Its Halloween before Christmas!
The conditions were just right for a bounce back in equity markets during the month of October. Factors such as a) fourth quarter typically being strong for the markets, b) extreme market pessimism with oversold conditions, c) rising expectations of a pivot by Central Banks on the pace of rate hikes, and d) better-than-expected third-quarter results from companies in general. These factors, together, worked in favor of equity investors as the S&P 500 Index and the S&P TSX Index advanced by ~+5.0% and ~+4.8% for the month, respectively. Fixed income markets, however, did not share the same enthusiasm as bond yields advanced across the tenures with the short-end increasing faster than the long-end, pushing the yield curves deeper into inverted territory on both sides of the border.
While the overarching fundamental story of the economy is still strong enough to continue to feed inflation and therefore a requirement of higher interest rates remained unchanged, the short-term technical factors were supportive of a bounce back in the markets. Historically, the fourth calendar quarter of the year has been typically the strongest (See Figure 1).
Figure 1: S&P 500 Index, % price change
March 2001 - September 2022
Favourable seasonality coinciding with washed-out investor sentiment provided the right backdrop for a market rally. The AAII’s (American Association of Individual Investors) US Investor Sentiment Bearish Readings index reflects bearish sentiment of individual investors and is considered a good contrarian indicator, i.e., extreme reflected pessimism generally indicates reversal in the markets. The index was near its historic highs at the start of the month (See Figure 2).
Figure 2: AAII US Investor Sentiment Bearish Readings
October 2005 - November 2022
During September (reported in October), the unemployment rate in Canada dropped from 5.40% to 5.20% and the unemployment rate in the US dropped to 3.5% from 3.7%. Inflation numbers at +6.9% in Canada and +8.2% in the US, were also ahead of expectations of +6.7% and +8.1%, respectively. Notwithstanding the still strong economic data indicating that conditions remain in place for inflation to stay high, investors’ optimism increased after the narrative gained momentum that Central Banks might be getting cautious of rising risks to financial stability. Early in the month, the Reserve Bank of Australia surprised investors by increasing policy rates by only 25 basis points as against the market expectations of 50 basis points. This coincided with the Bank of England’s intervention to support UK’s government bonds markets. The narrative received further boost after the Bank of Canada increased policy rates by only 50 basis points as against the market expectations of 75 basis points, citing it is trying to balance the risks of over-tightening and under-tightening.
Given that markets have been fixated on policy rates trajectory year-to-date, the prospects of Central Banks nearing a pivot was supported by equity markets during the month. The FOMC (Federal Open Markets Committee) rate decision on November 2nd, however, reminded investors that it is usually Halloween that comes before Christmas. While the pivot did come as the US Fed chair, Jerome Powell, mentioned “it could be appropriate to slow the pace of increases as soon as the next meeting or the one after that”, investors were spooked as he also stated that peak policy rates might be higher than currently expected, i.e., hikes might continue to for longer even as the pace of hike slows. The markets gave up some of the gains of recent weeks on prospects of higher terminal policy rates than previously expected. In a nutshell, the fight against inflation is still on and it is not yet an all-clear that market volatility will abate soon.
