Weekly market guide
Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
Equities surged on November 10 in response to the October CPI report, which showed the lowest monthly growth rate of core CPI in a year – S&P 500 +5.5%, Nasdaq Composite +7.4%, and Russell 2000 +6.0%. Leading indicators have been suggesting that inflation should moderate, but the hard/actual CPI data has remained sticky for months. With October’s better-than-expected Core CPI reading of 0.3% m/m, the question may shift from “when will inflation start to come down?” toward “how quickly will inflation come down?” It is clearly a step in the right direction, but will also take follow-through in the coming months for the Fed and investors to get clear and convincing evidence that inflation is indeed on a better path. Overall, the report supports the Fed slowing its pace of hikes but remaining hawkish as inflation is still too high. Nonetheless, the potential “light at the end of the tunnel” is a welcome sign for markets.
Fed expectations remain an important influence on bond yields, which in turn are affecting equity market valuations. In the initial aftermath of the November 10 CPI report, market expectations for the peak Fed funds rate ticked lower to 4.84% from ~5%. Additionally, we note that in prior Fed tightening cycles, the 2-year and 10-year Treasury yields have reached (at least) that peak Fed funds rate. So, if Fed expectations (which remain very fluid) can continue to recede, it would ease the upward pressure on bond yields in our view – which would be supportive of equity market trends. Thursday’s drop in the U.S. 10-year Treasury yield and U.S. dollar are encouraging – and could be the beginning of a more stable trend for bond yields and the dollar – but we need to see follow-through next. One day does not make a trend.
Technically, Thursday’s strength (which was the largest S&P 500 price change since the Covid lows) may support additional upside for equities in the short-term. We believe that the S&P 500 may be set to challenge resistance at the 4000-4100 area, which would be consistent with the recent decline in high yield CDS spreads (a good indicator for short-term trends this year). Additionally, advancers vs. decliners reached an elevated 7.7x today – the type of “thrust” you like to see as market trends attempt to rebuild themselves from low levels.
In summary: There is a lot to like about Thursday’s CPI report finally showing the potential for a slowdown in inflation. This is supporting lower Fed expectations, lower bond yields, and higher equity valuations. We believe that this recipe for equity market upside will transpire over the next 12 months, however the Fed remains in tightening mode and more data will be needed over time to gain clarity that inflation is indeed moving to a more reasonable level. With this in mind, the worst may be behind us, but we continue to expect choppiness over the coming months.
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