- Markets finished much higher last week, posting their best week in more than 2 years following a softer than expected CPI report, which injected some much-needed optimism back into US equity markets.
- The positive economic report has finally affirmed the “peak-inflation” thesis that investors had been hoping for and now brings into focus the possibility for a slightly more dovish Fed.
- Also, adding to the risk-on tone was the results from the midterm elections, China’s willingness to back off their Covid-zero approach, and the de-escalation of geopolitical tensions.
- Following the positive developments, the Nasdaq jumped more than 8%, while the S&P gained just under 6%.
- Mega cap Tech had a very strong week with FANG+ (Includes NVDA, BABA, BIDU, META, TSLA) closing up more than 9.50%. Growth as a factor outperformed value by more than 4.0%.
- This week also saw the long-awaited midterm elections largely conclude, with all signs pointing to a divided government for the next 2 years, as Democrats were able to outperform in the Senate, holding on to at least a split Congress (Pending the GA Senate runoff in December).
- With Q3 earnings wrapping up, 91% of S&P 500 constituents have reported. In aggregate, the blended earnings growth rate currently stands at 2.2%, which is below the 2.8% expected at the end of the quarter and is on track for the slowest growth since the 3Q of 2020.
- Germany announced the nationalization of SEFE, which is the central distributor for commercial and residential users, and former trading and supply unit of Gazprom PJSC.
- In the United Kingdom, the economy contracted in the third quarter for the first time since the first quarter of 2021 as output remains 0.4% below pre-pandemic levels.
- In China, officials announced a notable shift in COVID-Zero policy by reducing quarantine times and ending flight bans.
Markets finished much higher this week following a softer than expected CPI report on Thursday, which injected some much-needed optimism back into US equity markets. Also, adding to the tailwind supporting equities was a report on Friday that China is “optimizing” its Covid-zero approach to include shortened quarantine periods, less stringent contact tracing, and more focus on home quarantines versus broader lockdowns. Additionally, the de-escalation of geopolitical tensions after Russia ordered a withdrawal of its forces from Kherson with Ukrainian troops advancing was flagged as a positive with some thought it might open a window for a diplomatic solution.
The week also saw the long-awaited midterm elections for Congress largely conclude (outside of the GA Senate race), with the expectation that there will be a divided government for the next 2 years. The “red wave” that many had anticipated failed to materialize, with Democrats outperforming in many key Senate races (AZ, NV, PA, GA). However, the GOP will still take control of at least the House and keep the divided-government theme intact, which is seen as somewhat bullish given the expectation that no expensive/transformational legislation will be able to move forward.
Following the key developments mentioned above, major indices saw their best weekly performance in over 2 years, helping erase the prior week’s declines as the S&P 500 jumped just under 6.0%, while the Tech heavy Nasdaq rallied more than 8.10% and closed up more than 7% on Thursday alone. Growth (+8.3%) names were a large outperformer due to their value counterpart (+3.9%), although both
posted strong gains over the 5-days.
Treasuries rallied, as the 10-year treasury yield slipped back below the widely watched 4.0% after declining 35 bps to end the week at 3.82%. The Dollar was weaker, falling more than 4%, and logged its worst week since March 2020. Gold had its best week in more than 2 and a half years, closing up more than 5%.
Although LFCM does not, nor have plans to, hold positions in digital assets like crypto currencies, the dissolution of one of the largest crypto currency marketplaces, FTX, sent all major crypto currencies down sharply. By Wednesday, Crypto hit a low for the week with Bitcoin falling more than 20%, Ethereum declining 22%, Cardano declining 19%, and Ripple losing more than 20%. This occurred while the
broader equity markets experienced one of their best weeks this year for risk-on assets and Tech names.
Mega cap Tech had a very strong week with FANG+ (Includes NVDA, BABA, BIDU, META, TSLA) closing up more than 9.50%. Semis were stronger across the board with the Philadelphia Semiconductor Index (SOX) closing up 15%. Homebuilders reacted well to the lower Treasury yields and the possibility of a sub-5% terminal rate for the Fed funds rate, as the XHB (Homebuilders index) surged more than 12%. There were also a number of standouts in cloud software and unprofitable Tech, with the risk-on tone gripping markets.
Other areas of strength in the market were credit cards, road/rail, media, apparel, building products, and exchanges. Autos were mostly higher, but TSLA set the tone for the EV space, weighing on others throughout the industry like Lucid, and Nio (Although RIVN earnings were well received and bucked broader selling pressures in the space).
CPI RELEASE- THE MAIN EVENT
The key event this week and primary reason behind the rally was the softer-than-expected CPI report which saw the annualized figure drop 0.5% from the month prior to 7.7%. Core inflation of 6.3% (ex – Food and Energy) also fell from a 40-year high the prior month (6.6%), and came in below expectations.
The release gave investors the reprieve they have been waiting for and showed the price of goods declining across a range of categories, especially used vehicles which saw a decline of 2.4% m/m (-3.9% decline from peak to trough starting back in June). However, shelter (mortgages and owners equivalent rents), which is the largest component to the CPI report, has remained elevated, as was feared, but a
slowdown in new leases is projected to reduce rent prices in the coming months, due to the “sticky” nature of rents.
The positive economic report has finally affirmed the “peak-inflation” thesis that investors had been hoping for and now brings into focus the possibility for a slightly more dovish Fed given the release.
The Federal Reserve has long maintained that they would not reduce their rate hiking regime until clear and convincing evidence came forward that price stability had been regained. While we may still be quite a bit away from a more relaxed monetary policy environment, as of Thursday the Fed now has the first piece of supportive data which could allow them to pivot their policy stance in the coming months if additional data releases echo similar results.
