A change in rhetoric from leading central banks on the movement of key interest rates was reflected in negative movements in financial markets in February. The aggregate bond index reported a decline of -3.3% for the month, while developed country equity markets fell -2.4%.
World indices retreat after surprisingly strong US labour market data
The past week was filled with emotions past Wednesday's Fed statement and then past Friday's labor market data.
The Federal Open Market Committee raised interest rates (expectedly for investors) by 25 basis points (0.25%), bringing the target funds rate to 4.5%-4.75%. This is a noticeable slowdown from recent increases of 50 and 75 basis points. More important to market participants was the softening in Powell's tone, and it was this that led to a rise in the stock prices and indices in general.
Last week was marked by inflation data in the US. They coincided with consensus expectations. This immediately eased the pressure and gave way to optimism that 2023 could loosen its grip. The S&P 500 rose, 10-year bond yields fell and the US dollar retreated against a basket of currencies. This is the complete opposite of 2022. Nonetheless, price pressures remain high, but if a similar market condition persists we could see a noticeable easing in the pace of Fed tightening.
Last week's data supports the idea of a pause by the Fed. Expectations are for one 0.25 basis point increase in February and another in March. This would reach the 5% target, where a pause in tightening is very likely.
Markets ended last week in positive territory, a good start to 2023. The factors that determine sentiment remain unchanged. These are inflation, rising interest rates and of course not least geopolitical uncertainty. Against this backdrop, the US employment figures were announced last week. We are currently in a phase where good news can be interpreted as bad news for the market and vice versa. It is because of this feature that equities came under some pressure earlier in the week past data pointing to a steady increase in employment and a reduction in jobless claims, equities then rallied, supported by weak wage growth. Anything that could lead to a pause in rate hikes or a slowdown in inflation will be interpreted positively by the market and vice versa.
The outlook for the US economy still remains unclear. The questions that worry investors are when and with what force a recession will occur as a consequence of high interest rates. Since mid-October, the major indices have made a strong rise of around 11%, but this growth has not been driven entirely by optimism about the future performance of the economy. The relative performance of the S&P 500 (large-cap stocks) versus the Russell 2000 (small-cap stocks) favors the broad index. Small-cap companies are much more sensitive to the trajectory of the economy and often outperform large-cap companies. Because of this, investor caution is likely to increase in the short term, so we are talking a reverse trend where we have relatively better performance of the S&P 500 versus the Russell 2000.
In recent weeks, the market recovery has gained good momentum. The broad S&P 500 index ended last week in positive territory again. Global equities recorded their first consecutive monthly gains in more than a year. On Wednesday, Fed Chairman Powell signaled a slower pace of rate hikes. That statement further reassured investors, although Friday's strong labor market data appeared to be a headwind.
The S&P 500 Index finished positive in a shortened trading week, led by the utilities and materials sectors. In addition, the financials and consumer staples sectors had a positive week and also outperformed the market average. The energy sector was the biggest loser relative to all others as oil prices (West Texas Intermediate) fell over 4% for the past week and over 10% for the one month period. Emerging markets ended lower as COVID-19 cases soared in China, prompting the government to continue the lockdown and mass testing.
US indices ended the week slightly lower, closer to neutral. Overall, defensive sectors led the gains - an expression of some caution on the part of investors. Retail sales rose in October by 1.3% strongly above analysts' expectations. This is negative news for the market, as it betrays that there is buying power, which in turn could push prices and inflation upward. Hence investors' concern that the Fed may continue with its aggressive tightening policy. On the flip side are suggestions that we are at the beginning of an economic slowdown that will lead to less excess funds with consumers and hence less headwind for inflation. This could describe the range of expectations in which the market fluctuates with short-term sharp moves in both directions.
Markets were extremely dynamic last week. Lower than expected US inflation data offered some relief for investors and the Fed. The published data gave room for expectations that a disinflationary trend could be seen in the coming year. The core consumer price index (CPI) rose 7.7% from a year earlier, the smallest annual increase since January and down from September's 8.2% pace. Importantly for the Fed, the core index, which excludes food and energy, slowed more than expected. The good news about the easing of inflation pressures was mirrored by equities with: a strong rally, a sharp fall in bond yields and a weakening of the dollar against a basket of currencies. All of this shows us that it is inflation that remains the main driver of markets. Sentiment is largely determined by indicators such as CPI and the Fed's future strategy.
