- U.S. equities were modestly up by the end of the shortened holiday week. The highest performing index, the Dow, was up 1.80%, the S&P at 1.56% and the NASDAQ 0.73%.
- The flash U.S. Composite PMI Output Index dropped to its lowest levels in 2.5 years at 46.3 for November, down from 48.2 last month, <50 indicates a contraction.
- Declining CPI reports continue to be seen as a source of optimism, and expectations for a more dovish Fed are high with market expectations for a 50 Bps hike at 81% according to FactSet.
- 4 of the 12 railroad labor unions have failed to ratify President Biden’s proposed labor deal with a strike to possibly begin Dec 9th and significantly hampering US domestic shipping.
- Online Black Friday sales came in at $9.12 Billion, with various other holiday sales metrics up around 2-3%, ahead of 2021 and modestly above expectations.
- In China, the government is struggling to contain thousands of protesters scattered around the country pushing back against COVID
- Zero policy and Xi Jinping’s leadership. The Hang Seng index dropped 2.33% last week, with industrials down 5.75%.
- In Japan, the finance ministry disclosed that government spent $42.3 billion in October to prop up its domestic currency. The Nikkei 225 index rose 1.37% last week.
- In Brazil, Jair Bolsonaro’s Liberal Party is questioning presidential election results as Lula da Silva won by a narrow margin.
Although the market was lower to start the week, U.S. equities were modestly up by the end of the shortened holiday week. The highest performing index, the Dow, was up 1.80% and the S&P 500 finished 1.56% higher. The NASDAQ came in the lowest at 0.73%, dragged down by relative underperformance among Growth names. The Treasury yield curve modestly flattened with the 10-year remaining deeply inverted relative to the 2-year yield. The Dollar index weakened to 105.95, a level not seen since early August.
Market headlines for the holiday week were limited, but included Chinese covid lockdown protests, lighter than expected CPI reports seen as a source of optimism, and expectations for a more dovish Fed, if not a full pivot. All sectors traded modestly higher with utilities and materials leading the pack, and energy the worst performer on lower energy prices. The WTI crude index closed the week at $76.28, its lowest level since 2021 amidst the news that Chevron received a permit to produce and export oil in historically embargoed Venezuela, therefore potentially increasing supply.
U.S. business activity continues to slow, with the flash U.S. Composite PMI Output Index reporting at 46.3, its lowest level in 2.5 years. Any reading below 50.0 is considered contractionary. Similarly, the New Orders Index dropped to 46.4, its lowest reading since 2009 outside of the initial covid-19 pandemic shutdowns. The slumping business activity can be seen as a direct result of the aggressive interest rate hiking cycle undertaken by the Fed to curb inflation.
RAILROAD STRIKE YET TO BE RESOLVED
Negotiations with labor representatives from 4 of the 12 unions that failed to ratify President Biden’s proposed labor deal have yet to find a suitable resolution as the deadline draws closer. The potential railroad worker strike could cripple domestic rail transport, starting Friday December 9th, and the effects of this possibility have already begun to appear. Tech cargo from ports on the west coast are now being sent in trucks rather than rail, and hazardous cargo such as chlorine and other chemicals will cease shipping by rail 96 hours before a potential strike to prevent dangerous concentrations in congested rail yards.
Furthermore, many shippers have chosen alternatives to the Atlantic Coast in anticipation of the outcome of labor talks. In fact, the Ports of New York and New Jersey have dethroned the Port of Los Angeles as the busiest trade gateway in the country.
Goetz Alebrand, head of ocean freight for DHL America said that truck capacity is now better suited to absorb excess demand in case of a strike like the one that occurred in September but cannot come close to replacing all rail freight. Logistics analytics companies have warned that Texas rail yards in Dallas, El Paso, and Fort Worth are especially vulnerable and would be national congestion spots of a strike due their labor makeup. The pressure on freight prices could potentially send goods inflation higher and further delay any Fed pivot or slowdown of future rate hikes.
FED MINUTES RELEASE THIS WEDNESDAY WERE POSITIVE FOR MARKETS
At the last scheduled meeting on November 2nd, the Fed raised interest rates by 75bps, in-line with previous hikes. However, Fed Chair Jerome Powell suggested at a press conference after that decision that slowing the pace of hiking could be on the table if economic data supports it. Fed minutes released showed that several policymakers agreed with Powell’s assessment as the press release stated that, “A substantial majority of participants judged that a slowing in the pace of increase would likely soon be appropriate”.
