I am one of those people who get silently and ever so slightly irritated with Christmas decorations in October.
I mean, I get the festive season and all… but it’s October. We are barely out of Halloween. Christmas is a weeκ-long celebration at maximum, not a quarter-year event. What’s wrong with people?
Yet, the festive and perma-happy crowd seems to disagree with me, almost as much as equity markets. For investors, Christmas came early. US stocks rose almost 9% rise in October, the best October since 2011.
Meanwhile, UK risk markets calmed as well, after Ms Truss resigned and Mr Sunak was confirmed as the new PM.
So let’s start with that.
The British Autumn drama entered its third act, and the worst seems behind us. The UK has what may pass for an equivalent to the Euro-crisis technocratic governments in Italy and Greece. Much like Italy’s Mario Monti (Nov 2011-Apr 2013) and Greece’s Lucas Papademos (Nov 2011-May 2012), Mr Sunak, a technocrat to be sure, stands as an unelected Prime Minister, backed by a large parliamentary majority, vowing to take ‘difficult decisions’ on consumers in order to appease markets. That particular playbook would, at this point, see market volatility ebb. Indeed the UK’s 30y bond is now almost at the same place as the day before the disastrous mini-budget and the Pound is back where it was at the beginning of September versus the Euro. Bar any other surprises during the Autumn budget, we would not expect the UK to be singled out by bond vigilantes again in the next few weeks.
Having said that, the play usually hides an unsurprising fourth act. In Italy and Greece, the ‘difficult decisions’ caused the incumbent economic and political elite to collapse. It takes an enormous effort and political skill to maintain credibility with voters when one opts to satisfy ‘bond vigilantes’ and hedge funds to the detriment of one’s electorate. Very few political leaders, if any, have managed to pass the ‘market-voter test’. It could be that Mr Sunak’s story is different. After all, he was an active politician, not an outsider, and he is backed by a strong one-party majority, unlike other technocrats backed by shaky multi-party coalitions. Most importantly, Britain is making ‘difficult decisions’ for itself, however much under duress, unlike other countries where those decisions were visibly imposed by external organisations, like the EU and the IMF. Nevertheless, this is a story for the near future, but not for right now. Markets, and press headlines, seem to be finally moving on.
Which should turn our attention to global stocks. Last week was exceptionally good for US large caps, which gained nearly 5%. Unless there’s an unexpected market rout on Monday, October 2022 will be the sixth best month since the 2008 global financial crisis.
Why the market rose, however, is not really clear.
The earnings season, nearing its end, saw a 1.5% quarterly rise in American corporate profits, half of what was expected. Tech earnings in particular disappointed, and suggest that this phase of tech growth has probably peaked. As usual, the peak is marked with a big buyout. The bird (Twitter) might have been ‘freed’, but the question is whether the 16-year-old platform can reinvent itself into something new, in hopes of justifying a 314x (!) estimated P/E ratio for the next twelve months. The same appears to apply to Meta, while Google and chipmakers also struggled this quarter.
Valuations are fair, but by no means depressed, so a buying frenzy is not really justified.
The going narrative conflates more dovish than expected central banks in Europe and Canada and a persistent stream of bad macroeconomic news: contraction in US manufacturing, a crashing US housing market, growing bond market dislocations and rising pressures in US short-term funding markets could bring the Fed’s pivot closer. The market may be pricing in bad news soon becoming good news.
While we have been in this camp for some time, we haven’t seen evidence to justify the narrative playing out now or lasting market euphoria. The month saw the most aggressive Quantitative Tightening since last May.
Fed officials have been persistently hawkish and bond futures continue to price in more than five rate hikes by mid-December. There is simply no signal from the Fed that they are willing to even consider easing up on their inflation fight right now. To position for this, one needs at least a year-long investment horizon. But usually, it’s the ‘fast’ money moving first, not the ‘slow’ money, so we can’t say that the S&P rebound is a longer-term bet.
Make no mistake. An equity rebound means health. And relief rallies of this magnitude are surprisingly good. The median 3m return for the S&P 500 following a big relief rally is 14%. The 11.8% rally from bottom to top may have covered a lot of the average Santa Rally (c. 10%), traditionally between October and December. However 1999 and 2008, two years similar to 2022 in many respects, registered Santa Rallies over 20%.
But still, markets may be getting slightly ahead of themselves and the rally has yet to acquire legs. Investors should tread carefully. We would not be surprised if we saw more retrenchments and volatility in the near future.