Bears continue to control the equity market, with the S&P 500® Index unable to sustain a relief rally and sitting less than 1% above the low for the year. The S&P 500 has registered gains in just four of the previous 19 sessions, but each was greater than 2%. Markets are attempting another bounce on Monday in reaction to the UK scrapping tax cut and emergency bond plans. Bonds saw similar volatility, with the 10-year Treasury yield jumping to a high of 4.06% Thursday before easing modestly by Monday. The MOVE Index, which measures bond market volatility, hit its highest level since 2009.
Institutional investors remain extremely conservative, with Goldman Sachs data showing net equity positioning was at a five-year low ahead of the CPI report. This, along with fund manager cash being at the highest since 2001, drove the sharp recovery, and reflect the potential for upside to expectations. The Bank of America Bull & Bear Indicator remains at 0.0 for the fourth week. While institutional investors remain on the sidelines, retail investors remain in buy-the-dip mode, with positive fund flows in seven-consecutive weeks.
We are witnessing a historic divergence in retail and institutional investment behavior. In past bear markets, retail money lags institutional trends, and its capitulation to the reality of a weak market typically signals the beginning of a recovery. But retail investors appear to be adhering to a different philosophy this time as they continue to reliably buy the dip, amid ongoing skepticism. That’s unusual, but it illustrates just how much the retail investor mindset has changed in the wake of the pandemic and a viral focus on r/wallstreetbets.
Consumer prices rose 0.4% from August and 8.2% from a year ago, again beating economists’ forecasts, driven by pressure in the services sector. Core CPI (+6.6%) was at the fastest pace in 40 years and has now exceeded economists’ estimates in nine of the past 11 months. Despite healthy wage gains, real wages have fallen by 3% from a year ago and have been negative for 18 straight months. The rising inflation resulted in a cost-of-living adjustment for retirees receiving social security of 8.7%, the highest level since 1981. Following the hotter-than-expected read, the 5-year breakeven inflation rate (derived from TIPS) increased to 2.4%, the highest level in three weeks, but well below the 3.6% peak in March. Following the report, the Fed Futures curve embedded a 65% chance of 0.75% hikes at each of the next two meetings.
Earnings season began with a wave of bank releases, including Bank of America, JPMorgan, Citi, Morgan Stanley, Wells Fargo, and US Bancorp. As expected, upside was driven by net interest margins, while investment banking and mortgage lending revenue fell sharply, and provisions for loan losses increased. Only 7% of the S&P 500 companies have reported third-quarter results, with growth forecast to be roughly 2% versus the 11% expected in May. Estimates for 2023 remain resilient, with 8% growth expected, though earnings season will be critical to see management guidance. Headwinds come from slowing global growth and continued cost pressures, as well as the strong dollar, the 15% minimum tax, and the excise tax on share repurchases.
The International Monetary Fund warned of increased pressure on the global economy, cutting the forecast for next year to 2.9%, down from 2.9% expected in July and 3.8% in January, with a 25% chance that it falls below 2%. Roughly one-third of the global economy es expected to decline, while the U.S., E.U., and China each expected to decelerate. Excluding 2020, this would be the weakest global growth since 2009. Inflation is expected to peak this year at 8.8%, but only fall to 6.5% next year and 4.1% by 2024. The U.S. is predicted to grow by 1% next year, down from 1.6% this year.
What to Watch
Earnings releases will be the primary focus of investors this week. Economic data include industrial production on Tuesday, housing starts and the Fed’s Beige Book on Wednesday, and existing home sales and leading indicators on Thursday.
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