Weekly market wrap

10 reversals that challenge the narrative

The recovery in financial markets has gained steam as we navigate the final stretch of the year. Global equities recorded their first back-to-back monthly gains in over a year, and U.S. investment-grade bonds posted their biggest monthly gain since 2008 (biggest gain since July in Canada), a reminder of the importance of maintaining a disciplined investment approach in times of uncertainty¹. Beyond providing portfolios with some relief, November was a month that included some major reversals. We draw attention to the recent trends that defy this year's narrative and provide our take on Friday's strong employment data in Canada and the U.S. that dented some of last week's excitement.

A November to remember

This year's challenging backdrop for investors has been shaped by multiple headwinds hitting the economy and markets. Four-decade-high inflation, surging borrowing costs, lockdowns in China, a war in Ukraine, and bearish investor sentiment. While these challenges have persisted throughout the year, here are 10 recent highlights and reversals that might have gone unnoticed.

1. Following last month's rally, the Dow is now up more than 20% from its October low and down only about 5% from its all-time high¹. Of course, that doesn’t reflect the broader weakness in equities, which is better showcased by the Nasdaq's 27% decline¹.
2. The TSX has been able to weather the storm better, down only 3% for the year helped by a 36% rise in energy. Even excluding energy, cyclical sectors outperformed defensives in November.
3. The average stock in the S&P 500 did better than the index, which was weighed down by the lagging mega-cap stocks¹.
4. Equity volatility plunged last month, pushing the VIX – the so-called fear index – back to its historical average (down to 20 from the March peak of 36)¹.
5. Canadian investment-grade bonds posted their ninth best monthly return over the past 25 years¹.
6. Bucking this year's trend, longer-duration bonds outperformed shorter-duration bonds¹.
7. Gasoline fell to its lowest price since before Russia's invasion of Ukraine, with the daily national average in Canada at $ 153 cents per liter from a peak of $213 in June¹.
8. The U.S. dollar had its worst month since 2010, depreciating 5% against a basket of other major currencies and 1.6% against the loonie¹.
9. Chinese equities led global markets higher on reopening hopes. Hong Kong's main index rose 27% in November, the most since 1998¹.

Overseas developed large-cap equities closed their performance gap with U.S. stocks, now both down about 9% for the year in CAD terms¹.

^{Source: Morningstar Direct. Past performance does not a guarantee future results.}

The graph shows the November and YTD performance of various asset classes. Many of this year's underperformers where last month's leaders.

What do these reversals signal, and are they sustainable?

• The recent strength in equities, rebound in bonds, and softening of the U.S. dollar (DXY index) are all directionally aligned with our expectations, but we doubt these trends will continue uninterrupted next year. Because of the lags by which central bank policy operates, past rate hikes are likely to weigh on the economy through 2023, raising the risk of what we think might be a mild recession. Yet November's reversals are a sign that the market is sniffing out a gradual easing of the two biggest headwinds that have been weighing on portfolio performance this year – high inflation and aggressive central bank policy.
  • Last week the U.S. PCE Price Index, the Federal Reserve's preferred gauge of inflation, fell to 5.0% from 5.2% a year ago in October and increased 0.2% from the previous month, less than expected. Together with the cooler consumer price index (CPI) data reported three weeks ago and the disinflationary signals from several leading indicators of prices that we track, they suggest that inflation could fall back sharply over the course of 2023.
  • A key catalyst for last week's rally in both bonds and stocks was comments from Fed Chair Powell:"…the time for moderating the pace of rate hikes could come as soon as December." But there wasn't much in Powell's comments that was new. The likely stepdown to a 0.5% rate hike at the Fed's next meeting on December 13-14 was signaled earlier by the minutes of the November meeting, and the market was already pricing in that outcome. But the market got some comfort in that Powell didn’t push back against the recent easing of financial conditions that has occurred as markets have rallied and borrowing costs declined. While it has been a long and painful way as interest-rate expectations kept adjusting higher throughout the year, there now seems to be some light at the end of the Fed's tightening tunnel, and market expectations for the peak fed funds rate have stabilized around 5% (even after the strong jobs data)¹. The BoC has already slowed its pace of rate hikes and markets are expecting a 4.3% peak which implies another 0.5% of hikes¹.

