Equity markets remain in rally mode, with the S&P 500® Index gaining in five of the past seven weeks and breaking through the 200-day moving average for the first time since April. The index has gained 14% since early October despite a deteriorating macro picture. The S&P 500 finished November with a 5.5% return, starting the seasonally strong fourth quarter with two straight 5% monthly gains. Historically, winning streaks of 5% are rare, happening just five times since 1999 and 13 times since World War II. It has served as a strong positive omen, with the next 12-month performance of the S&P 500 positive in each of the 13 occasions, by an average of 22%.
Stocks and bonds remain positively correlated, with bonds experiencing an impressive rally as the Bloomberg US Aggregate Bond Index has gained in seven of the past nine weeks. The yield on the 10-year Treasury has dropped 0.75% to 3.50% on hopes for a Fed pivot following a speech by Chair Powell that said, “it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down.” The Fed Futures curve reflects a terminal rate of below 5% as of May, with two cuts expected by the end of 2023, which is more dovish than the tone of most Fed officials. The dollar has also substantially retreated from the 20-year high, falling to the lowest level since June.
With U.S. and global markets seeing signs of strength, interest rates moderating, and the dollar coming off its high, the pendulum has swung from being universally pessimistic to more neutral. When looking back historically, there’s a high likelihood that the pendulum will continue to swing into optimistic territory.
The Fed’s preferred measure of inflation, the core PCE deflator, reinforced the belief that inflation has likely peaked, but will remain stubbornly elevated for a while. The core PCE price index rose by 0.2% from October and 5.0% from a year ago, down from the peak of 5.4% in February. Including the volatile food and energy categories, headline PCE was up 0.3% for the month and 6.0% from a year ago. Another Commerce Department report showed personal spending rose 7.9% from a year ago, better than expected and better than the pace of inflation as measured by PCE. Personal income rose 4.9%, resulting in slightly negative real wage growth. Overall, economic data continue to surprise to the upside despite dire recession predictions, with the Citi Economic Surprise Index solidly positive and the NY Fed’s Weekly Economic Index reflecting the pace of real GDP growth of roughly 1.5%. Economists have a gloomy outlook for growth, with a Philly Fed survey showing a near-50% chance of a recession, the highest level in the near 60-year history of the survey.
Nonfarm payrolls continue to reflect a healthy labor market, adding 263,000 jobs in November, well above the 200,000 consensus estimate and near the strong 284,000 pace in October. Growth was seen in leisure/hospitality, health care, and government, offset by declines in retail and transportation. The unemployment rate remained steady at 3.7%, while wage growth was elevated at 5.1%, though still materially below the pace of inflation. This strong report was echoed by a JOLTS job openings report on Wednesday that showed 10.3 million job openings remain, well above the 6.3 million unemployed people. The market reacted negatively to the report, as it was seen as providing the Fed cover to remain aggressive in its tightening.
Earnings estimates continue to ease, as analysts begin to face the reality of the headwinds for growth. The estimate for the fourth quarter has dropped nearly 6% since the beginning of the quarter, the largest decline at this point of a quarter in two years. Drivers of the decline include a weakening macro picture, continued inflation pressure, difficulty in maintaining pricing pressure, and the headwind from the strong dollar. Additional pressure next year will come from the global minimum tax. Current consensus estimates point towards a decline in earnings of 2% in the fourth quarter from a year ago and growth of 5% for 2023, with the 2023 estimate little changes since October.
What to Watch
This week will be the calm before the storm that includes a report on CPI and an FOMC meeting in the following week. Data this week include PMI data on Monday, consumer credit on Wednesday, and producer price inflation and consumer sentiment on Friday.
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