Monthly Market Commentary - November 2022
Date: 07 November 2022
Global stock markets ended October with sizable gains after posting a strong recovery from their lowest levels of the year. A growing belief among market participants that central banks are getting closer to the end of the current hiking cycle has been cited as the most likely catalyst for the rebound, even though there has been little to support this in the economic data and official communications of rate-setters in the US, UK and Eurozone.
The move higher in equities began in volatile trade following the latest US inflation data which initially sent US benchmarks to their lowest levels of the year, before staging a remarkable recovery to end the day firmly higher. The intraday move, the market was down by 2% at one point and closed 2% higher, was the largest for US stocks since the height of the pandemic-induced market turmoil in March 2020. While it remains too early to say the bottom is in, this does serve as another example of the wild swings that can often occur around market bottoms and why it pays to remain invested during bear markets.
By the start of the fourth quarter US benchmarks had gotten off to their third worst start to a year since 1950. The only two years with a worse return over the first three quarters were 1974 and 2002, during which stocks bottomed on 3rd October and 9th October, respectively. The year-to-date low thus far was made on 13th October, shortly after the US Consumer Price Index rose to 8.2% year-on-year. Although this is still some way from the peak of 9.1% for June, the figure was higher than expected and the core reading, which strips out food and energy, rose to a new 40-year high.
Although inflationary pressures seem to be beginning to subside somewhat, it appears increasingly likely that the return of inflation gauges to central bank target levels will be a protracted process. The stubbornly high inflation data came just a few days after another stellar US jobs report, which showed the unemployment rate unexpectedly falling back to cycle lows of 3.5%. Both of these caused immediate, knee-jerk, selling in the markets as they were taken as reducing the chances of a dovish pivot from the Federal Reserve anytime soon.
Bond yields continued to rise
However, while economic data has not been supportive of a pivot, a journalist at the Wall Street Journal, Nick Timiraos, has been. Timiraos has gained a reputation as a Fed “whisperer” for accurately reporting, in advance, previous changes in Fed policy and an article stating that officials have begun signalling a desire to slow the pace of interest rate increases and to stop raising rates. This sparked a rally on Wall Street, building on the CPI-day reversal and left US benchmarks with a sizable monthly gain of around 7.9%.
Bond yields continued to rise, even after the reversal in the stock market, with the US 10-year yield hitting its highest level since 2008 at 4.34%. Yields pulled back into month-end though, ending at 4.08%, up 28 basis points on the month. This pullback has coincided with a lowering of expectations surrounding the terminal Fed Funds Rate, which is now seen around 5% in early 2023, up from the current 3.25%.
While further interest rate increases are expected in the US, UK and Eurozone, investors are beginning to feel that the end of the current hiking cycle is in sight. The US appears to be leading the way in positioning for this, and that has been reflected in recent stock market moves, with US benchmarks outperforming the UK and Eurozone in October, with equivalent indices rising by around 3.0% and 6.6% respectively.
A recovery in sterling has provided a headwind to UK equities in the past month, as the GBP/USD rate has recovered from September’s all-time low below 1.04 to trade back near end of August levels, around 1.15. This represents an October gain of around 3.1%.
It has been a tumultuous time in UK politics of late, with Liz Truss becoming the shortest serving prime minister just seven weeks after being sworn into the role by the nation's longest-serving monarch. September's “mini-budget” and subsequent market fallout effectively proved terminal to Truss's tenure. Rishi Sunak, the new prime minister, marks a return to more orthodox economic policy and there has been a remarkable recovery in UK assets, following the restoration of credibility. As mentioned previously, the pound has rebounded c. 8% from its September nadir and government bond markets have completely reversed their panic sell-off.
At the end of October, the UK 10-year gilt yielded 3.5%, around 100 basis points below its peak earlier in the month, and almost 50 basis points lower than where it ended September. To put the credibility restoration in perspective, the UK 10-year now yields around 50 basis points less than it’s US equivalent after yielding roughly 30 basis points more, at its peak. This 80 basis point relative swing in the UK/US 10-year rate differential can be seen as reflective of faith returning to UK assets, and an elimination of the so-called “moron premium”.
The UK Treasury's economic statement has been postponed until 17th November, after previously having been brought forward in an attempt to allay market concerns. However, the latest move is rooted in more positive news as the strong recovery in gilt markets has provided additional fiscal leeway, with falling yields significantly reducing the servicing cost of UK government debt. Holding off for 2 ½ weeks will allow the recent moves to be included in the Office for Budget Responsibility’s figures. This looks like meaning the UK public deficit will be reduced to approximately £20bn, from £35bn-£40bn previously, effectively saving in the region of £15bn-£20bn for the budget which may spare deep spending cuts on public services.
This restoration of stability also provides more flexibility for the Bank of England, with the markets now expecting the base rate to peak around 5%, compared to more than 6% less than a month ago. The current rate is 3.0%.
Xi secures third term
China has dominated the news lately, with president Xi Jinping securing a third consecutive five-year term as party chief following the 20th National Party Congress. This makes Xi the most powerful Chinese leader since Mao Zedong and has caused a notable adverse reaction in the markets, with the Yuan falling lower and large losses seen in Chinese equities. The fallout seems to be due to Xi surrounding himself with loyalists who are viewed as not willing to challenge the leader. There was also a notable absence of any good news on the Covid-19 front, with no indication of any change the in existing zero-covid policy.
In summary, October has been a more encouraging month for markets with more investors seeing glimmers of light at the end of the tunnel. While we welcome the recent moves, we remain somewhat cautious and believe that it is still too soon to decisively say the worst of the market sell-off is behind us. Third quarter earnings have been a mixed bag, with several of the companies expected to struggle still hold up ok while there has been some surprise weakness in large tech companies. Inflation remains stubbornly high and jobs' markets tight, by historical standards. Demand has softened in some areas, but on the whole remains fairly robust. It is apparent that the speed with which businesses can cut expenditures is playing a role as shown by the fairly sharp drop in digital advertising – which can be turned off relatively quickly – compared to the persistence of demand in other places where corporations remain committed to longer-term, strategic, campaigns.
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