^{Source: Bloomberg, Edward Jones.}

The graph shows market expectations for the terminal fed funds rate which is now expected to be reached in May 2023 at around 5%.

• A wildcard next year is the trajectory of the Chinese economy and the implications it has for global growth. The country's zero-COVID-19 policy has weighed on economic activity, as strict restrictions and worsening health trends have resulted in lockdowns of large cities. But headlines seem to be moving in the right direction, and Chinese stocks were sharply higher in November on reopening hopes.  The tweaks to zero-COVID-19 policy, combined with additional measures to support the property market and easing monetary policy, all signal that China is starting to put more emphasis on growth. A potential stabilization in China's economic outlook and a softening of the U.S. dollar as the Fed dials down its rate hikes could prove to be tailwinds for overseas investments in 2023.

^{Source: Bloomberg, Edward Jones, 9/30/2022, U.S. stocks represented by the MSCI USA and international stocks by the MSCI World ex US index. Indexes are unmanaged and cannot be invested in directly, past performance does not guarantee future results.}

The graph shows that the relative performance of international stocks is inversely correlated with the trajectory of the U.S. dollar. The stronger the USD has historically overlapped with U.S. outperformance.

Strong November jobs report complicates the Fed's efforts. Unemployment rate in Canada declined despite a slowdown in hiring.

Unlike some of the developments mentioned above that run counter to the prevailing moves, the November jobs reports in Canada and the U.S. were consistent with the ongoing trend of resilience and strength in the labour market observed throughout the year. While this strength is good news for the economy, it was interpreted as bad news for the markets because it implies that central banks are having little impact on slowing wage growth. Following the jobs reports, bond yields rose and stocks gave back some of the weekly gains. The takeaway is that the still-tight labour markets complicate and potentially prolong the central bank efforts to tame inflation. However, we don't think that officials will overreact to this one data point and will still opt to slow the pace of tightening by hiking rates 0.5% later this month. But a pause won't come until the job market begins to cool, which we still expect to happen in the first half of 2023. Below are some highlights from the November employment reports:

• The U.S. economy added 263,000 jobs, more than the 200,000 expected and largely on par with October's upwardly revised pace. This pace of job gains is far above the 100,000 estimate that Chair Powell has cited as consistent with population growth¹. The Canadian economy added 10,000 jobs in November, in line with expectations. Despite the housing downturn, finance, insurance & real estate employment increased by 21,000, but that was largely offset by a 25,000 drop in construction employment¹.
• The unemployment rate held at 3.7% in the U.S. and declined to 5.1% in Canada. Annual wage growth accelerated to 5.1% from 4.9% in the U.S. and held steady at 5.6 % in Canada, the sixth straight month above 5%. Possibly explaining the persistence of higher wages was that the supply of labour decreased and stayed constrained. The labour force participation rate (the share of the population that is working or actively looking for work) dipped slightly to 62.1% in the U.S. and 64.8% from 64.9% in Canada¹.

^{Source: Bloomberg, Edward Jones}

The graph on the left shows the strong monthly U.S. payroll gains that far exceeds the gains needed to keep unemployment from rising. The graph on the right shows that the Canadian unemployment remains near record lows despite last month's slowdown in hiring.

Diversification poised for a comeback

Last week's jobs reports are a reminder that patience is needed until some of the imbalances in the economy get resolved. But the November reversals highlight the value that diversified portfolios can unlock once macroeconomic conditions start to shift in a more meaningful way. The investment backdrop is no less complicated now than it was in June when the S&P 500 first entered a bear market. Yet as investors and policymakers gradually gain some comfort that the tide of inflation is receding, the worst-case outcomes will narrow, and support around the mid-October lows will keep building.

Angelo Kourkafas, CFA
Investment Strategist

Source: 1. Bloomberg, Edward Jones

Weekly market stats

^{Source: Factset 12/02/2022. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. * Source: Morningstar, 12/05/2022.}

The Week Ahead

Economic data coming out this week include the overnight night interest rate and the trade balance.