By Jan Faure
Global equity markets rallied in October with major gains in US and European stock markets. The exception was Chinese and Hong Kong equity markets that declined on fresh growth concerns following Xi Jinping securing a third term as head of the Chinese Communist Party. US equities were supported by third-quarter company earnings that broadly beat market expectations. The S&P 500 index gained 8% in October while the tech-heavy Nasdaq Composite index added 3.9%.
Much like July’s narrative, markets again embraced the idea of a Fed pivot in monetary policy. This followed a less hawkish tone from the European Central Bank (ECB) and the central banks of Canada and Australia, both of which raised rates less than expected at their respective October policy meetings. The US Federal Reserve is expected to hike interest rates by another 75 basis points (bps) at its November meeting. It would be the fourth in a row of that magnitude and would take the Fed Funds Rate to a new range of 3.75 - 4.00% (highest since 2008).
Focus has shifted to the prospect of a less hawkish policy tilt at December’s FOMC meeting. There are hopes that chairman Jerome Powell will signal a softening in the Fed’s aggressive approach to taming inflation, with the market pricing in a shallower 50bps hike at the December meeting. The expectation is peak interest rates (terminal rate) of somewhere between 4.5% and 5%, with rates to remain there until inflation shows clear signs of moving back towards the Fed’s 2% target.
Markets have cheered any indication that inflation could be moderating. Pending home sales in the US declined 10.2% month on month in September, indicating weakening activity in the housing market as higher interest rates hurt affordability. The 30-year fixed mortgage rate has risen above 7% (to 7.16%) for the first time in twenty years and is predictably having a negative impact on residential investment.
The ECB raised interest rates by 75 basis points in October, the 2nd consecutive 75 bps rate hike by the ECB. The ECB noted risks to growth from policy tightening and was less hawkish in its forward guidance. Europe’s soaring inflation is being largely driven by record high gas and electricity prices, the result of supply constraints stemming from Russian sanctions. Interest rates can’t solve structural problems, so they have a very limited impact on a supply driven inflation. Inflation in the eurozone hit a record 10.7% year-on-year in October (preliminary data), well above the forecast of 10.2%.
Liz Truss resigned as prime minister after only 44 days in office amid a backlash over her ill-fated economic plan that shook investor confidence and hammered the British pound. The pound did recover somewhat after Rishi Sunak became prime minister, giving hope for some stability after a month of major upheaval. Headline inflation in the UK hit 10.1% year-on-year in September, a 40-year high, driven by rising food and energy prices. The Bank of England meets in November and is expected to fall in line with the US and raise interest rates by 75bps.
Economists broadly expect inflation to peak in the next couple of months and then begin to ease into 2023, as supply chain bottlenecks improve further, and consumer demand weakens. The biggest uncertainty and threat to inflation is energy prices that have structural and geopolitical challenges.
Chinese and Hong Kong equity markets sold off sharply (down 7.8% and 14.7% respectively) in October as Xi Jinping secured a third term as party leader. There are potentially more terms to come after packing party leadership positions with allies, thereby centralising power even further. This raised fears among investors that Chinese authorities would continue with zero-Covid lockdowns and other policies that have hurt the Chinese economy in recent times.
Chinese GDP growth has been on a downward trend since Covid-19 took hold in Q1 2020, declining from 6% annualised growth to 3.9% in Q3 this year. The party congress revealed Xi Jinping’s priorities being predominantly national security, economic independence, and equality (common prosperity). Economic growth appears to have taken a backseat and this negatively impacted Chinese securities.
The NASDAQ Composite index underperformed the S&P 500 as major technology companies reported underwhelming financial results. Some of the key themes included softening consumer demand, weaker online ad sales and foreign currency headwinds. Alphabet (Google), Meta (Facebook), Netflix, Microsoft and Amazon all recorded a slowdown in revenue growth as the tech giants felt the effects of inflation on consumer demand.
At end October, approximately two-thirds of S&P 500 companies had reported financial results for Q3 and 70% of those had reported positive revenue and earnings surprises (FactSet Research). Total earnings growth (so far) was 2.2% for the third quarter with the energy making the largest positive contribution. If the energy sector were excluded, the S&P 500 would have reported a year-on-year earnings decline of 5.1% in Q3.
Investors have had to contend with major volatility throughout the year. Risks to the economic outlook remain with sticky inflation and the war in Ukraine having major ramifications on international relations, business prospects and consumer confidence. There are signs that investor sentiment is improving as inflation approaches peak levels. We do not believe it is in investors’ best interests to be overweight cash at this late point in the cycle, but rather to be encouraged by the opportunities available to astute investors.
Table 1: Global Indicators – Local reporting currencies