November Rally, but a Potential False Flag for What Lies Ahead
December 1, 2022
Strong November financial market results were driven (yet again) by inflation reports, the Federal Reserve’s FOMC meeting, and the bond market’s response to them. In early November, the Federal Reserve raised short-term interest rates 0.75% (as expected) to 4%, while indicating that it may raise interest rates to a higher peak rate — and potentially slow the pace of rate hikes. Longer term bond market participants had been looking for a sign that short-term rate increases would decelerate.
The bond market led the stock markets again this month. After smaller than expected increases in the CPI and PPI reports in mid-November, the 10-year U.S. Treasury rallied – falling in yield over 50bps from approximately 4.25% to 3.75%. The S&P 500 rallied +5.6%. And the U.S. Dollar Index (DXY) sold off -5.2% – leading to a sharp rally in international stocks, which ended November up +11.2%.
Despite the strong November market performance, there continue to be signs that point toward an economic recession. The Federal Reserve has indicated that it will prioritize fighting inflation over its employment mandate; and the Treasury yield curve — the difference between the 2- and 10-year Treasuries — has become more inverted than any point since the 1980s. (The yield curve generally inverts when investors believe that the Federal Reserve will cut interest rates in the future, in response to a weakening economy – and has been a reliable leading indicator of coming recessions.)
China’s zero-Covid policies are causing a level of unrest that is unprecedented in recent decades. If the Chinese government further locks down the economy, in response to recent Covid outbreaks (or chooses not to shift its policy to allow for the import of foreign vaccines), China’s economy would likely further decelerate – and affect the world’s economic growth, as it has done several times since the start of the pandemic in 2020.
As we have discussed in previous commentaries, stock and bond markets have historically bottomed out during recessions, not after them. It is possible that we may be in a different situation in which markets bottomed out in 2022 before a mild recession in 2023. With the future unknown, however, we recommend staying diversified and disciplined in rebalancing portfolios after both rallies and sell-offs.