Following the results, we have seen some Federal Reserve members lean more dovish and speak up publicly against the outlook of additional rate hikes. Although comments such as these are more dovish than investors have heard in months, it still remains the consensus opinion that Fed policy will need to remain restrictive for some time to return inflation back to 2.0%. While under-tightening is still seen as the larger threat versus over-tightening due to the potential for persistent inflation, the general takeaway is that higher rates are needed, and additional hikes will come, but at least now the hold and a potential rate cut environment appears to be on the distant horizon.
Dallas Fed president Lorie K. Logan said it may soon be appropriate to slow the pace of hikes but there remains a long way to go
• Mary Daly of the San Francisco Federal reserve stated that it is now appropriate to consider a step down in the rate of increases although pausing at this time is not yet a prudent topic of discussion.
With Q3 earnings slowing and only 30 S&P 500 constituents reporting over the past week (another 15 are expected this week), investors have seen 91% of S&P 500 companies reported. The blended earnings growth rate currently stands at 2.2%, which is below the 2.8% expected at the end of the quarter and is on track for the slowest growth since the 3Q of 2020.
On the week the big takeaways were:
• DIS (-4.6%) jumped to number 1 in direct-to-consumer subscriptions, overtaking Netflix with 235M global subscriptions, but posted
largest DTC losses of almost $1.4B.
• RBLX (-9.5%) saw deceleration in m/m bookings growth despite a relatively low bar to hurdle.
• DHI (+13%) missed earnings with light closings, with orders sliding 15% and cancellations coming in at almost 33% up from 19% a year
earlier. However, next quarter guidance and management commentary were well received.
The Bloomberg World index closed the week up 6.35%, with growth up 9.03% and value up 4.54%. Reports of easing COVID-Zero policy coming out of China as well as lower-than-expected US CPI print triggered a risk-on rally. Moreover, the announcement that Russian troops retreated from the city of Kherson in Ukraine was also well-received by markets massively positioned for the worst-case scenario. In Europe, gas storage capacity climbed to 96%, which could prove to be enough for the winter. Brent oil futures declined 2.62% last week, while commodities erased 0.52%.
In the United Kingdom, the economy contracted in the third quarter for the first time since the first quarter of 2021 as output remains 0.4% below pre-pandemic levels. Chancellor Jeremy Hunt reaffirmed his commitment to “grip inflation, balance the books and get debt falling”. His fiscal tightening plan is reportedly set to be the biggest since the 2010 budget under George Osborne. However, Hunt is expected to delay the implementation of his plan until after the next election to protect UK economy and Tory election hopes. In October, UK Manufacturing PMI dropped to 46.20, from 48.20 a month earlier. Services PMI dropped below 50.00 for the first time since February 2021. British stocks gained 0.87% last week, led by auto and parts, up 30.34%.
The European Central Bank (ECB) raised its inflation projections for the Euro-area amid energy price pressures, a strong dollar, and weakening economic conditions. Policy makers now see inflation rising 8.5% year-over-year in 2022, 6.1% in 2023, and 2.6% in 2024. Germany is the most likely in the Euro-area to suffer a recession in 2023 according to the European Commission, given its exposure to shortage of gas stemming from supply disruptions. On Monday, Germany announced the nationalization of SEFE, which is the central distributor for commercial and residential users, and former trading and supply unit of Gazprom PJSC. The government plans to inject €7.7 billion into the company, pending regulatory approval from the European Union. The DAX index gained 5.68% last week.
In China, officials announced a notable shift in COVID-Zero policy by reducing quarantine times and ending flight bans. The measures appear aimed at limiting the impact of COVID on the economy and reopening borders. In fact, in October, the manufacturing PMI print reflected the ongoing softness in the economy with another sub-fifty reading for the third consecutive month. Services PMI deteriorated from 49.30 a month earlier to 48.30. The news of easing restrictions reassured markets, with the Hang Seng China Enterprises index jumping over 8%. However, the full reopening of the economy will remain a slow process as major cities are still battling a surge in COVID-19 cases. Last week, Mainland China registered more than 10,000 daily cases, the highest level since April.
In Japan, Bank of Japan Governor Haruhiko Kuroda applauded the fact that the rapid weakening of the yen has halted and said that he does not expect a strong dollar to persist for an extended period of time. He reiterated that the BOJ should continue to support the economy and work closely with the government to contain the impact of inflation and foreign exchange rates. In October, Japan’s Manufacturing PMI ticked down to 50.70 from 50.80 a month earlier. Services PMI improved from 52.50 to 53.20 during the same period. Kishida’s cabinet approved $198 Billion extra budget to fund a stimulus package aimed at supporting corporations and households. The NIKKEI 225 index rose 3.91% last week.
In Mexico, the Central Bank raised interest rates by 75bps to 10%, matching the Fed’s tightening pace. In the October reading, headline CPI decelerated for the first time in five months to 8.4%. Manufacturing PMI remained flat at 50.30 during the same period. The current consensus among economists is that Banxico will consider slowing the pace of rate hikes to 50bps at the next meeting. The Mexican economy remains resilient despite the tightening, in fact, GDP accelerated 4.2% in the third quarter, up from 2.04% in the second quarter. The Mexican peso rallied last week as the dollar weakened. The Mexico 10-year yield dropped from 9.82% to 9.21% last week amid risk-on mood across asset classes. Mexican stocks gained 1.53% last week.
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