Markets continue higher, though protests in China threaten to derail the recovery

Thoughts

• Markets are coming off their fourth gain in six weeks, with the S&P 500® Index touching the best level since early September, though Monday will be choppy following unrest in China. Long-term interest rates continue to fall sharply, with the 10-year Treasury yield below 3.7% for the first time in nearly two months, as investors bet that sluggish data will result in a Fed pivot. The odds of a slowing to a 0.50% Fed Funds rate hike in two weeks have stabilized at roughly 70%. Crude prices fell to the lowest level since 2021 as western countries prepare to impose a price cap on Russian crude.
• The technology sector continues to struggle, led by Apple and several chip companies that will be disrupted by the protests. For the year, the Russell 1000 Value Index is down just 6%, while the Russell 1000 Growth Index is down 25%, though the valuation for the value index remains at a substantial discount to growth (14x vs. 23x). Small caps are also doing well relative to large-cap growth, with the S&P Small Cap 600 Index down 12% with a forward valuation of 13x. More recently, international indexes have recovered, with the MSCI EAFE Index up 11% and the MSCI Emerging Market Index up 12% over the past month, compared with 3% for the S&P 500, though they both trade at substantial discounts.
• Despite declines in large-cap tech companies, the overall market is healthier than perceived. In this environment, investors would do well to turn away from big tech and toward small-cap, international, and value stocks, which have been largely forgotten over the last decade as large tech valuations have soared. This may very well be the story over the next 2-5 years, where the average company is in better shape from a risk/reward perspective than the overall market.

News

• The holiday shopping season is off to a strong start, with Black Friday showing strong in-store trends, rising 2.9% from a year ago. Online shopping set a record on Black Friday, up 2.3% from a year ago. Analysts are split on the outlook for the holiday season, as consumer demand remains strong, but real wages have been negative for 20-straight months, straining budgets and leading to greater credit card borrowing. Retailers are heavily discounting due to elevated inventories, with the average customer discount expected to be 30%. The National Retail Federation expects sales this season to increase by 6-8% from a year ago, which would be roughly in line with the pace of inflation.
• The weekend saw large protests in China due to continued Covid lockdowns, leading officials to ease some restrictions in remote areas while affirming the zero Covid policy. China’s benchmark index fell 1.1% on Monday, the largest drop in a month, while the yuan fell sharply. Goldman Sachs estimates there is a 30% probability that China will reopen before next Spring, effectively ending the zero Covid policy. They also see the likelihood of increased support for the suffering property market and focus on driving growth following last Friday’s interest rate cut.
• A survey by Merrill Lynch of retail and professional investors showed that stagflation is a key risk for the global economy next year, with little confidence in the sustainability of the recent market rally. Half of the respondents see slowing growth and continued elevated inflation, with the second most likely outcome as a deflationary recession, and economic recovery as the least likely outcome. Nearly two-thirds see investors as too bullish on asset prices. Retail investors were modestly more optimistic than professionals, though their responses were directionally similar.

What to Watch

• A busy week of data awaits, focused heavily on the labor market’s health. On Tuesday, we get November’s reading on consumer confidence, Wednesday has revised third-quarter GDP, JOLTS job openings, and the Fed’s Beige Book, Thursday has the PCE deflator, personal income and spending, and ISM data, and Friday has the monthly payroll report.