The six-month period after the U.S. midterm elections has historically been one of the best times for equity returns. But coming up to this year, there was concern if this would play out, given the number of additional factors affecting markets from war, to inflation, to aggressive central bankers. Well, so far so good, as November was broadly a positive month across risk assets.
As has been the case this cycle, everything starts with the bond market. Bond yields and currencies have been the factor that sets the tone for equity performance. With signs inflation is beginning to dissipate, there has begun to be real optimism that we may be approaching peak hawkishness from central banks. This was most apparent when looking at the U.S. 10-year bond, as yields fell throughout the month to finish at 3.6%.
The fall in bond yields has also helped to stabilize currency markets, and we may have seen a short-term peak in the USD vs most other currencies. A weaker dollar combined with speculation around the reopening of the Chinese economy, as they move on from their zero Covid policy, has kickstarted the commodity market. Commodity-producing companies are leading this bounce and enjoyed a strong month. This adds fuel to the idea that we are rotating from technology companies as the old market leaders towards the cyclicals.
At its core, markets hate uncertainty, and during the third quarter of this year, there was too much uncertainty for risk assets. But as these uncertainties began to fade away and became better understood, equities climbed higher.
Earnings have been announced roughly as expected. The U.S. midterm election resulted in a divided government where neither party can be happy. Most importantly, messaging from the central banks is becoming more balanced, and many are expecting to see the end of this tightening cycle in early next year.
The end result of November was an impressive bounce higher. The S&P 500 was higher by 5.4%, the Nasdaq by 4.4% and the TSX, which has been the leader, is now only off 3.5% on the year after gaining 5.3% on the month.
This bounce is even more impressive when you consider the financial world may have witnessed one of the largest frauds in history from FTX. The crypto market has been under stress throughout the year, and in a market lacking global regulation, we are seeing exchanges and funds collapse under extreme leverage. This has resulted in the destruction of hundreds of billions of dollars of value. So far, there has been no contagion to other asset classes, and we hope it stays that way.
The debate will now be around if the October low the bottom, or just a bottom. We know investor positioning had become extremely cautious, and with some good news, these gains may be more of a short squeeze as investors play catch-up. But all bull markets need to start somewhere, and the factors we need to start another cycle are starting to appear.
Still, it’s too soon to signal the all-clear—we aren’t fully out of the danger zone yet. We still need to see inflation continue to fall so central banks can ease off their aggressive policies and prepare to face the risk of a recession early next year.
Multiples have contracted through the year, but the real concern remains earnings. Analysts haven’t taken down numbers yet for many companies for 2023. Is this the correct call or will the new year start with a wave of earnings misses and downgrades? That will be the key concern for investors as we start 2023.
The bounce for November was a welcome change of tone and will allow investors a chance to better enjoy the holidays. But volatility will remain with us and being tactical and active across all asset classes will be needed to weather the coming months.
— Greg Taylor is the Chief Investment Officer at Purpose Investments
Sources: Charts are sourced to Bloomberg L.P.
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