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%.
Value investing (dividend income) continues to have an edge over growth equity investing, where the main source is capital gains, but less aggressive central banks and peak 10-year bond yields may lead to a better balance between the two investing styles.
What to watch in the week ahead
There will be a host of US data releases this week, but the most important will be retail sales. These will give some indication as to whether the Fed's aggressive rate hikes are working and starting to cool the economy.
The UK government will finally announce its new budget plan and investors will be paying close attention after the market crash triggered by September's "mini-budget".
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