This article has been written by an expert contributor, Kerry Craig, Global Market Strategist, J.P. Morgan Asset Management.
Pivot!
October saw a return to risk as equity markets gained and bond yields fell. The slowdown in the pace of rate hikes by the Reserve Bank of Australia (RBA) and Bank of Canada and messaging from others, was interpreted as a signal we are passing the peak in monetary policy hawkishness. While this may be the case, we have not passed the peak in policy rates. The MSCI World Index rose by 7.2% in October, while the Global Aggregate Bond Index fell by 0.7%.
The ‘good’ news on the rates outlook came late in the month as investors looked towards the November central bank meetings. Earlier in the month, the outsized rate hike by the likes of the European Central Bank and persistent inflation pressures in the U.S. (headline CPI rose by 8.2% y/y and core inflation by 6.6% y/y) helped drive bond yields to new cycle peaks. The U.S. 10-year bond yield rose to 4.23% and the German 10-year bond yield reached 2.44%.
The tighter financial conditions in the U.S. are starting to bite as the more rates sensitive parts of the economy, such as the housing market, start to slow. The flash PMI data disappointed and the manufacturing survey fell to 49.9, its lowest level since early in the pandemic.
Politics featured heavily in October with the transition of power in the UK, the China National People’s Congress and an escalation of the war in Ukraine.
Rishi Sunak became the new Prime Minister of the UK which brought stability to the UK bond and currency markets. There was a sharp reversal in policy as proposed tax cuts were unwound and a more restrained budget is expected to be delivered in November. UK government bonds rallied by 3% over the month, and the British pound gained a similar amount against the U.S. dollar. Market expectations for the peak in the Bank of England policy rate moderated significantly.
As expected, President Xi was reappointed at the 20th National Party Congress for his third term. The new Politburo and changes to some leadership positions created some volatility in in Chinese equity markets. The release of GDP figures showed that the economy grew by 3.9% in the third quarter, but the outlook remains weak as COVID-zero policies are yet to be relaxed and business surveys remain weak.
The economic and earnings news received in October was not good, but markets have rallied on the assumption that much of the bad news is in the price. While it’s true that equities historically bottom before the economy, the still challenging economic outlook and uncertain path for inflation and rates suggest investors should maintain a degree of caution towards risk assets.
Economy:
- Headline inflation in Australia was stronger at 7.3% year-over-year (y/y) and the core rate rose by 5.6%. Electricity prices were materially higher. While the figure was higher than anticipated, the data is not far from the RBA’s projections and did not materially change the outlook for policy rates into 2023 (GTM AUS page 7).
- Business survey results were mixed as the confidence levels fell but views on the current conditions picked up. This suggests the companies are relatively comfortable with the tightening of policy that has been delivered by the RBA and ability to pass on rising costs.
- Housing data continues to show moderation as loan commitments fell 3.4% month-over-month (m/m) in August and are 13% lower than June. This data should continue to decline given the impact of higher rates and the feed through as fixed rate mortgages reset. However, building approvals jumped by 28% m/m. This series has been volatile given the disruptions to the approval process and the need to clear backlogs of applications rather than reflecting surging demand.
- House prices declined again in October, falling by 1.1% across the eight capital cities. Adding to the prior declines, this means that prices are now down 6.5% since the peak in April (GTM AUS page 10/11).
- The September labour market report held few surprises as the unemployment rate was steady at 3.5% and job gains were pretty flat on the prior month (9000). The number of COVID-related absences declined sharply and was ‘only’ 14% above seasonal norms. Other indicators on the labour market, such as job vacancies and weekly payrolls data, suggest that further falls in the unemployment rate from here would be hard to come by and that the rate should start to rise (GTM AUS page 8).
Equities:
- The 7.2% rally in the MSCI World for October means that it was the second-largest monthly return for the year, and only the third positive monthly return for the year. The 8.1% gain in the S&P 500 and the 6.1% rise in the European equity market help to deliver developed market outperformance against emerging ones as the MSCI Emerging Markets index fell by 2.6%. The 16.4% decline in Chinese equities weighed on the emerging market equity performance and the MSCI Asia ex-Japan index was down 5.4%.
The ASX 200 matched the developed market return posting a 6% return. Financials lead the rally gaining 12.2%. However, nearly all sectors ended the month up. Only materials and consumer staples recorded small declines (-0.1% and -0.2% respectively).
- The U.S. earnings season passed the 75% mark and earnings growth is sequentially lower compared to the prior quarter. Operating earnings per share (EPS) growth is tracking 2.3% y/y. 57% of companies are beating EPS estimates (well below the average of 73% since 2012), however, 52% are beating on revenue estimates, in line with historical averages.
Fixed income:
- Bond yield rose over the month in October but ended off their earlier peaks. The U.S. 10-year Treasury increased by 28 basis points (bps) to 4.07% and is up a remarkable 250bps in the last year. The rise in yields and policy rate expectations and recession risk lead to an inversion of the 10-year 3-month yield curve. The first time this has occurred since the early days of the pandemic. Meanwhile, the 10-year Australia government bond yield fell 13bps to 3.76%, as markets adjusted to the slower pace of rate hikes (GTM AUS page 50).
- The risk-on sentiment extended to credit markets. The U.S. high yield index gains 2.8% over the month, however, investment grade (IG) bonds were relatively flat as the global IG index declined by 0.3%. Spreads across the credit spectrum tightened in recent weeks and are still not at a level which reflects the full potential of economic risks (GTM AUS page 51).
Other assets:
- The Australian dollar had relatively flat performance against the U.S. dollar over October (-0.5%). However, the Japanese yen depreciated by a further 2.6% and broke through 150 against the U.S. dollar during the month before the Bank of Japan intervened (GTM AUS page 67).
Commodities exhibited mixed trends. The price of Brent oil rose US$5 to US$95 per barrel as European Union tried to enforce trade embargos and supply constraints, causing concerns. The price of iron ore fell to US$82 a ton given some seasonal demand impacts (GTM AUS page 62).
- Meanwhile the price of gold continued to lose ground and fell to US$1,648 given the strength of the U.S. dollar and rise in real rates (GTM AUS page 65).
Kerry is responsible for communicating the latest market and economic views from J.P. Morgan Asset Management’s Global Market Insights Strategy Team. With more than 10 years’ experience, Kerry provides valuable insights and perspectives on the economy and markets to investors. As a frequent commentator on Bloomberg, CNBC, the AFR and the wider financial press, Kerry is able to explain complex economic and market issues in a language that investors understand.
Prior to making an investment decision, retail investors should seek advice from their financial adviser. This document is intended as general information only.