Global equity markets continued to build on the gains made over the past couple of weeks. Inflation surprises to the downside confirmed that what might be bad news for retailer revenues could be good news for interest rates. Indeed, inflation continues to fall, and Consumer Price Index numbers are now at their lowest levels for two years. Comparable data in the US, together with a cooling in its labour market, suggests that the Federal Reserve Bank may be able to consider starting to cut interest rates – possibly in the second half of next year.
It would be foolhardy to declare victory over inflation – remember, it did pick up slightly over the summer. But October’s figures do indeed suggest that the worst is over. In the UK, the annual rate of inflation fell sharply to 4.6% – that’s the steepest single-month decline in the consumer price index since 1992. A significant fall in oil and gas prices should push it down further over the coming months. That said, core CPI (which excludes food and energy and is a better indicator of the underlying trend) remains well above the central banks’ overall targets – even if it is at its lowest for two years.
The key takeaway is that inflation is slowing faster than perhaps the central banks were expecting. Policymakers may even consider lowering their inflation projections at their forthcoming official meetings. But each region has a slightly different view as far as the next steps are concerned.
The likelihood is that “higher for longer” will be the phrase used by most central banks. But this will be offset by a slightly more dovish tone in their statements, with a possible pivot in 2024.
Following a long period of above-average growth in the US, a combination of consumer and employment data released this month suggests that we may be seeing some weakness in household spending: the rise in the cost of living is starting to bite, albeit gradually.
Easing inflation and a cooling labour market are the primary factors driving the rally in the equity and bond markets this month. Yields at the sensitive end of the bond markets have declined on hopes that central banks will consider cutting rates in 2024. We believe that last month’s surge in rates will prove to be the peak in this particular cycle – incoming data supports an extended pause in central bank rate hikes.
The market is currently being led by a limited number of stocks, chief amongst them being the “Magnificent Seven” (Alphabet, Amazon, Apple, Microsoft, Meta, Nvidia and Tesla). If rates have indeed peaked, then this market leadership might broaden out over the coming months. Indeed, the S&P 500 Index is now down by only 6% relative to its all-time high of early 2022. The cap Russell 2000 Index, on the other hand, which is a proxy for US small caps, is still down 27% from its peak, leaving plenty of potential for further upside.
In the UK, growth in wages eased slightly in the third quarter as the rate of hiring slowed. Consumer spending has also slowed in recent months – a development which might alarm retailers as we move closer to Christmas and the period of the year when their expectations are traditionally high.
In the markets, the FTSE 100 Index rallied by around 1.7%. The FTSE 250 Index, meanwhile, gained 4.1% as investors began to consider the benefits for mid- and small-cap stocks going forward (always assuming, of course, that rates and inflation have peaked).
On the world stage, US and Chinese presidents Biden and Jinping met in California for a summit meeting. Progress was made in limiting narcotics trafficking, restoring military lines of communication and discussing the possible global risks of artificial intelligence. But no agreement was reached regarding the fate of Taiwan – “the biggest, most potentially dangerous issue in US-China relations”, according to Jinping.
There can be no doubt that the Israel-Hamas conflict, Russia’s invasion of Ukraine and Taiwan’s uncertain future all constitute dangers and uncertainties. However, the economic and monetary backdrop seems to be changing. The economy is slowly cooling, inflation is still on its way down and Fed rate hikes look to be over. Corporate profits have been satisfactory, and companies are talking less about inflation and impending recession.
Both bond and equity markets have begun to embrace these changes, and indices such as the S&P 500 Index have already risen by just shy of 20% year-to-date. 10-year US Treasury yields, meanwhile, have dropped by nearly 60 basis points from their intraday highs less than a month ago. And US core bonds have now totally erased their 2023 losses.
Even though there has been a significant rally in specific markets since October 2022, investing at these higher levels is no bad thing. Historically, even after rallies such as these, forward-looking returns for both the short- and long-term investors have still been impressive. November is on track to be the best month of the year so far, and we are now gearing up for the final few weeks of the year which are likely to deliver further gains.
Simply sitting on the sidelines as the markets rally higher can have consequences: getting back into them at even higher valuations will become increasingly difficult. Now is a particularly good time to invest in both equities and bonds. But investing in quality businesses that can adapt to this ever-changing world remains crucially important.