If the disinflation trend persists and the focus shifts away from this theme, we are likely to see a sharp decline in bond yields and strong support for the technology sector and other growth segments. Thursday's market reaction supports a similar view with the NASDAQ rising 7%.
The markets fell last week after another, but expected, 75 basis point increase in the key interest rate. It was the fourth consecutive hike, and it brought interest rates to 4% in about eight months, an unprecedented pace of increases for the U.S. economy. As we wrote in last week's commentary, the catalyst for the move in US indices was not so much the rate hike itself but the prospect of future tightening. It was noted at the press conference that rate increases act with a lag relative to the real economy. However, Jerome Powell maintained his hawkish tone and that is what drove the indices down. He stressed that any discussion around stopping the hiking cycle would be "very premature". Chairman Powell also noted that recent data projected the key interest rate to be higher than what was outlined in September. At that time, the peak was projected to be around 4.6%. The consensus is now around 5.3% by the end of the first half of 2023.
Over the past week, the markets were torn between two major forces. On one side were disappointing earnings results from mega-cap technology companies and signs of softening economic activity. On the other side were rising hopes of a Fed policy easing and a momentary decline in bond yields. All of this led to a large divergence between the Dow Jones Industrials Average and the Nasdaq, where the Industrials Index rose 5%, while the Technology Index rose just 1%.
Corporate earnings were the focus of investors last week as 164 S&P 500 companies, or nearly 50% of the index's market cap, reported results. In particular, the spotlight was on tech giants, exerting a strong influence on the markets as a whole. Alphabet, Microsoft, Meta, Apple and Amazon together accounted for 20% of the index and on average their shares fell 9% on the day earnings were released.
Over the past week, a slight optimism has crept into the markets that things are not as bad as investors expect. Q3 earnings are so far better than expected. The company that stood out last week was Netflix (part of the Compass Global Trends portfolio), surprising most market participants with results that beat analysts' expectations. Earnings season is now underway and earnings data for the four giants by market capitalization, Microsoft, Alphabet, Amazon, Apple, are to be released. The broad S&P 500 index remains above the psychological zone between 3500 and 3600 points. Its oversold condition makes it extremely sensitive to positive corporate earnings data or any signs of a less aggressive Fed. In the Eurozone, many are expecting a 0.75 basis point increase in key interest rates as inflation approaches 10%.
Equity markets ended last week in negative territory after strong volatility. Last week's inflation data on the 13th showed that the Fed has a strong case to continue aggressive rate hikes through the end of this year. That led to a rapid sell-off in stocks even before Thursday's open. More interesting was the intra-session reversal during which the S&P 500 registered a sharp pullback and closed the day in positive territory. This is the fifth largest reversal in a single day in the history of the index. Investor sentiment, represented by the spread between "bulls" and "bears", is still extremely negative.
The growing macroeconomic uncertainty in September was reflected in the decline of most global market indices.
Markets ended last week on a token gain. Friday's strong sell-off was driven by U.S. labor market data. The unemployment rate fell to 3.5% from an expected 3.7%. Investors' fears are that a stable labor market with falling unemployment will give the Fed additional "confidence" in the cycle of aggressive tightening.
The broad S&P 500 index failed to register a new low for the year despite selling pressure. This is largely due to its oversold condition to date. Levels around 3600 remain key for the index.
Last week, markets globally declined. The S&P 500 finished down with more than -1%. Investors continued to sell risk assets under pressure from expectations of weaker-than-forecast Q3 earnings. Trader sentiment comes as an additional drag. Their mindset is for a hard landing on the economy by the Fed, driven by struggling price pressures. The markets are in an extremely bearish environment. This can be interpreted as a positive signal. Often, when we have a mass swing in investor sentiment towards one of two extremes (optimism/pessimism) the slightest surprise, contrary to general expectations, can lead to a sharp reversal in index movements. Currently, such a positive catalyst could be inflation data or corporate earnings. The bullish reading in the latest Investors Intelligence report fell to 25.4% from 30% last week, marking the lowest since 2016. The American Association of Individual Investors' (AAII) reading for the bull-bear spread (bulls minus bears) was -40.8, the eighth most pessimistic weekly reading in the survey's 35-year history.