This last sentence was arguably the catalyst for the uptick in equity prices as language was much more dovish than the Fed had been in previous releases. The current implied probability from FactSet sees an 81% chance of a 50bp hike in December, which is not significantly different from where expectations have hovered for most of the month. The two-year yield rallied on the news to close the week at 4.45%. The Fed fund rate currently stands at 3.83%, which is the highest level it has been in 15 years.
BLACK FRIDAY AS A RETAIL INDICATOR
This year’s Black Friday saw pessimism abound with many retailers providing cautious guidance going into the holiday season. The actual results, however, make this Black Friday, nominally, on track to be the largest of all time. In fact, online sales came in at $9.12 billion, with various other sales metrics up around 2-3% ahead of 2021 and modestly above expectations. Based on these early numbers, the National Retail Federation is predicting holiday sales growth of 6% to 8%. As a result of high inflation, there may be less actual earnings growth among firms who will see their holiday profit squeezed by higher input prices. Nevertheless, these stronger than expected numbers show that consumer demand may be stronger than expected throughout the holidays, and into 2023.
The Bloomberg World index closed the week up 1.42%, with growth up 1.32% and value up 2.02%. Cyclicals appeared to be in favor this week on the report that labor market remains tight in developed nations with the OECD average unemployment rate hovering around 4%. The decline in oil prices was also perceived as a tailwind, with Brent futures dropping to $83.63 per barrel, the lowest level since January. Commodities followed the same pattern amid reports of protests in China against COVID Zero policy. In Germany, a closely watched yield curve inverted as uncertainty regarding energy supply rises.
European Central Bank (ECB) President Christine Lagarde committed to raise interest rates to bring inflation down even if the economy weakens. She added that the ECB will continue to monitor wages and inflation expectations as well as the economic activity. While a few ECB officials were in favor of half-point hike in October, the consensus remains that it may be too soon to slow rate hikes as consumer prices advanced at an annual rate of 10.6% in October. The latest ECB projections imply elevated inflation in 2023 as the war in the Ukraine remains a headwind. Governing Council member Klaas Knot warned EU members that “large-scale and generic fiscal policy can lead to higher inflation, higher interest rates and higher public debt.” The Euro STOXX index gained 1.17% last week.
In Germany, the yield spread between the 2-year and the 10-year inverted by the most since 1992. The yield curve inversion can be interpreted as investors demanding more compensation for short-term risk due to imminent events that could weaken financial conditions. The OECD sees a potential 0.3% contraction of the German economy in 2023 due to the energy crisis. Furthermore, the Germany composite PMI has been below 50.0 since July despite stimulus initiatives from the government to shield households from rising prices and interest rates. The Governing Council of the ECB will meet mid-December to update monetary policy and agree on Quantitative Tightening principles. The DAX index gained 0.76% last week.
In China, the government is struggling to contain thousands of protesters scattered around the country pushing back against COVID Zero policy and Xi Jinping’s leadership. The tipping point was reportedly a tragic apartment building fire that protesters believe could have been avoided without lockdowns and pandemic controls that obstructed building access to emergency crews. A blank piece of paper was adopted by protesters as a symbol against censorship. On Monday, Bloomberg reported that protests also spread to Hong Kong for the first time since the national security law was adopted. Yuan’s November rebound versus the dollar has faltered as this new development adds near-term uncertainty. The Hang Seng index dropped 2.33% last week, with industrials down 5.75%.
In Japan, the economy unexpectedly shrank 1.2% in the third quarter amid weakening yen and slowing economy. The finance ministry disclosed that Japan spent $42.3 billion in October to prop up its domestic currency. Although the finance minister claims its capacity for currency intervention is “unlimited”, the sustainability of this operation is questionable. Rating agency Fitch recently graded Japan’s sovereign debt ‘A’ with a stable outlook. Embedded assumptions in the rating include growth recovery, narrowing deficits and shrinking public debt. Further deterioration in public finances could engender a downgrade. Earlier this month, the government approved a $198 billion stimulus package to partially offset rising prices. The Nikkei 225 index rose 1.37% last week.
In Brazil, Jair Bolsonaro’s Liberal Party is questioning presidential election results as Lula da Silva won by a narrow margin. The Liberal Party claims that the machines used for electronic ballots had problems and that all votes made through them should be nullified. The electoral court says the machines were used in both rounds and no issues have been identified. President-elect Lula is proposing that his $32.6 billion social spending plan be removed from the spending cap. As a result, Brazil analysts lifted their inflation and interest rates target to reflect additional spending and currency pressure. According to their new forecast, the benchmark Selic rate should decline to 11.5% by December 2023, versus 11.25% previously. Brazilian stocks gained 0.10% last week.
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