarters will be with the denominator (i.e. earnings) should the economy slip into a recession as expected.
And speaking of optimism – bordering on just plain silly – you might want to listen to this recent #Bloomberg interview with Cathie Wood of ARK, available on YouTube here. I can’t imagine any scenario in which Bitcoin would reach $1 million in five years!
MARKETS THIS WEEK
Risk markets were better across the board this week, reflecting the broadening of investor optimism. If US equities manage to hold onto their MtD gains for November, then this will be positive returns for two consecutive months for the first time this year. US Treasury yields fell across the maturity spectrum this week, and the 2y-10y yield differential slightly narrowed. Total returns for the 20y UST bond index are positive so far in November for only the second month this year. Lower yields on USTs could reflect hopes that inflation might finally be slowing, or lower yields could reflect expectations of a slowing US economy in the coming quarters. The price of WTI crude (down 11.8% so far in November, and nearly 28% in the 2H22) is also steadily declining. I suspect that OPEC+ will step in again to curtail supply if prices continue to head south, although this is an OPEC+ storyline that has played out on numerous occasions over the past few decades with limited long term success (which will not keep OPEC+ from trying). Both the investment grade and high yield bond markets also rallied strongly this week as both yields and spreads declined. Inflows into high yield bond funds have been significant over the last two weeks as investors have come rushing back into the asset class.
Below is a table that summaries the week and YtD performance of select indices and asset classes that I track.
WHAT’S NEXT?
Below are some of the key data and economic releases and other events that matter for the weeks ahead.
Economic data will start to trickle in later this week for November, but data releases will be more significant starting the week of December 5th. Eurozone flash inflation for November will be released on Wednesday, ISM manufacturing data for the US will be released on Thursday, and non-farm payrolls (for November) will be released on Friday.
Jerome Powell will address the Brookings Institute on Wednesday at 130pm (EST) in a speech entitled “Economic Outlook, Inflation, and the Labor Market”. You can register to watch it here.
Upcoming central bank meetings:
Federal Reserve – Dec 13th-14th
Bank of England – Dec 15th
ECB – Dec 15th
Bank of Japan – Dec 19th-20th
THE TABLES
Global equities
US equities
US Treasuries
Corporate bonds (credit)
Safe haven and other assets
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