Markets pause as investors contemplate positioning into year-end

Thoughts

• Equity markets have stalled following a four-week rally that saw an 11% gain, as investors are increasingly concerned about global growth and Covid cases in China. For the third time since April, the S&P 500® Index approached the 200-day moving average but has yet to break through, which many technicians are watching closely in determining the likely path forward for equities. Volatility remains elevated, with the S&P 500 experiencing 3% directional moves in nine of the previous 13 weeks. Since World War II, only the mid-70s, the financial crisis, and the pandemic saw similar runs.
• Retail investors continue to aggressively allocate to equities, with $23 billion of inflows into equity funds and ETFs in the latest week, the fastest pace since March, per EPFR data. Year-to-date, equities have attracted a net $200 billion, on top of the $400 billion from 2021. Contrarians point to this lack of capitulation as a negative for markets, though the Bank of America Global Fund Manager Survey shows institutional investors at near-record levels of cash, which shows the divide between retail and institutional positioning. Fund manager cash of 6.2% is down from a 21-year high of 6.3% in October, but well above the long-term average of 4.9%. The report reflected continued pessimism, with 73% of respondents expecting a weakening economy and 77% expecting earnings deterioration, 92% expecting “stagflation, and 0% seeing a “goldilocks” environment. Technology allocations are at the most underweight since 2006. More than half of respondents expect lower interest rates in 12 months to a record high and more than half see a steepening yield curve.
• To many, it may look like the market has stalled. However, this is actually a sustainable situation where market returns appear modest but are instead growing into their valuation. Because the average company is doing much better than the indexes themselves due to the flux in mega-cap technology, equities investors need to be more creative in their investments for now.

News

• Federal Reserve officials are sending mixed signals about the degree of tightening that remains necessary. Atlanta President Bostic advocated shifting away from the 0.75% pace in December, with a terminal rate peaking at 5% followed by a prolonged pause. Others are pushing a “higher for longer” theme, with St. Louis President Bullard saying rates should rise between 5% and 7%, while Fed Governor Waller said the Fed still has a way to go to get inflation back to the target (echoed by Boston President Collins) and that the market overreacted to the CPI report, as it is just one data point. The Fed Futures curve implies a 75% chance of a 0.50% hike in December, down from 80% last week, but up from 50% a month ago.
• This week has seen mixed signals on the health of the consumer, with an encouraging report on retail sales on Wednesday showing growth of 8.3% from a year ago, which was the fastest pace since February and well above the pace of inflation. Gasoline was a substantial driver of the increase, as were autos, home furnishing, and building supplies. A Federal Reserve report showed household debt soared at the fastest pace in 15 years as credit cards jumped 15%, driven by robust consumer demand and higher prices. Target noted in its earnings release that consumers are running out of borrowing capacity and are seeing an increase in theft and organized crime. The leading economic indicator index was negative for the third-straight month, a historical flag for a looming recession.
• The health of the labor market is in focus with an increasing number of companies announcing intentions to reduce their workforce. Target announced an aggressive cost-cutting program to reduce $2-3 billion in costs over three years after reporting disappointing results. This follows the announcement by Amazon to lay off 10,000 employees, Meta to cut 11,000, Twitter to cut 50% of its headcount, and Intel and Snap to trim 20%. The technology sector has announced more than 120,000 job cuts, already exceeding the level from the technology bubble in 2000, though job openings in the space remain above pre-pandemic levels.

What to Watch

• The market has few catalysts in the holiday-shortened week, with data including durable goods, PMI data, consumer sentiment, and new home sales all on Wednesday. The minutes from the recent FOMC meeting will also be released on Wednesday. Volatility tends to be elevated around Thanksgiving, as volume is low and investors tend to react to Black Friday news.