Monthly Market Commentary | Quilter Cheviot
By Duncan Gwyther, Chief Investment Officer
Stock markets ended November on the front foot, with global equity benchmarks rallying to three-month highs on growing hopes that central banks will shortly begin to reduce the pace of their interest rate increases. As is often the case, where the US leads the rest will follow and recent rhetoric from Federal Reserve (Fed) rate setters and falling US inflation have seen many of the year’s prevailing trends reverse of late, with not only stocks gaining but also bond yields falling and the US dollar pulling back from a 20-year peak.
Global share indices rose by around 8% on the month, in US dollar terms, with US benchmarks lagging a little and ending in the region of 5% higher. The bulk of the month’s gains on Wall Street came from only two trading days and the catalysts for these moves clearly demonstrate the market’s present propensity to react positively to falling inflation and a less aggressive Fed.
Early in the month, the latest US consumer price index came in at the lowest level since January, rising 7.7% year-on-year to October, and providing investors with their clearest sign yet that price pressures in the world’s largest economy are starting to cool. The core reading, which strips out energy and food prices also delivered promising news, easing from a four-decade high.
The size of the market reaction leaves little doubt as to what investors and money managers are currently focused on with US stocks posting their best daily gain in over two years as large cap benchmarks rose in excess of 5% and tech indices jumped over 7%. The reaction was similarly striking across other asset classes, with the yield on the two-year Treasury note falling 25 basis points, its largest drop since October 2008.
Short-dated bonds including the two-year tenor are particularly sensitive to monetary policy expectations, and the sharp fall in yield shows investors pricing in less Fed interest rate hikes going forward. Subsequent communications from policymakers reaffirmed this belief, culminating in chair Jerome Powell’s speech from Washington DC on the last day of the month, when he stated that “the time for moderating the pace of rate increases may come as soon as the December meeting.”
This caused the second large daily gain for stocks last month and after three consecutive 75 basis point increases, derivatives markets are now pricing in a 50 basis point increase at the December meeting and 25 basis point increases at the first two meetings next year. This would take the official rate to 5.0%.
Although US benchmarks are still down by around 14% on the year, they have bounced over 16% from their September lows and investors are becoming more hopeful that the current rally will prove more sustainable than the one which began in June. A key difference between the summer’s rally and the present one is that the Fed are now no longer behind the curve, having moved monetary policy into restrictive territory. There is a growing feeling that policymakers will start to adopt more of a wait-and-see approach, whereby the trajectory of inflation metrics will play a greater role in determining the path of interest rates compared to the last six months when the central bank has moved aggressively to swiftly tighten policy.
Return to austerity
The Autumn Statement delivered by UK chancellor Jeremy Hunt was clearly targeted at repairing public finances and the UK’s credibility and, judging by the positive market reaction came as a welcome tonic to investors. Coming less than two months after the market turmoil of his predecessor Kwasi Kwarteng’s expansionary “mini-budget” containing largescale unfunded tax cuts, this budget marked a return to fiscal orthodoxy with plans to raise taxes by £25bn and cut spending by £30bn by 2027-2028.
As the plans were well telegraphed in advance the market reaction on the day of the news was muted, an outcome that would have pleased those inside HM Treasury after the fallout from the previous fiscal announcement. The UK 10-year gilt yield ended November at 3.16%, almost 150 basis points lower than its early October peak and down by 38 basis points on the month.
Sterling has also recovered after hitting its lowest ever level against the US dollar just a matter of days after the “minibudget”. The GBP/USD exchange rate ended November back above the US$1.20 level, rising a little over 5% on the month. UK large cap stocks broadly tracked global benchmarks on the month, rising by around 7%.
China’s changing Covid-19 stance
There are a number of encouraging signs that China has begun changing tack regarding its stance on Covid-19, with optimism growing that Beijing could shortly move away from its strict “zero-Covid” policy. The fight against the virus has entered a “new stage”, according to Sun Chunlan, China’s top zero-Covid enforcer and state media have also begun to play down the risks associated with the Omicron variant.
Although the country remains in the midst of its largest outbreak of the virus, popular resistance to strict measures has undoubtedly grown, with mass demonstrations in recent weeks following a deadly fire where the deaths were blamed on a lockdown. While the western world has adopted a “living with Covid” strategy for much of this year, China’s persistent adherence to its strict controls has undoubtedly weighed on global growth – not only stymying activity in the world’s second largest economy but also causing wide ranging supply chain issues.
The reimposition of Chinese restrictions in early November as case numbers surged along with rising fears of a slowdown in global economic activity due to sharply higher interest rates stoked recession fears. Expectations for slowing growth and the associated demand reduction has weighed on the oil price, with Brent crude, an international benchmark falling by more than 6% in November to trade at its lowest level since January.
Another factor behind the decline in Brent crude is news that European Union (EU) member states are close to agreeing a US$60 price cap on global purchases of Russian oil. The price cap will be implemented through the insurance market, as importers seeking to insure cover and shipping services from G7 and EU countries would be locked out the market if they fail to comply with the ceiling. Although the cap, currently rumoured to be set at US$60, is comfortably below the market rate (Brent crude ended November in the mid US$80s) it is still considerably higher than the US$30 limit some parties proposed, and that has caused some of the downward pressure on the oil market.
In summary, the performance of equities in the last two months has been pleasing and there are encouraging signs for cautious optimism going forward. The Fed seem set to imminently slow the pace of interest rate increases and the adoption of a wait-and-see approach, rather than a continueto- increase-rates-until-something-breaks mentality, has significantly reduced the chances of a further policy mistake, for now.
With interest rates approaching their terminal level we believe a sizable portion of the derating of stocks has already taken place and going forward the market’s focus will be more on the earnings component. Corporate earnings for the third quarter remained fairly strong, by and large, although we do expect to see some softening in Q4. That said, consumer spending is holding up relatively well at present, as seen by the retail sales figures around Black Friday, which kicks off a seasonally crucial time for retailers.
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