The Markets
U.S. indexes ended the month flat, but equity markets had an impressive run, with the S&P 500 Index ending the month up nearly 9% and the Nasdaq Composite up nearly 11%. It was the best month for both since July 2022, snapping a three-month losing streak.
Investors have been processing a more favorable inflation trajectory, coupled with some easing in the labor market, which has contributed to downward pressure on interest rates. This overall environment has set a positive tone for risk assets, with many investors recognizing the Federal Reserve’s success in managing inflation without triggering a severe recession, a concern that was a large part of the 2023 narrative.
November’s narrative can be characterized as one of realization, recognition, and capitulation, particularly with respect to the direction of interest rates and the outlook for the future. The month began with the 10-year Treasury yield at 4.90%, but it is now poised to close nearly 60 basis points lower, providing a favorable boost to equity valuations.
Looking through the looking glass, uncertainties remain amid geopolitical risks such as Russia/Ukraine tensions, Middle East dynamics, the upcoming U.S. presidential election, and the lagged effects of prolonged higher interest rates. Potentially more significant than the current “known” risks, however, are the tail risks that markets have grappled with throughout this extended post-pandemic period, particularly inflation, which is beginning to recede.
Critical U.S. personal spending and inflation data released on Thursday were largely in line with expectations, reinforcing the narrative defining a “November to Remember” for bonds.
Core PCE (Personal Consumption Expenditures) prices rose 0.2% m/m in October, in line with estimates. The unrounded number was 0.16345%. On a year-over-year basis, the measure rose 3.5%, in line with consensus forecasts. October’s results represent the slowest pace of annual core price growth since April 2021, when U.S. inflation accelerated significantly.
This update is consistent with the broader narrative of a notable shift in Federal Reserve rhetoric during the week, particularly regarding the potential for “insurance cuts” in 2024.
Chris Waller played a pivotal role in changing perceptions and inadvertently initiated a game change. Bonds had one of their best months since 2008, with the Bloomberg Aggregate poised for its biggest monthly gain since the Reagan era.
Despite these shifts, Thursday’s data showed that spending remained relatively resilient last month, with real spending rising 0.2%, beating expectations for a marginal increase.The combination of resilient spending and cooler inflation is a Goldilocks recipe.
With the need for the Federal Reserve to raise interest rates in response to inflation concerns diminishing, the prevailing sentiment is that the central bank‘s next move will likely be to cut rates. Over the course of November, markets have gradually priced in a higher probability of substantial Fed rate cuts next year.
Slowing inflation, Fed cuts and stronger-than-expected growth could provide a constructive backdrop for equities. However, falling costs point to a reversal of profit-driven inflation, suggesting that corporate margins may have peaked and that equity P/E multiples are a bit stretched.So perhaps earnings, not lower interest rates, will have to do the heavy lifting for equities going forward, as there are plenty of Fed cuts in the pipeline.Oil MarketOil prices fell as OPEC failed to deliver on production cuts.While Saudi Arabia, Russia and some OPEC+ members agreed to voluntary production cuts of 2.2 million barrels per day (bpd) for the first quarter of 2024, the reduction fell short of market expectations.Saudi Arabia maintained a 1 million bpd production cut that had been in place since July, and Russia increased its pledged cut from 300,000 bpd to 500,000 bpd.
Only eight of the 24 OPEC+ countries voluntarily agreed to reduce supply in the first quarter. The decision followed a ministerial meeting that was postponed until November 26 due to opposition to additional cuts from OPEC countries in Africa.The dissension within the African ranks of OPEC is bearish, and whether or not Russia will stick to the plan is anyone’s guess. So for the oil markets to turn bullish, visible inventory data needs to fall to confirm that OPEC cuts are sufficient to reduce the current supply overhang.
